Don't Start a Business without One

Credit cards are now among the most common small-business financing tools. Used carefully, they might even work

Like every good entrepreneur, we felt we'd ultimately be able to turn things around and go forward," says Stephen Brents, cofounder with his wife, Julie, of Brents Sportswear, in Fayetteville, Ark. But during an overseas expansion effort in the fall of 1996, the Brentses' sportswear-manufacturing business slipped into a cash-flow dive and didn't pull out. "We both had good credit, so we started taking cash advances on the credit cards to make payroll and taxes. We were robbing Peter to pay Paul," says Stephen.

That lasted for several months, while the Brentses made minimum payments on a half-dozen personal credit cards. Ultimately, they ran the cards up to about $150,000 and then crashed and burned in January 1997, after sales never picked back up.

Amazingly, the Brentses' credit didn't end there. "Right after we filed Chapter 7, we got a dozen approval letters from credit-card companies. The interest rates were very high, 18% to 21% with a $1,000 to $2,000 credit line. They said they could help us build credit back up," Stephen says, laughing at the irony of it all. "We threw them all away."

But plenty of other small companies are raking in those cards. In 1997, according to Survey of Small and Mid-Sized Businesses, by Arthur Andersen's Enterprise Group and National Small Business United, the top two methods of financing for small companies were bank loans and credit-card financing, which were used by 38% and 34% of the respondents, respectively. That's a mighty spike in credit-card use compared with the situation in 1993 when only 17% of businesses surveyed used plastic. According to the survey, 25% of the companies that use credit cards are using them "often or routinely," which means they're whipping out the cards--both personal and business--month after month for business purchases.

Here's how one West Coast manufacturer's routine goes. Typically, he could have expected to have a 30-day billing cycle with his suppliers, but they have agreed to charge his purchases on the day after the closing date of his credit-card statement rather than on the date he buys the goods. Say he makes a purchase on May 23. If he didn't use plastic, the payment would be due June 23. But with a statement-closing date of June 29, the supplier bills the card on June 30. The credit-card company bills the manufacturer on July 29, and he pays his credit bill on August 29. Presto! He stretches his payment to 90 days. On top of that, from the $1 million in yearly charges, he's earning enough frequent-flier points to pay for all company sales trips. Obviously, he'd rather remain anonymous.

Using credit cards is a riskier-than-usual way to finance your company. You have that huge bill to face every month, instead of several smaller ones that can be juggled. Once you max out, you can't pay your bills anymore. And the interest payments on carrying a balance can make a grown entrepreneur cry. Funding businesses with a card violates the consumer-cardholder agreement. Yet it's a standard practice for thousands of company owners.

A case in point: Paul C. Porter, chief operating officer, vice-president, and co-owner of Automation Inc., which makes Clean Shower bath cleaner, is pulling in more than $2 million in sales each month, and his company has had outside investors since 1995. But Porter also turned to credit cards. "My wife and I borrowed about $80,000 on about 25 different cards in 1995," he says. Automation is the latest in a long line of companies for Porter, including a Blockbuster franchise and an engineering consulting firm. "I've used credit cards for all of them," he says. "Now they're sending us so many applications, we just throw them away."

There are certainly no lack of opportunities for business owners to sign up for yet another credit card. Consumer-card issuers sent out 2.5 billion applications in 1997, and record numbers of consumer cards have been issued--450 million at last count (with the entire U.S. population numbering fewer than 270 million). In 1997 consumer credit limits--the total amount of credit issued--increased by about 25% over the previous year's figure. Not surprisingly, there has been an accompanying rise in personal-bankruptcy rates (which surpassed 1 million filings for the first time in history in 1996 and were expected to have exceeded that in 1997). But with credit limits as high as $100,000 on some premium cards and introductory rates as low as 3.9%, who's going to just say no?

"If you're going to start your own business," a consultant told Charlene Connell, "get as many credit cards as you can before you quit your job." Connell got 10, for a total credit limit of about $15,000, which she used for cash advances to make payroll. That was seven years ago, when she was struggling to make minimum payments. Today her company, Vital Resources Inc., in Cleveland, is a profitable computer consulting firm that made the Inc. 500 in 1996.

Happily, 60% of the companies using credit cards in Survey of Small and Mid-Sized Businesses say they pay the cards off monthly. "The worst thing is to make a late payment in the current environment," says Robert McKinley, president of RAM Research Group, publishers of bank-card publication CardTrak. Five years ago banks would let customers slide for 30 days and charge a small fee, McKinley notes. But since government restrictions were lifted last year, the bank can charge whatever it likes in late fees--and some charge up to $25, even if you're only one day late. "But the real risk is that if you do that twice in a 12-month period, you're considered a risky cardholder, and they bump you up to a punitive interest rate, about 25% to 30%. Late payments show up in your credit file, and banks are very nervous about signs of weakness right now."

It's a short hop from weakness to bankruptcy. We talked to dozens of successful entrepreneurs who grew their businesses on credit cards, and every one had seen comrades choke and die on the stuff. "For every person who tries this, one out of three might not succeed," says McKinley.

Despite all the horror stories, personal credit cards can be a fast, cheap, and easy way to finance a business. That is, if you're smart about them.

"It was cheaper than our Small Business Administration-guaranteed loan," says Sally Williams, a founding partner at Hellas International Inc., an olive-oil importer based in Salem, Mass. When it started, in mid-1995, the company received a $150,000 loan, which Williams and her two cofounders nearly doubled by signing up for 18 personal credit cards. They immediately maxed out some of the cards or took cash advances, and then put the cards in a drawer and created a payment schedule in the company business plan. "If you take the $7,500 in loan fees plus the 11.5% interest rate versus some good interest rates on the charge cards, the cards are about the same money or cheaper. Our average is about 13% on the cards. Plus our time is money too, and the amount of time on that SBA loan was huge."

Careful management of those cards is what kept Hellas from becoming enslaved to high interest payments. "Each month I review each interest rate and our budget for interest and principal repayment," explains Williams. "You have to really keep a tight control, watching your interest rates. When those low introductory rates expire, cards can jump up to 17%. I call, and 9 out of 10 times they'll drop it down to 13%. I have one at 11.65%. And I transfer balances when I have room freed up on a lower-interest card." (Williams urges extra caution on transferring balances--some companies charge very high fees for such transactions.)

The real secret to credit-card financing isn't just to juggle the cards and make the payments on time. It's this: parlay those personal credit cards into corporate-credit history. First, make the credit cards part of your financial plan. (Keep personal and business charges on separate cards.) Second, stick to it. Third, impress a bank with your financial management of the cards and earn a credit line.