Half of all start-ups are financed with credit cards. But be careful: Sky-high interest could bury you for years.
Diana Frerick loved to sing, and always seemed to draw cheers when she belted out Whitney Houston and Celine Dion power ballads at karaoke bars in her hometown of Phoenix. But in 1993, when Frerick tried to turn her passion into a business, no one wanted to listen. Forget about bank loans: She couldn't even get a second mortgage on her home. So she found easy financing in her own wallet. Using two credit cards, she charged $5,000 for a custom karaoke system and music. With her new equipment in tow, she traveled around town, hosting private parties and corporate shindigs. Three years later, when she and her partner, Kevin Steele, opened Karaoke Star Store & Stage, a retail equipment store, she used her cards to pay for supplies and inventory. "I thank God for credit cards," says Frerick, 39, who now boasts 14 employees and revenue of more than $2 million. "They're the easiest way to get money."
Americans are often said to be addicted to plastic, and that's especially true for entrepreneurs. About half of all small businesses finance their formation or expansion with credit cards, according to a survey by the National Small Business Association and Arthur Andersen. The same survey showed that only 6% were financed with an SBA loan, and just 2% received venture capital funding.
Of course, for all their convenience, credit cards are also extremely risky. Interest rates can be exorbitant, and there are numerous penalties for those who fail to make their payments. It's easy to get in over your head. Just ask Matt Jung and Chip George. In 1995, as undergraduates at Michigan's Hope College, the pair founded Comfort Research--a Grand Rapids manufacturer of funky, beanbaglike chairs. "We had no assets," says Jung. "We were taking anything we could get." For the most part, that meant credit cards. Demand for their products soared, and with little cash on hand, the pair used credit for everything from buying equipment and raw materials to travel expenses and daily operating costs. "We tried not to look at the rates," says Jung. They tried to make the minimum monthly payments. But after six years of operation, they found they owed about $17,000 at an excruciating 23% interest rate. "You can play the balance transfer game, and we were able to do it a couple of times," Jung says. "But it got to the point that a lot of credit card companies wouldn't let us take advantage of those lower rates anymore." Comfort Research grew rapidly, with $2 million in annual revenue by 2002. But it still took Jung three years to pay off his debts, which included several thousand dollars in interest. These days, Jung--who now taps a line of bank credit when he needs funding--pays off his credit cards at the end of each month. "It's a very expensive way to borrow money," he says. "I think they should be a last resort."
About 50% of small businesses are financed with credit cards, 6% use SBA loans, and 2% get venture capital.
What's more, lenders are anything but forgiving when you fall behind. Thirteen years ago, Steve Rotermund founded Plane Detail, a St. Louis-based company that cleans passenger jets for commercial airlines. Today, the company has 13 locations, 109 employees, and Rotermund draws a six-figure salary. Nonetheless, until recently, he had trouble purchasing a car, or even a television set, on credit. That's because at age 19, unable to secure any other funding for his start-up, Rotermund financed Plane Detail with a number of personal credit cards--racking up more than $100,000 in debt at high interest rates. Eventually, the monthly payments grew so high that Rotermund was forced to choose between paying his bills and keeping his fledgling company afloat. He opted for the latter and stopped paying his credit card bills for a few months, effectively ruining his credit for years to come. He still has several thousand dollars to pay off. Nonetheless, he says, "I'd go through the same thing again if I had to." Of course, in the same breath, he offers the following advice: "Don't risk destroying your personal credit. Try to get money other ways if you can. Anything is better than credit cards."
Obviously, for most start-ups, there aren't a lot of options. But there are ways to make things easier on yourself. Be sure to use different cards for business and personal expenses. The credit card interest on items you charge for your business is tax deductible, and mixing business and personal expenses on the same card inevitably creates headaches come tax time. You also might apply for credit cards offered by retailers you frequent. Stores such as Staples, Office Depot, and Costco are generally more apt to issue a card in your business's name, and they can also provide extra perks like coupons or discounts on store merchandise. Pay your bills on time, and it will help you establish a solid credit history as a business that will make it easier to graduate to a corporate small-business card, such as those offered by Visa, American Express, and MasterCard.
Whatever happens, learn to master the art of credit cards now. Because chances are, you'll be relying on them for years to come. Remember Frerick? Her karaoke business is thriving. Three years ago, in fact, she decided to build a new show room--complete with a stage and cafe tables. An equipment-leasing company agreed to help finance the espresso machines and other necessary appliances. But at the last minute, the company pulled out of the deal. "I was furiously angry," she says. "We still had to find a way to pay for this stuff." Fortunately, her credit cards came to the rescue. "With banks, there are all of these hoops to jump through, a whole process that takes time. When we need money, we need it fast."