Like many business owners, Jessica Svoboda charged her way to a better life. Four years ago, she launched Svoboda, an apparel company based in Santa Ana, California. Unable to borrow from a bank, she simply applied for a bunch of credit cards and rang up computers, office supplies, shipping materials, and her patternmaker's bill. She even took out cash advances to pay the rent. Her total credit card debt soon topped $75,000. "I literally lived on my credit cards for that first year," she says.
The siren call of those little pieces of plastic has always been hard to resist. Now, with bank loans harder to find, many entrepreneurs will rely even more heavily on credit cards, running up personal debt to finance new ventures and cover costs for existing ones.
What they will discover is that the funding of last resort is not as plentiful as before.
The numbers are staggering: Americans have approximately $968 billion in outstanding credit card debt, and now, with the economy slumping, they are struggling to pay their bills. That's bad news for companies that issue credit cards. The number of accounts that are 30 days or more past due is higher than it has been since the first quarter of 2002. At many banks that issue credit cards, the charge-off rate -- the balances that a credit card company writes off as uncollectible -- is near a three-year high. American Express is feeling the pinch of the weak economy; its second-quarter profit fell 37 percent compared with the same period last year.
None of this is good news for business owners who rely on personal credit cards to finance their companies. In a bid to limit their exposure, 65 percent of U.S. banks have tightened their standards on credit card loans, according to a July survey from the Federal Reserve Board -- more than double the number of lending institutions that reported tighter credit in April. Many are raising the minimum credit score required for new cards. And mailboxes are no longer quite so full of new card offers: Chase, Bank of America, and HSBC each reduced its direct mail efforts more than 15 percent in the first quarter of 2008, according to market research firm Mintel. Given that credit card issuers are under increased scrutiny from legislators, that trend is likely to continue.
As the industry retrenches, start-up founders will not be the only ones affected. Business owners who rely on plastic to supplement their working capital will also suffer, according to Brad Stroh, the co-founder of Bills.com, a consumer- finance-education website. "Small businesses are very risky borrowers, so they, more than anybody else, are seeing their credit limits cut," he says. Interest rates are rising, too, which means that any entrepreneur who carries a high balance is likely to get killed on his or her cost of capital. The Fed survey revealed that 36.7 percent of banks have increased the amount they charge over and above the prime interest rate.
The stricter lending rules and higher rates come only three years after another big change that had a chilling effect on entrepreneurs. In 2005, after heavy lobbying by credit card companies, Congress passed a sweeping package of bankruptcy reforms. The legislation made it tougher for those filing for bankruptcy protection to avoid paying their credit card debt.
This leaves would-be entrepreneurs exposed to more risk in the event they should fail. "There is essentially no safety net this time around," says Stroh. "We're seeing a debt purgatory that we've never seen before. People who've gotten into serious debt problems can't figure out how to get themselves out."
That doesn't mean entrepreneurs are going to stop charging away, with success stories like Svoboda's spurring them on. Her company now employs six full-time staff members and is on track to do $2 million in sales this year. "I'm not going to say it was a great idea," Svoboda says, "but running up my credit cards did allow me to bring my product to the market." The next Jessica Svoboda will have fewer options, and they will cost more.
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