Why using credit cards to fund your start-up is a risky strategy that could endanger not only your business but also your personal finances
It’s easy to reach for plastic. More than 180 million people in the United States have credit cards, including 80 percent of the small business community. However, a credit card isn’t always the right choice for a small business owner. Using credit cards can sometimes put both your company and your personal finances in jeopardy. That's why it's important to avoid these common mistakes and adopt a plan for plastic that will best serve your needs and those of your company.
First, there are a few things you should know about business credit cards:
Contrary to popular belief, small business credit cards do not shield business owners from personal liability. Every major credit card issuer holds both the company and the small business owner as an individual liable for the debt.
The major credit card companies pull applicants' personal credit reports when making approval decisions for business credit cards. In fact, your personal credit standing has more of an impact on your ability to land a business credit card than that of your company.
The new legal protections that swept the consumer credit card market following the Great Recession do not apply to business-branded cards. That means, among other things, issuers do not have to abide by the law preventing the increase of interest rates on existing debt unless a cardholder is at least 60 days delinquent. With business credit cards, they can raise the rates whenever they please.
Sixty percent of start-ups finance first-year operations with credit cards, and for every $1,000 in debt they incur, their probability of shutting down increases 2.2 percent, according to a study from the Ewing Marion Kauffman Foundation.
That last point brings us to the largest credit card pitfall for small business owners: using credit as an initial funding source.
It’s obviously very tempting to reach for plastic when starting a new company, partly because it’s easier to come by than small business loans and angel investors. There’s a reason that loading up on debt decreases the odds of small business success, however, and it begins with the fact that credit card debt is expensive and demanding.
The fact that you have to begin paying back what you owe from day one means that, unless you become profitable quickly, you could easily find yourself overburdened by interest and vulnerable to the whims of the economy. This is especially true if you opt for a business credit card for funding purposes. The average business credit card interest rate is a rather high 15 percent and, as previously mentioned, issuers can increase business credit card interest rates at will. If you ultimately reach a tipping point, not only will your company be at risk of going under, but personal credit score damage and bankruptcy also enter the equation. That is why it’s a much better strategy to seek investors, sacrifice equity, and reinvest the money that you would have spent paying credit card interest back into your business.
A few years later, when a company is more established, using small business credit cards makes more sense. Managing expenses across multiple employees becomes a higher priority and credit cards are well suited for that job. Small business credit cards provide specially targeted expense tracking features as well as helpful rewards in important small business expense categories, such as office supplies and telecommunication services. In addition, a small business credit card account will enable you to set personalized spending limits for authorized employees, which should alleviate concerns over unleashing them with company plastic and will help you centralize company rewards earning.
Ultimately, adopting a smart credit card strategy for your company will help you save a ton on interest and earn hundreds of dollars in rewards each year. It will also boost the chances that your company will still be around several years from now--and that your family's finances will be protected.