Joe Johnson, Ph.D.
Entrepreneur. Investor. Startup Expert.
Given such well-known, non-traditionally financed success stories such as Google and Airbnb, basing your initial corporate financing on credit cards may appear to be a wise move. As with all financing, however, the most critical factor for success boils down to implementation. Google and Airbnb weren’t successful as a result of how they financed their businesses. Rather, their success was a direct result of their ideas, their knowledge, and their hard work. In fact, they may have experienced the same or better results had they utilized another financing method. While credit card financing can force business owners toward helpful frugality, the decision to avail oneself of plastic options isn’t the sole defining factor in the success of a business. Indeed, for many businesses, it can present a significant pitfall.
While business credit card offers may begin arriving in your mailbox shortly after your business is formally registered, those offers are not appropriate for everyone. When considering a new card application, take the time to weigh these pros and cons:
Credit Card Financing – Pros
Credit cards are simple to obtain and can often function as a ready means of maintaining revolving credit. For new businesses, they can aid in building a credit history.
Simple to Obtain
It’s a relatively simple matter to obtain a new credit card, as the application process is much less onerous than that associated with applying for a loan. A credit card can help to finance ventures which have been denied funding by traditional lenders. For some businesses, a credit card is the only type of financing that may be secured. Additionally, you won’t need a business plan to apply for a business credit card – though you should definitely still have one.
A credit card enables you to maintain a revolving line of credit – so long as you’re consistently repaying it. This can be useful during periods of slow cash flow. Some businesses prefer to use credit cards for all of their expenses, then repay the entire balance each month in order to earn rewards.
Improve Business Credit
A new startup won’t have a business credit score. Rather, banks will rely on the personal credit of the owner(s) in order to determine their creditworthiness. By using a credit card responsibly over time, businesses may build their own credit histories.
Credit Card Financing – Cons
Business credit cards can damage your personal credit and may leave you on the hook for business debt. They can decrease the likelihood of your business’ survival and, because they’re so easy to use, can lead to unnecessary spending.
Can Damage Your Personal Credit
Failure to pay will have negative consequences to your personal economy. Not only will credit card companies charge fees, but they’ll report late payments. This will negatively impact not solely your business credit, but your personal credit, too.
What happens if your business fails? Who would be responsible for any accrued credit card debt? You may be surprised to learn that you (and any business partners) are personally responsible for all business debts. While certain business structures may help to protect business owners from personal liability, credit cards frequently require owners to personally guarantee their lines of credit.
Can Decrease the Likelihood of Long-Term Survival
In a 2009 report, the Kauffman Foundation found that credit card debt reduces a small business’ likelihood of survival during its first three years of operation. For every $1000 of credit card debt accrued, the likelihood that a small business would fail increased by 2.2 percent.
May Make Future Borrowing More Difficult
If you max out your credit cards, you may be unable to borrow money from a traditional lender or to obtain another credit card. When you have more debt than you can repay within a certain period, your company’s resources may appear to potential lenders as overtaxed. If you’re utilizing more than 30% of your available credit, your debt capacity is reduced and your likelihood of securing future financing decreases accordingly.
Ease of Use
You might not think that ease of use is a negative factor, however, because some people tend to spend more money when they’re charging a purchase versus paying cash, it can certainly become one. Whereas loans tend to come with stipulations for use, credit doesn’t. In other words, it’s easy to use credit on unnecessary expenses and to spend more than we otherwise might were we held to immediate account for our spending.
Is a Business Credit Card Right For You?
Once you’ve considered the various pros and cons, you may decide that it would still be useful to have some plastic in your pocket. If so, the next choice to consider is whether to opt for a personal or business credit card. After making this decision, you’ll need to select the specific card for which to apply.
The most important issues to consider at this juncture are your business structure and any card-specific terms.
Sole proprietors – who are already personally liable for their business debts – may save money by utilizing a personal credit card. Often, cards marketed as “business” credit cards are accompanied by higher interest rates. Additionally, there are more government protections for those using personal credit cards. Even so, partnerships and LLCs with more than one founder may be better served, in practice, by a business card. While each partner or founder may still be liable for the business debts per the card’s terms, a business card account is often more readily configured for shared use.
Credit cards and other high-interest lenders should be a borrower’s last resort. If you decide to use a credit card, read the fine print and check the terms carefully.
You may decide that the annual percentage rate (APR) on your card is effectively comparable to lender loan rates and so decide to use the card. However, it’s worth paying close attention to whether the interest is being accrued in the simple or compound manner. Credit cards generally utilize compound interest. That is, your monthly accrued interest is added to your balance and is then used to calculate the following month’s interest. Essentially, you’re paying interest on interest. Simple interest is only calculated from the principal. While sites that peddle credit cards will tell you that their APRs are comparable to loan rates, compound interest generally renders them far more expensive options. Look for a card with a low APR or with an introductory offer. Also, check to see whether the credit card issuer is permitted to increase the rate without notice.
Some cards charge annual fees, while others do not. Weigh the amount of an annual fee against a card’s benefits and determine whether the fee is justifiable. Some business owners will find that a specific card’s rewards adequately justify its annual fee, while others will not.
Checks and Cash Advances
Some business expenses may require the use of credit card checks or cash advances. Ensure that each card you’re evaluating will permit these types of transactions and determine the range of applicable fees. Often, cash advances are subject to a higher interest rate or have an associated one-time fee. If you anticipate primarily using your card in this manner, by all means, search upfront for the lowest fees.
Whether via airline miles or outright cash back, credit cards are frequently bundled with a reward/incentive system. Consider, too, the possibility of applying such rewards against any fees (e.g. annual fees) that may be associated with a reward card.
It’s essential to investigate the range of fees that may be charged to your account and under what circumstances they’ll be applied. Late payment fees, balance transfer fees, and cash advance fees can all add up. Plus, because they’re added to your balance, you’ll accrue interest on the fees, themselves. Remember: when credit card companies apply payments to your account, the oldest items are credited first, leaving new charges such as assessed fees to collect interest. The only way to avoid this compounding process is to pay your entire balance monthly.
Making a Credit Card Work for You
Don’t let credit card debt sink your business. Be certain that you take these steps to help ensure that your credit cards are working for you:
The best way to make credit cards work for you is to simply plan and spend responsibly. Understand what you’ll need to purchase and on what schedule. Shop for the best prices and only use your credit card when necessary. Some businesses rush into leasing space when they don’t need it and make other unnecessary expenditures leading to heavy debt loads. Deliberate planning can help you to reduce your costs and ensure that you’re spending wisely.
Create an Agreement
Ultimately, if you opt to fund your business with credit cards, you’ll likely be held personally responsible for your business debts. For startups structured as partnerships or those which have more than one owner, be sure that everyone understands the liability inherent with a business credit card. Everyone should be in agreement as to the card’s intended usage. Create a document to clearly articulate just how the credit will be used – and debt handled – to ensure that everyone is on the same page.
Keep Personal and Business Expenses Separate
Always keep your personal and business expenses separate. Even if you’re utilizing a personal credit card for your business, be sure to only use that card for business expenses. Doing so will serve to make expense tracking easier, as well as separating interest and fees paid for tax purposes.
If you’ve had your card for a while, you may be able to negotiate more favorable terms with the issuing company. Similarly, those with competing offers in hand may be able to negotiate a better APR with their existing credit card company. Doing so can save money in the long run and is frequently worth the effort.
While researching this article, I found countless sites ready to offer credit cards to small business owners. If you decide that a credit card is for you, make sure to utilize a reputable bank and fully understand its terms. Too often, the costs of credit card financing are understated or entirely unmentioned. Compound interest and certain fees are rarely mentioned on these sites, as they earn their incomes by enticing you to apply for a card. Card issuers, however, must inform interested parties of their card’s terms. Too many of us fail to thoroughly read these documents. Make sure that you take the time to do so and to learn about the fees associated with each specific card you’re considering.
About the Author
Dr. Joe Johnson is an entrepreneur, investor, and startup expert. He is the founder and principal of GoodField Investments and the GoodField Foundation (www.GoodField.com).
Joe has a Ph.D. in Entrepreneurial Leadership and an MBA. He is the author of the upcoming book on The Science of Why Most Entrepreneurs Fail and Some Succeed.
Most importantly, he is the incredibly blessed husband of one amazing wife and father of six wonderful children. He resides in Bradenton, Florida. For more information on Dr. Johnson and his work, go to www.JoeJohnson.com.