As any entrepreneur knows, one of the most difficult aspects of starting a new business is having enough cash flow to grow. Securing funding can be a challenge, which is why many small business owners turn to their credit cards as an important source of funding.
“I’ve heard a lot of stories about credit card startups,” says Paul Downes, author of Life of a Boss: Surviving Your Own Small Business. “But that’s the survivor’s bias. No one pays attention to the people who went down this path and did not succeed. I believe there are many more such stories than huge success stories.”
Credit card funding, despite its popularity among startup founders, comes with some risks. Here are the pros, cons, other funding options, and what you need to know if you charge in advance:
Benefits of Using a Credit Card to Fund a Startup
The most obvious advantage of a credit card to finance your startup is that it is easy to get one if you already have good credit and credit cards in your name. But there are other unobvious advantages:
All you need is a good credit score
“Funding with credit cards requires minimal paperwork,” says Dallas-based small business finance expert Myra Good. Issuers “do not care that you started your business yesterday. They only look at your credit score. A lot of entrepreneurs love it.”
If you can pay off your balance in full each month, a business credit card can also provide lucrative rewards. These cards usually have higher credit limits than personal cards and often allow employees to be added as authorized users.
You can use credit cards as a strategic cash management tool.
Ken Wentworth, owner of Wentworth Financial Partners, advises small business customers to wait until the bill expires before paying with a credit card.
This could potentially give you 60 days after your purchase until you need to pay for it, assuming a 30-day billing period and a 30-day credit card statement cycle.
Wentworth has also worked with clients who use zero interest credit cards with long lead times to provide seed money for new businesses.
“You can have interest-free money for more than a year, but you have to budget for payments so that they pay off before the end of the introductory period,” he says.
Disadvantages of Using a Credit Card to Fund a Startup
For many entrepreneurs, using credit cards as their primary form of financing is risky. Find out what the risks are and if you are up to the challenge:
You may end up being personally liable for your business’s debts.
If the business fails, you will be saddled with debts for which you are personally responsible, whether you have taken business or personal credit cards.
This is because both types of cards usually require a personal guarantee.
If you use credit cards for long-term spending, this can be an extremely expensive way to access cash. The average annual interest rate on credit cards is about 16%, which is about double the amount you pay for a loan secured by the Small Business Administration.
Using Credit Cards May Contribute to Sloppy Financial Habits
If you tend to delay payments, using credit cards to fund your business can negatively impact your not-so-good financial habits.
“If you don’t pay off the card in full, that will only make the cash flow problem worse,” says Christa Tuomi, an entrepreneurial finance expert.
In contrast, when you take out a business loan, you need to set aside a certain amount each month to pay it back, and you don’t have the ability to make the minimum payment when cash is tight. This forces you to maintain adequate cash reserves.
Tips for Responsible Credit Card Use
If you choose to fund your startup with credit cards, keep the following “commitments” in mind in order to do so responsibly:
- Make payments on time, every time.
- Try to pay more than the minimum amount whenever possible, and ideally pay off the entire balance each month to avoid interest and fees.
- Read the credit card agreement carefully to know its terms.
- Stay below your credit limit to maintain a low credit utilization ratio (the amount of credit you currently use divided by your total available credit).
- Check your monthly statements to make sure they are accurate and dispute any non-compliant expenses.
Other Startup Funding Options to Consider
Using a credit card is not the only way to raise capital for your startup. A few other options include:
This is an option to consider if you don’t have a strong enough credit to get a loan from a bank.
In peer-to-peer lending, the money comes from investors who earn money by earning interest on the loan. Prosper and Lending Club are two peer-to-peer lenders that offer small business loans, and the sites offer tools you can use to determine what your interest rate will be.
For example, a business owner with excellent credit history seeking a $40,000 loan for their Lending Club business may be offered an interest rate of 6.83% and an APR of 9.61% (including a one-time fee for issuance of a loan in the amount of 4% or $1,600 collected from the proceeds of your loan and used to pay Lending Club as a fee for its services).
You will go through a more stringent credit check than you would need for a credit card if you are applying for a bank loan and you will need to provide some sort of collateral to secure the loan. The bank may also require a business plan to assess your business potential.
For example, to qualify for a Bank of America Business Advantage Line of Credit or Term Loan, you will need satisfactory personal credit (usually defined as a FICO score above 670), at least two years in a business with existing property, and at least $100,000. in annual income.
Angel investors can provide funding, but they also usually want to have a say in business operations. These can benefit you if they bring in valuable business knowledge, but it can backfire if you end up running into them.
There is also the risk of giving up too much capital in exchange for investors’ money. Getting good financial advice is a must if you’re going down this path, and it often means contacting a lawyer with startup finance experience.
Borrow against your receivables
If your clients pay you after you’ve worked with them, for example at a professional services firm, you can take out a loan against your receivables.
If you go in this direction, it is important to understand that the company will deduct the repayment amount directly from your corporate bank account in set amounts each week until the loan is repaid. This can put you in a position where you are low on cash for the duration of the loan, unless your future cash flow is stable.
Running a campaign on sites like Kickstarter or Indiegogo is another option, especially for product-selling entrepreneurs who are very active on social media and can generate interest quickly.
Such sites rely on donation-based crowdfunding, so you don’t have to return money to donors. However, companies usually use cash as pre-orders for products.
If you choose to charge in advance, consider opting for a small business credit card instead of a personal credit card. A small business credit card will make it easier to keep records and tax purposes to separate your business expenses from your personal expenses.
The disadvantage of corporate credit cards is that they do not provide the same consumer protection as personal cards. So, if you’re considering a business card, make sure you shop around to find the best one for your business needs.
“If you think you’re going to balance from time to time, look at the interest rate,” says Jerry Detweiler, head of market education at Nav, a lending service for small business owners.
“If you are someone who hates debt and is going to pay in full, choose a card that offers rewards. Signup bonuses can be very good on business cards,” she added.