Use of credit cards rises for business startup financing
Self-financing can empower entrepreneurs, but skips outside review
By Ben Cramer | Published: October 2, 2007
Call it a David and Goliath story. Small business entrepreneurs increasingly finance their ventures with credit cards. No longer must they sign away a chunk of the business to venture capitalists or go through an arduous loan approval process with a bank.
If you have a brilliant startup idea, self-financing through credit card debt means a quicker path to success, experts say. They quickly add that for bad business ideas, credit cards mean a quicker path to failure.
Small business loans for less than $100,000 had increased by 25 percent between 2004 and 2005, the Small Business Administration reported last year, and credit card debt comprised most of the increase.
Although the SBA hasn't studied the credit card financing of small businesses since then, it's a trend that likely has continued, given credit card issuers' ever-expanding offers of credit. But is this a good thing? We asked the experts, starting with Canadian Sean Wise.
The Wise money
Broadly speaking, Wise's mission is straightforward: Find good startup business ideas, help the entrepreneurs get their acts together and connect them with people with money to invest. As online host of the Canadian Broadcasting Corporation's "Dragons' Den," Wise drives to all corners of Canada vetting business plans while looking for candidates to compete for the chance to pitch their business to a panel of five venture capitalists. He also writes a column on entrepreneurship and venture capital for The Globe and Mail and heads up Toronto-based Wise Mentor Capital, which runs half-day educational boot camps aimed at bringing entrepreneurs closer to big money. Over the past 10 years, the firm has trained 3,500 entrepreneurs who have gone on to raise $2.1 billion. You could say this man lives and breathes startup financing.
By using personal or business credit cards to finance startups, entrepreneurs can avoid predatory big-money lenders who might take a controlling share of a company's equity.
But Wise points out that there is an additional benefit to using cards, especially for Web-based businesses. These businesses cost so little to launch that they don't interest venture capital firms. These lower-than-ever costs are partially due to the plummeting price of bandwidth and the fact that one pays for bandwidth only when it is being used, which means entrepreneurs don't need big bucks right away.
Showing some 'skin'
In earlier days, an entrepreneur needed $5 million to launch a Web-based business, but now you can launch one for less than $50,000. "Not many people can come up with $5 million," says Wise. "But anyone with good credit can get $50,000. This has dramatically shifted the power from the investors to the entrepreneurs."
If an entrepreneur does begin to incur large-scale costs due to large-scale customer use -- that is, if he has a service that's proven useful -- then he's in an even better position to pursue venture capital at this more mature stage. And personal credit card debt, says Wise, is a good way to give an entrepreneur what venture capitalists call "skin in the game."
"Venture capitalists are going to ask you, 'Why should I put my money up when you're not putting your money up?'" Play your cards right, says Wise, and you could be next in a line of successful Web-based businesses launched on credit cards.
But launchers beware. Steve Bangs, lead lender relations specialist for the SBA, attributes this growth in credit card financing to the speed, ease and nearly universal availability of credit via cards versus traditional bank loans. Bangs warns that, beyond the risk of getting trapped in high-interest-rate debt, launching on credit card debt can be dangerously like starting up in a vacuum.
"Banks won't approve a loan unless they see that it has a strong chance of success," says Bangs. "The downside of financing yourself with cards is that there is no loan officer taking a close look at and vetting the business." It's the danger of what Wise calls "drinking one's own Kool-Aid."
If an entrepreneur contemplates launching on credit cards, Bangs suggests inviting outside skepticism through advisory services such as the SBA's no-cost business-counseling group SCORE.
- 6 reasons entrepreneurs should get a business card – Benefits such as expanded buying power, spending rewards and tracking assistance can help fuel business growth ...
- Corporate cards go virtual, offering added security – Virtual corporate cards allow companies to generate a card number, unique CVV code and expiration date. And they’re expected to be used to spend billions in 2017 ...
- How to rebuild credit after a business setback – After a business setback or bankruptcy, repay your debts, learn from your mistakes, and get back in the credit game ...