Should you fund your startup business with a credit card?
Your Business Credit
Elaine Pofeldt is a journalist whose articles on entrepreneurship and careers have appeared in Fortune, Working Mother, Money and many other publications. She is a former senior editor at Fortune Small Business magazine and an entrepreneur herself, as co-founder of 200kfreelancer.com, a website for independent professionals. She writes "Your Business Credit," a weekly column about small business and credit, for CreditCards.com.
Ask Elaine a question
or read her prior answers in the 'Your Business Credit' archive
Dear Your Business Credit,
launched a small technology startup with a friend last year. We pooled our
savings to get started, but are running out of money to keep developing our
software. We're still at least six months away from getting the product to
market. Would I be better off borrowing some money on my credit cards for the
time being or should I try to find an outside investor? -- John
read articles about entrepreneurs who borrowed their startup money on credit
cards -- and built wildly profitable businesses. The most obvious advantage of
credit card financing is that it's easily available if you already have good
credit and cards in your name.
many entrepreneurs, using credit cards as a main form of financing is very
risky. If the business fails, they will be saddled with debt for which they are
personally responsible -- regardless of whether they have taken out business or
personal credit cards. This is because both types of cards typically require a
"Credit cards are supposed to be short-term
debt," says Nat Wasserstein, chief restructuring officer at Lindenwood Associates, a
crisis management firm based in New York City and Upper Nyack, N.Y.
One reason you
should restrict them to short-term purchases is that it's not cheap to borrow
on them. The average annual percentage rate on credit cards is just below 15 percent as of early 2013,
while interest on loans up to $25,000 that are backed by the U.S. Small
Business Administration can't exceed the prime rate (currently 3.25 percent)
plus 4.25 percent (bringing the total to 7.5 percent).
cards can also be a crutch that leads you to sloppy financial habits at your
business. "You lose the monthly discipline -- or never develop the monthly
discipline -- of paying down a line of credit," says Wasserstein. When you take
out a business loan, in contrast, you need to set aside a certain amount every
month to pay it -- and you don't have the option of making a minimum payment
when money is tight. That forces you to maintain adequate cash reserves.
says that your situation "almost screams" that you should be looking for
long-term capital instead. "It should probably be equity," he says. It is also
worth looking at hybrid debt instruments, such as loans that can convert to
equity, he says.
a stake in your company to early-stage private investors -- known as angels -- usually
means you'll have more cooks in the kitchen. They will typically want to have
some say over how the business runs. That can benefit you, if they bring
valuable business knowledge to the table, but it can backfire if you end up
clashing. "The main risk of equity is adding another human element you don't
really know," Wasserstein says.
the risk of giving away too much equity in exchange for investors' money.
Getting good financial advice is a must if you go this route, and that often
means springing for a lawyer with experience in startup financing.
third option to consider. I've come across some entrepreneurs recently who have
opted to take on part-time or full-time jobs for a while to raise some funding,
so they don't have to borrow or sell equity. If you have a lot of energy and
few outside demands on your time, this approach may work for you.
Wasserstein believes there's a high risk of getting distracted from your main
business if you don't give it your all. You'll need to look at your situation
to determine if this is a suitable solution for your business.
See related: Used wisely, small-business cards can keep business afloat, Small-business credit card comparison chart, Is bad credit bad for small business startups?
Elaine Pofeldt is a journalist who specializes in entrepreneurship and careers, contributing to publications such as Fortune, Money, Working Mother and many others. She is a former senior editor at Fortune Small Business magazine and an entrepreneur herself, as co-founder of 200kfreelancer.com, a website for independent professionals.
Elaine answers a question about small business and credit from a CreditCards.com reader each week.
Send your question to Your Business Credit.
Published: February 19, 2013