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As credit lines dry up, small businesses turn to credit cards

By Brian O'Connell

Business credit card use is up -- but so is debt
Business credit card use is up
-- but so is debt

Though credit card companies are imposing tougher restrictions on business card users, that's not stopping small business owners from using credit cards.

  • The National Small Business Association reports that credit card usage among small business owners hit 44 percent in 2007, compared to just 16 percent in the 1990s.
  • Thirty-six percent of business owners carry debt burdens of $10,000 or more; 13 percent are carrying more than $25,000 in credit card debt.
  • Small businesses will rack up more than $300 billion in credit card charges, up from $140 billion in 2002, according to the TowerGroup, a financial services industry research and advisory firm.
  • The TowerGroup also says that business cardholders are increasingly late in paying their bills. Advanta wrote off $16.3 million in bad business credit card debt in 2007, and Bank of America wrote off 5.57 percent of its U.S. business credit card debt -- both doubling previous yearly totals.

There's an old saying: When a person is in love or in debt, somebody else has the advantage.

So it goes in the small business sector these days, where more entrepreneurs are priming their companies' financial pumps with that old consumer temptress -- the credit card.

"I have no qualms about using credit cards to run our business," says Mitch Frankenberg, co-founder of the Paw House, a Vermont resort catering to dog owners and their pets. "Right now, banks are scared and have tightened up. We use credit cards because they have more favorable terms than our credit line."

Frankenberg's refrain is a common one among business owners in a tough economy where credit is becoming as scarce as a cowbell in the Mormon Tabernacle Choir. Consider:

  • A 2008 survey from the National Small Business Association reports more than 50 percent of small business owners report having difficulty getting a loan.
  • The Federal Reserve's quarterly survey of bank lending practices reports that 90 percent of U.S. banks included in the study have tightened their business lending standards for small businesses in the third quarter of 2008.
  • Small business loans, as measured by the U.S. Small Business Administration, are down 38 percent since 2007.
  • The Federal Reserve survey says that 60 percent of banks say they are tightening credit card practices -- the worst market for business credit ever recorded by the Fed survey. Furthermore, card issuers are increasingly getting more aggressive about lowering card limits, shutting down cards for some customers.
  • Of particular risk to small business owners, many small business credit cards don't have interest rate caps, so late payers may face interest rates that exceed 25 percent.
  • According to a November 2008 report from the Kauffman Foundation, "Capital Structure Decisions of New Firms," the credit crunch is a particular concern as most small businesses rely on bank loans to keep the engines running. The report says that about "75 percent of most firms' startup capital is made up in equal parts of owner equity and bank loans and/or credit card debt, underscoring the importance of liquid credit markets to the formation and success of new firms."
  • Also according to the report, the amount of credit card debt to finance startups is roughly $3,200 (including a mix of both personal and business cards), but of those business owners who only use personal credit cards for a startup, their balance is roughly $10,000 or a third of the size of the owner's equity.
  • Major credit card companies are beginning to clamp down on small business credit card use. In fall 2008, American Express slashed credit line limits for 50 percent of its customers in 2008, compared to 20 percent in 2007.

Paying a premium
David Walker, a business professor at Georgetown University whose specialty is studying the impact of business credit card debt, says that business owners who rely on credit cards are asking for trouble. "The costs of credit to small business are often very high compared to rates available to other sectors, and this is especially true during a credit crunch," Walker said in testimony to the U.S. House Committee on Small Business last April. "Small firms that rely on debt secured by credit cards usually pay more than twice the interest rate that large firms pay when borrowing at the prime rate."

Walker estimates that a 30-year conventional mortgage, issued in April 2008, would have a mortgage rate of 5.75 percent and a prime interest rate of 5.25 percent. But a rewards-based business credit card released by a credit card issuer on the same day might include a "low" interest rate of 13.42 percent. Credit card issuers know that small business owners need access to plastic, giving them enough leverage to "shut out" small business owners with mediocre credit from lower interest rate deals," Walker says.

Credit cards for business owners are like baseball cards for kids -- it's nice to have a collection of them to use if you need them.

-- Mitch Frankenburg    
   Paw House co-founder, Vermont

Even so, sticking business owners with onerous rates for and tighter usage restrictions is a theme that most small business observers say won't be going away soon.

"Why should banks issue lines of credit when they can earn more by pushing credit cards on entrepreneurs?" asks Mitch Calderwood, chief executive officer of Ratesurfer.com, a Santa Barbara, Calif.-based credit card software management firm. "Lenders know that small business owners are increasingly dependent on credit cards in a tight credit environment."

Calderwood adds that Bank of America's small business line of credit program is essentially a Visa card, and it's been that way for some time now. "Like most banks, Bank of America is raising interest rates based on owner's credit scores, cutting credit lines, and lowering credit amounts even for business owners with stellar credit," he says. "And they're doing so by design because they can cut risk and make money on the higher rates -- and because business owners don't have many financing options right now."

Paw House's Frankenberg says it wasn't overly difficult finding decent credit card deals when expanding his business with a second location in West Dover, Vt. "We purchased an entire inn near Mt. Snow that was twice as big as our first facility," he says. "We'd had a great relationship with our bank, so that wasn't an issue. If you're smart, credit cards are a great way to create reserves for expansion. It's not like 2002. Promotional rates have really dried up, but the financial conditions attached to his new cards were better than expected," he says. "I got a $25,000 credit card deal from one lender, and I can live with the interest rate."

"The key was doing my homework and finding the best deal, and that takes time," he says.

Borrower beware
So how can small business owners who need access to capital make the best of a bad credit environment?

Job No. 1 is to keep interest rates down and credit lines open by protecting your credit. "Make absolutely certain you are paying your bills on time. Don't let anything fall through the cracks," says Ed Hess, a professor of business at the University of Virginia and author of the book "So You Want to Start a Business? 8 Steps to Take Before Making the Leap." "If you are having trouble making a payment, let the company or bank know why. If there is a dispute on a payment, get something in writing that says you aren't to blame. Being turned in to a collection agency will tank your credit score --  something you absolutely can't risk."

Ratesurfer's Calderwood advises small business owners to keep a sharp eye out for card deals with variable and low-introductory interest rates. "Don't opt for cards that promise 0 percent interest. Chances are the rate will shoot up after the introductory period. Find out when the rate will jump and by how much."

He also says that business owners should know their maximum debt liability figure. "Don't take out $50,000 in credit card debt if you can only handle $10,000 in credit card debt. Then you're in over your head."

If small business owners can learn how to read the fine print, manage their debt expectations and shop for good deals, using a business credit card needn't be a painful luxury. "Credit cards for business owners are like baseball cards for kids -- it's nice to have a collection of them to use if you need them," says Frankenberg.

The trouble is, if mishandled; it can be tough living with them.

See related: When starting a small business, get a business card, Small business credit cards help balance capital needs

Published: November 12, 2008


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