Financing your small business with plastic: A capital idea?
Credit cards can get your business off and running, but not without hurdles
By Elaine Pofeldt | Published: August 9, 2012
Like many founders of startup companies, Scott Yates didn't have a line of credit from a bank to smooth out financial bumps when he launched MyTrafficNews.com in Denver in 2001 to help commuters stay aware of driving conditions.
So Yates sometimes tapped his credit cards to cover routine office expenses and tackle more urgent situations -- such as making payroll when a client was late sending in a check. "At the maximum, I had maybe $20,000 in debt," says Yates, who built the company's revenues to about $250,000. He sold the company to Traffic.com in 2006.
Many business owners, like Yates, see credit card financing as a tool that can be handy in the right circumstances. In its 2011 Year-End Economic Report, the National Small Business Association found that about 33 percent of small businesses had used credit card financing in the past 12 months to meet their capital needs. Credit cards ranked the third most commonly used source of capital financing, behind only bank loans and the earnings of the business.
Figuring out when it makes sense to use credit cards in your business -- and how best to use them -- can be confusing.
Loading up on debt when a business is young can choke cash flow later, says Xavier Epps, owner of XNE Financial Advising in Woodbridge, Va., whose clients include small businesses. Borrowing to pay the bills at a money-losing business is not a great idea.
"The owner may need to take a step back, look at the overall operations of a business and consider restructuring, if necessary, to get the business close to break-even before utilizing credit card financing for purchases," Epps says.
But in many instances, credit card financing does make sense, say experts and small-business owners. Yates -- a serial entrepreneur who turned to equity financing from private investors for BlogMutt.com, a blog-writing service he co-founded in 2010 -- says he still sees credit card financing as valuable because it's so easy to use.
"It takes a lot of time to raise money from investors," he says. "It doesn't take that much time to fill out a credit card application." In retrospect, he says, using credit cards made him hyperfocused on achieving the cash flow he needed to stay current on them.
Keeping your card choice business, not personal
While many business owners initially use personal credit cards to finance a business, it's better in the long run to secure a business credit card -- perhaps from the bank where you have a business checking account, says Rohit Arora, CEO of the online loan broker Biz2Credit, based in New York City. For one thing, doing so can protect your individual credit rating by helping you to avoid maxing out your personal cards.
Also, business and personal accounts are not directly linked -- although card issuers commonly consider a small-business owner's personal credit in the application process. "If you are using a business card, unless you default, it doesn't show up on your personal balance," he says. Which means a high credit-to-debt ratio on your business card, for instance, won't affect your personal credit score -- but it will affect your business's score.
So be smart. Arora notes that if you use your business credit cards for recurring personal expenses such as utility bills (while keeping card balances in check) it can help you improve your business's credit score as well as help you keep more cash on hand.
Business credit cards can also help you easily keep track of your business expenses -- which both you and the Internal Revenue Service will appreciate at tax time. Don't forget to deduct the credit card interest that applies to business-related expenses, says Bruce Givner, a Los Angeles tax attorney who advises small business owners and wealthy individuals.
"I have a client who runs restaurants that do $10 million in sales a year and force their vendors to take credit cards for everything," he says. "They pay for food, linens, silverware." The restaurateur comes away with a nice tax deduction -- and a lot of rewards points, he notes. The amount you can deduct depends on your tax bracket, he says.
Another upshot of possessing a business credit card is that it may help you get a bank loan during your company's early months -- a traditionally daunting task. "You don't have a shot of getting a bank line of credit for your business for 18 months to two years," says Arora, whose firm matches businesses seeking loans with banks or other lenders.
But showing you've used your business card wisely, month after month, can be a good way to build up your business's credit rating with Dun & Bradstreet, trackers of business credit ratings. Then, armed with records of paying your business credit card bills on time, you'll be able to make a better case for yourself when you eventually apply for a small business loan. "When you go to apply for a loan, a banker looks at how you handle your business debts," says Arora.
The biggest mistake I've seen is that people are not really careful about the interest rates.
This is especially critical at a time when bank loans to small businesses of any age are hard to come by: The Biz2Credit Small Business Lending Index in July 2012 showed big banks approving only 11.3 percent of loans to small businesses, while small banks approved fewer than half at 47.4 percent. The index looks at data from 1,000 business applications made through the website.
The credit card solution still carries cautions
Of course, business credit cards are far from a perfect solution to a business's financing needs. The Credit Card Accountability, Responsibility and Disclosure Act of 2009 (aka the CARD Act ) brought protections to personal credit card holders from sudden hikes in interest rates and other practices deemed unfair -- but it exempted business credit cards. In addition, business owners often must sign personal guarantees for their business credit cards -- meaning they still owe the debts personally if their companies fail.
And it's important to shop around for the best interest rates, say experts. "The biggest mistake I've seen is that people are not really careful about the interest rates," says Lena Rizkallah, who advises small business owners and other clients about financial matters at Money Moxie, based in New York City. She points out that business cards often will offer better rates than personal cards. (Compare today's credit card rates.)
Using business cards right
Finally, you'll want to make sure you use credit cards for the right types of purchases. For instance, it's not a good idea to use credit cards to finance large equipment because they'll often devour a lot of your available credit. "For big-ticket items, you can get low-cost financing very quickly," says Arora.
But credit cards can come in handy when you need to make a short-term financial outlay and expect it to be recovered quickly. "If you're a consultant, you may want to use credit cards for travel costs, knowing you're going to get your expenses back from a client in 30 days," says Rizkallah.
Similarly, if you run a construction firm and need to spend money to hire a subcontractor before you get paid, credit cards may help you stay current with your vendors until that happens, she notes. They can also help you to take advantage of opportunities that might be hard to pursue without additional capital -- a key to keeping your company growing.
"A credit card for some items and a line of credit could be what a business owner needs to go for it," says Rizkallah.
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