Starting a business necessarily involves significant amounts of capital spending. The industry, and the product or service the business seeks to provide, may dictate purchasing equipment, factory or office space and hiring employees.
Entrepreneurs who want to start a business and work at building it full-time have little choice but to go into debt. The alternative is to issue shares of stock to investors in anticipation of future dividends. Since a new business is not likely to attract venture capitalists, financing the creation of a business through debt is the only option.
A new business has access to several potential sources of credit. The business owner can apply for a business loan from a bank, preferably one with whom the owner has a prior relationship. This is risky because the owner may be turned down and have to look elsewhere for credit.
Credit cards may be the answer to his dilemma. Charles Huang of Harmonix maxed out his credit cards to finance the business in 2007. The popular video game series, “Guitar Hero,” grew of his efforts. The founders of the search engine Google, Sergey Brin and Larry Page, also used their credit cards to fund the start-up in the mid 1990s.
[Side note from Jason: There are hundreds of examples of credit cards backfiring as well. A business credit card can get you through times when cash flow is tight. As always, you must have a solid business plan to grow your sales and increase your revenue]
Personal Credit Cards
The quickest way to starting a business is to use personal credit cards. This route is a fast track to either success or failure, depending on the start-up idea and execution. The trade-off is to go into debt now in order to make enough money to pay it off later. The entrepreneur borrows from his future success in order to start the venture and get it going. The primary motivation for these businessmen is the chance to try something big and turn a hobby or a crazy idea into a profitable enterprise.
Using personal credit cards to do this is fraught with pitfalls. Creditors may get jittery when faced with rapidly increasing debt loads and suddenly lower credit limits. Alternatively, using so much available credit increases the credit utilization ratio, which can also trigger negative consequences. The ratio is a useful indicator of the risk of default. The higher the ratio, the higher the risk of default, at least in the minds of creditors.
Small Business Credit Cards
The differences between personal credit cards and business credit cards do not mean that entrepreneurs should treat them differently. For a start-up with no capital and no history, creditors view it as indistinguishable from the owner. The owner’s credit history becomes the business’s credit history. All the steps borrowers can take to clean up their credit report will help them get approved for a business credit card.
The risks are different with small business credit cards than with personal credit cards. The regulations and rules of the Credit CARD Act of 2009 do not apply to small business credit cards. Entrepreneurs have more flexibility for their funding needs at the cost of increased risks, like a sudden rise in interest rates or lower credit limits. The advantages of small business credit cards can help compensate for these risks. Some cashback credit cards are specifically tailored for business purchases and can offer as much as 3%.
But with anything, you must be sure to weigh the costs, and make an informed decision.
Anothony Benedict writes for CreditDonkey.com, a credit card comparison site.
