Read the small print and calculate the risks: business credit cards can leave you in real peril.
By Odysseas Papadimitriou (CEO & Founder, Evolution Finance)
Entrepreneurs often have few options when it comes to startup financing. Investments from friends and family are nice, but raising enough money that way is difficult, and business owners don’t always want the stress of potentially letting loved ones down. Obtaining adequate financing from a crowdfunding campaign is unlikely, SBA loans are tough to obtain, and venture capital is expensive in terms of both lost equity and control. Angel investors would be ideal, but few of us know those uber-wealthy individuals. So, where does that leave us?
The Risk Factor
Used by 57 per cent of entrepreneurs, personal loans and credit are far-and-away the most popular source of start-up funding, according to Startups.co. There are also, however, disadvantages to this approach – namely putting all your eggs in one basket. If the business fails, the owner personally fails, and, according to the U.S. Small Business Administration, about half of all new businesses fail within their first five years. So, no matter how solid your concept may seem, pouring personal savings into the venture is a situation best avoided. This somewhat explains the popularity of small business credit cards.
Most believe business credit cards shield them from personal liability. However, due to regulatory imbalance, following this common myth is decidedly bad for business funding. The notion that small business cards provide personal immunity is nothing but effective branding. All major card issuers hold the small business owner and their business liable for unpaid balances, and most report information on the owner’s personal credit report. Thanks to this same lack of legal protections, small business credit cards also pose unique risks from a funding perspective.
Small Print for Small Businesses
You’ve probably heard of the Credit CARD Act of 2009, the transformative law that improved transparency in the credit card space, reduced the overall cost of credit by two percentage points, and forced the near-extinction of over-limit fees. But, due to a combination of banking industry lobbying efforts and regulatory ignorance, the CARD Act does not apply to small business credit cards. So, small business owners do not benefit from the rule against raising rates on revolving balances unless a cardholder is at least 60 days delinquent. There is no rhyme-or-reason for a credit card company to raise rates, which means there is also no limit to the debt instability that owners who fund their companies with small business credit cards may endure.
This raises a number of important issues for companies operating on razor thin margins, and the inability to plan or strategically allocate capital are chief among them. As a result, when credit represents the best source of funding – as it most often does – owners should take some steps to minimize the associated risks.
Minimize the Risks
First, implement a two-card approach that uses a 0 per cent general-consumer card for company expenses that won’t be paid-in-full by the end of the month, and a business rewards credit card for everyday transactions. Consumer cards used for revolving debt have CARD Act protections and a wider selection of 0 per cent offers. Since they’re “primarily for personal, family, or household purposes,” and eligible for protection under the law, use these cards regularly for household purchases, but don’t forget to pay the company back. Business rewards cards used for everyday purchases offer the benefits of the phenomenal earning rates that many provide on office supplies, telecomm services and various other small business-specific categories.
Another thing to keep in mind is how much is spent on the business, and what are the expenditures. Business success is contingent upon carefully controlling spending, especially in the early stages. Many experts believe being initially strapped-for-cash is beneficial. “An abundance of capital tends to dull the mind,” says Angelo Santinelli, adjunct professor of entrepreneurship at Babson College. “There is the tendency to hire too fast, pursue too many un-validated ideas, and spend on non-strategic elements of the business.” Take advantage of the expense tracking tools that are unique unto small business credit cards.
Our fate as business owners is the product of countless small decisions. From our choices of funding methods to the types of credit cards we use, the importance of how we manage the limited capital at our disposal cannot be emphasized enough. Choose wisely and I’ll see you at the summit!