The Dangers of Using a Credit Card To Fund a New Business

Although a business credit card can be a very helpful means to finance your business, it doesn't mean that you can overspend. Like any credit card, a business credit card also has its pitfalls.

Funding Options for Business Start-Ups

Just about any new business has a fundamental need to get rolling – cash. In the heat and the passion of starting things up, four reasonably quick ways exist to raise funds for a start-up. Every entrepreneur should consider each:

• The Friendly Loan

  A friendly loan requires approaching family, friends or colleagues for a loan. This can be awkward in the asking. Most financial advisers warn against taking this sort of loan, mainly because of the damage it can cause to important relationships should things go sour. Just be sure interest rates (if any) and terms are well-thought-out and mutually agreeable. Draw up, sign and date informal I.O.U. papers. Will your friendly lender want a percentage of later profits?

• The Business Credit Card

  Eventually, any business plan should look forward to the establishment of a credit base apart from that of the owner. However, entrepreneurs may be ill-equipped to immediately establish the creditworthiness necessary for a business credit card. Also, a new credit card application, even if it is for business, may place enough of a ding on an individual’s credit record to put a halt to any alternative venues for credit.

• The Personal Loan

  Pay-day or cash-advance loans usually have loan amount limits that would not cover any necessary start-up funds. A typical personal loan of any significant amount from a brick and mortar financial institution could take a week or more to process and may require the posting of collateral, or the presence of a co-signer, depending on the creditworthiness of the entrepreneur.

• The Personal Credit Card

  A personal credit card could already be in the possession of the entrepreneur, or easy enough to come by. The credit limit could be substantial enough to allow plenty of money for start-up and ongoing expenses. Of course, credit limits, interest rates, and the like will depend on the creditworthiness of the individual. While this is a viable means of initial financing for a business, its use should be well-considered.

Putting Your Personal Credit Card On the Line

History is rife with compelling stories of entrepreneurs who risked their personal creditworthiness to bring wonderfully successful businesses into the world. They were able to say, “Charge it!” on their personal credit cards often enough and long enough to eventually realise profits – sometimes rather fantastic profits. But, using personal credit cards can become very expensive – even ruinous. Failures are seldom mentioned, but it’s important to realise the consequences of personal credit card use should things go sour.

Business Costs to Watch with Personal Credit Cards

Using a personal credit card for business expenses will incur the same sort of costs associated with personal expenses. It’s just that an entrepreneur may overlook these costs while focused on the business, defending these extra expenses as necessary, as the cost of doing business. Remember, credit card issuers don’t see these expenditures as business costs. As far as they’re concerned, they are dealing with an individual, not a business, not an entrepreneur. But the expenses can still be formidable and can take their toll on a new enterprise.

• Cash Advances

  Should cash money be needed for some start-up expenses, cash advances are significantly expensive. Interest rates on cash advances are usually the highest charged of any credit card expenditures and the interest kicks in the minute the cash leaves the slot. Administrative fees could be imposed, further expanding the expense. And ATM fees are usually incurred.

• Debt to Income Ratios

  Debt to income ratio could increase significantly enough with the new spending for the business start-up, that it could prompt a credit card issuer to raise interest rates. These ratios are simply a comparison of income to outgo.  Since the charge account is personal, rather than business, costs such as housing and food will be considered in the ratio figures.

  To a credit card issuer, debt to income ratios can indicate that a user may find any new debt difficult to repay. As their risk increases, thus are the issuers prompted to raise interest rates. Also, start-up business owners should watch this ratio carefully. Its significant increase could very well signify a business start-up headed for a business failure.

• Over-the-Limit Fees and Late Penalties

  Should the entrepreneur exceed the limit on the personal credit card because of business expenses, penalties could be imposed, minimum monthly payments could be increased, and interest rates could be raised. Making a payment late will also incur penalty fees, possibly raise interest rates, and could raise minimum monthly payments as well. A month of low cash flow for the business won’t matter to the card issuer — they will still expect timely payments.

Going It Alone May Feel Right; But Is It Really Right?

Precious, single-minded zeal is one of the main ingredients for success with start-up businesses. But, the majority of start-up ventures fail due to the single-minded entrepreneur. With only themselves to worry about, they overlook a number of important steps involving research and market testing. The main problem is often the lack of a coherent and well-thought-out business plan.

Going Down with the Business

Lenders willing to offer loans to people starting out in business most often require that an entrepreneur take these most important first steps. Folks who have the financial wherewithal to go it alone, including those using only personal credit cards, often don’t take these precautionary first measures – their business start-ups most often become unfortunate business end-ups. And that could mean a personal credit history scarred for quite some time, an impediment to any future entrepreneurial activity.

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