Risks of Financing A Small Business on Credit Cards

Financing a new business can require some careful planning and creative thinking, and the choices you make at this stage are likely to have major financial implications down the road. With banks approving fewer loans to small businesses, many entrepreneurs are turning to small business credit cards to help fund their growing businesses.

Whipping out the plastic comes with a number of risks, though, so before you apply for a new credit card (or four) consider your options. Getting your business off to a good financial start is not something to be taken lightly, and using credit wisely will go a long way toward helping your business succeed.

Know your options

Although many banks’ approval rates for business loans have dropped into the single digits, community lenders and credit unions tend to have approval rates around 40%. Loans generally have lower interest rates than credit cards, but keep in mind that you’ll probably have to borrow a set amount of money. Borrowing more than you need could mean paying more interest in the long run. Having that extra cash at your disposal can also tempt you to spend money unnecessarily.

Finding investors to fund your venture is another option to consider. Remember, though, that you’ll lose much of your freedom and ownership of the business if you go this route. If you’re starting a nonprofit, look into government grants that can help you get on your feet financially.

Financing your business with credit cards comes with its own host of risks, but done carefully it has the potential to get your business off the ground. Before you make any decisions, take a close look at what financing with credit means, and decide whether it’s right for you.

Is financing with credit right for your business?

Some people are more likely to succeed at financing with credit than others. Shine a bright light on your financial history and take an honest look at it. Are your personal finances in order? How’s your credit score? Unless your company has substantial revenues (or you’re bootstrapping it), you’re likely to have to make a personal guarantee. This means that your personal finance history matters, and that the bank will come to you if the business goes under.

Having a great credit score to begin with will help you find lower rates when you apply for a credit card to finance your business, a critical factor in the success of your financing endeavors.

How’s your financial stability? If you’re already in debt, or anticipate big expenses down the line (is your kid headed to college? Are you dying to install a new pool?), adding more financial liability to your plate is probably a bad idea.

If you’re financially squared away and have a fantastic credit score, figure out how much you can afford to pay each month. Really afford. Then stick below that no matter what.

Plan for the worst

It’s not fun, but it’s a fact of life. You can’t always anticipate how high your expenses will be, or what else will go wrong. Your product may fail, your interest rate may rise, and your deals may fall through. Expect the unexpected, and be prepared for it. Try to save up an emergency fund in case things go wrong, and plan for the possibility of cost increases down the line. As much as it may be tempting to assume a best-case scenario, you’ll be glad you planned ahead when you hit a financial bump in the road.

Make sure the card benefits your business

If you do decide that financing with credit is the right choice for your business, make sure you get a card that will allow you to maximize benefits and reduce risks. As with any credit card, read the fine print before you apply, so you know what you’re getting in for. For example, find out how long your rate is fixed, so you’re not surprised by sudden interest rate increases.

Consider applying for a business credit card instead of a personal one. A business card may give you access to lower interest rates, and many also offer rewards geared toward common business expenses. Put your card to work for you earning airline miles and hotel stays to cover business travel expenses, or snag as much as 5% cash back on certain business purchases.

Keep track of business and personal expenses separately to save yourself bookkeeping and tax-season headaches. This will also save you trouble if you’re ever audited; you won’t have to disclose both personal and business finances.

If your company already has substantial revenues, or if it has built strong credit, you may be able to avoid making a personal guarantee. Go this route if you can, as it will protect your personal assets if the business goes under.

This is a guest post from Tim Chen is the CEO of NerdWallet, an unbiased resource to help you find the best credit cards for business and personal use.

[Image credit: andresrueda]

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  • http://www.directionstech.com.au April Neylan

    This is a great article. Very helpful tips!

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