One of the most common issues that new small business owners run into is a lack of startup capital. Expenses add up quickly when you’re starting a business, and even if you’re confident your idea will be successful, it still takes some time to turn a profit. Therefore, a good, easy-to-obtain and flexible form of small business funding when starting out is a must.
It’s surprising, then, that more entrepreneurs don’t turn to business credit cards as a way to fund their business. When used responsibly, credit cards can help new businesses get going—and they also set the stage for larger, more traditional financing down the road.
As it stands, most people overlook credit cards. The National Foundation for Credit Counseling's 2018 Consumer Financial Literacy Survey shows that just 7% of people say they’d turn to a credit card to finance their new business. That ranks behind options like selling personal assets, seeking angel investment, or borrowing money from family.
Credit cards can be an excellent financing tool or a road to financial perdition. The answer to whether you should use one is a decisive “maybe.” It all depends on your situation and needs.
Let’s start with the basics:
Can you use a credit card to finance a business?
Absolutely. In fact, you can use either a business credit card or a personal credit card (though the latter isn’t advised—we’ll get into why in a bit) to finance your small business.
A credit card is a form of short-term financing that “revolves” similar to a line of credit. You have a credit limit, and you can borrow up to that amount in varying increments that you hopefully pay back on schedule. Then you draw from that credit limit again as needed—no need for reapplying as with a term loan.
Business credit cards are an excellent tool for any small business owner to have on hand, even sole proprietors who feel they can simply load up all their business expenses on their personal cards. They offer unique, business-oriented perks, and should help you keep your finances organized.
There are pros and cons for using a business credit card to finance your business, whether you’re an established business owner or are just starting a new venture.
What are the pros of using a credit card to fund a business?
No matter what kind of credit card you use to fund a business, you’ll quickly see some of the following benefits of doing so:
1) They’re easy to obtain
The process for obtaining a credit card is sometimes as simple as filling out a form. You may already have a credit card in your wallet, which means you have thousands of dollars of credit at your disposal already.
Compared to the process of acquiring a term loan—which often requires submitting bank statements, tax returns, business plans, copies of leases, and other documents, along with meeting certain standards such as time in business—getting a credit card is a breeze.
2) They (can) function a low-cost loan
Though interest rates for credit cards can be high, you can occasionally qualify for cards with extremely low APRs, depending on your credit history. In fact, some business credit cards come with an introductory rate APRs of 0% for a limited time. During that period, you’ll have access to essentially free financing, as long as you stay in good standing.
3) They don’t require putting up collateral
Unlike loans or lines of credit, credit cards don’t require you to put up collateral to secure the financing. When you’re a startup and you don’t have much collateral anyway, this lack of a barrier can be a huge relief.
4) They rack up rewards
Unlike other forms of financing, a credit card essentially helps pay for itself by providing you with rewards points you can use to reinvest in the business. Depending on the kind of business you run, you can get a card with rewards that play to your strengths. Do a lot of driving? Get a business gas card that rewards filling up. Spend a ton on office supplies? Get a card that lets you customize rewards and gives you extra points when you hit Staples.
5) They help you establish your business credit
The moment you start a business, you start building a business credit report. In the early months and years, you won’t have much credit history to your name—unless you start using a business credit card. Making your payments will help you build a solid score that will come in handy when you want to apply for a larger loan down the road.
Credit cards also help businesses with less-than-stellar credit to get back on track. Again, making your credit card payments will help right the ship that is your credit report.
6) They protect your equity
If you don’t want to give up equity in your small business to investors, a credit card may cover the expenses that an investor might—without sacrificing long-term profits.
What are the cons of using a credit card to fund a business?
Credit cards aren’t perfect. Though some of the issues with credit cards are the results of irresponsible usage, there are intrinsic drawbacks to them that you should keep in mind:
1) They leave you liable
If for any reason your business idea doesn’t work out, you’ll be personally liable for whatever you paid for using either your business or personal credit card. That’s because credit cards do typically require a personal guarantee.
2) They have relatively low spending limits
Small business loans, such as SBA loans, can potentially offer you millions in funding. Credit cards are simply not going to go above $50,000 in most cases—and usually, it's much less.
If you need to make major renovations or upgrades to your business that requires a lot of funding, a credit card won’t be much help.
3) They can complicate your expenses
If you use a business credit card to keep track of your expenditures, that’s a good thing. If you use a personal credit card for both your business and personal finances, that can quickly turn your bookkeeping and accounting responsibilities into a nightmare. And if things go south, your personal credit score will take a hit as well.
4) They may have high interest rates in the long-term
As mentioned above, low-interest rates in the introductory period for credit cards is an appealing benefit. But those interest rates don’t last forever, and they can jump up as high as 20% or more in the years to come. What was once a cheap form of financing can become rather expensive quickly, and you’ll pay a premium in the long run.
All forms of funding and financing come with benefits and drawbacks, and credit cards are no exception. Depending on where you and your business are financially, a credit card can either be the perfect tool or an expensive lifeline. Take the time to review your current situation and long-term goals before you start relying on a credit card as your primary form of business financing.
Have any questions about starting your business? Ask us in the comments below!