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When you’re launching a small business, your biggest financial backers might be you, yourself and your credit card. On one hand, it’s exciting: You get to call the shots! On the other hand, a business credit card misstep could leave your startup financially strapped or increase your personal legal exposure. Before leaning on plastic, be sure to avoid these common mistakes.
1. Racking up credit card debt on an untested idea
Business credit card debt is easy to take on, but hard to pay off — particularly when it comes with a high interest rate. That’s why using a credit card to finance unproven business concepts is so risky.
"I’m not against all leverage. I understand its power in business,” says Stephanie Bacak, a certified financial planner and founder of Capstone Global Advisors in Peachtree City, Georgia, who works with small businesses. “But I have witnessed its power to dig a pit of debt so deep that you cannot recover when that credit accelerates you on a path that’s not going to work."
How to avoid this mistake: “If you’re going to use a credit card, use it to scale an already-proven concept,” says Bacak, who founded a website-hosting company in 2005 that she later sold. It helps to test your ideas, she adds.
Say you want to start a greeting card business. Before taking on credit card debt to order a large volume of inventory right away, you could show designs to potential customers and ask for feedback about which ones they like most and order accordingly. Or, you might take pre-orders to gauge interest.
2. Giving employees cards without a spending policy
Giving your employees credit cards can certainly make it easier to delegate business errands. But without a clear spending policy, Bacak warns, even a simple shopping trip for office supplies could add up to far more than you bargained for.
Because balances on employee credit cards are generally billed to your small-business credit card account, out-of-control spending could cut into your profits. And as balances balloon, your business credit scores — and potentially your personal credit scores — could fall, making it harder to qualify for business loans or other forms of credit.
How to avoid this mistake: Get a small-business credit card that allows you to set limits on employee cards and create spending notifications.
“If an employee has a card, you definitely want to have limits on it and receive alerts on anything over a certain dollar amount — whatever would be significant for you,” Bacak says. Talk to employees about these limits before giving out cards.
3. Justifying credit card overspending with tax deductions
Tempted to charge new computers or fancy software to your business credit card in the name of lowering your company’s tax liability? Just remember: “deductible” doesn’t mean “free.”
“Getting the deduction is great, but you still have to pay for that expense,” says Kelly Luethje, certified financial planner and founder of Willow Planning Group, who consults with clients virtually and has worked with several entrepreneurs. Business expenses can reduce your business’s net income, lessening its tax liability. But you’ll still have to pay taxes on that remaining net income, she notes. And, of course, you’ll also have to pay your business’s credit card bill.
How to avoid this mistake: Ultimately, you don’t want your business to consistently spend more than it makes. If your startup falls into a pattern of overspending, evaluate your expenses and look for opportunities to trim costs. Don’t let deductions dictate your spending strategy.
Luethje emphasizes that small-business owners should carefully monitor their business’s cash flow and pay attention to credit card bill balances and due dates. You can do this by setting up email, text or push alert notifications on your credit card account.
18.49%-24.49% Variable APR
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0% intro APR on Purchases for 12 months
0% intro APR on purchases for 12 months from the date of account opening
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4. Using the same credit card for business and personal spending
Setting up a limited liability company, or LLC, is a good first step toward minimizing your personal legal exposure. But if your personal and business credit cards are one and the same, it might not offer much protection.
“Generally speaking, by commingling funds or using business funds for personal, you run the risk of losing the limited liability protections you get through an LLC,” says Jamie Lieberman, partner and founder of Hashtag Legal, a law firm specializing in influencer marketing and online businesses with offices in Hoboken, New Jersey, and New York City.
This doesn’t happen frequently and standards vary by state, she notes. But if your business were sued, and a court decided that your LLC wasn’t valid because you hadn’t followed certain formalities, you could become personally liable. Such a decision is called “piercing the corporate veil.”
How to avoid this mistake: After setting up an LLC, take care to follow all of the operating formalities. For starters, open a business bank account and a business credit card, Lieberman says.
"Make sure that all the funds going into your business go into your business bank account, and any business expenses go out of your business checking account or through your business credit card,” she says. If you accidentally use your business card for a personal expense, reimburse your business for that amount.
This article was written by NerdWallet and was originally published by Forbes.