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Should you use a credit card to finance your small business?

Feb. 4, 2012
Business Credit Cards, Credit Cards
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The following is a post from Neal Frankle, CFP® and owner of the lovely personal finance blog Wealth Pilgrim. His most recent post is his Prosper Review.

If you own a small business, you are going to face a cash crunch sooner or later. If fact, many veteran business owners face this dilemma quite often. But should you use your credit card to finance your business?

Of course, nobody likes to pay interest to credit card companies because it can be extremely expensive. And taking on this kind of debt is especially risky when it comes to your business. That’s because you really never know if the investment you are about to make is going to pay off. And if it doesn’t, how are you going to pay back that loan? Is it going to crash your good credit score? You can see there is a lot at stake. Here’s how I suggest you approach the question when you are forced into this situation.

1. Do you absolutely have to spend the money right now?

If you are running a successful business you should be able to plan ahead. The more time you have before you have to spend that money means you will have more financing alternatives. Can you delay the expenditure? If you are forced to make a decision now, it might mean that you haven’t done the right planning. That could be a far more important issue to tackle than this particular investment. Find out what keeps you from doing effective business planning and correct that problem pronto.

2. Is the credit card your only choice?

You might have more financing avenues than you think. Have you considered a home equity line of credit? Have you looked into a peer-to-peer lender like Lending Club? These companies put people who need to borrow money like you together with people who want to make loans. The interest is far lower than the typical credit card if you have a good credit score. Have you approached family and friends to invest in your business? Have you looked into getting a new credit card with a higher limit? This can be especially attractive if they offer you the opportunity to take a cash advance and pay no interest for an extended period of time.

3. How are you going to spend the money? When is the payback? What is the risk?

If you borrow money from a credit card company, you take on debt. Ask the following questions to determine if it’s worth it or not. Are you using the money to expand your business? How long will it take to recoup that investment? And what are the risks that the investment won’t payoff. Let’s take an example.

Say you own a pizza parlor and you need $5,000 for a new oven. You estimate that it will take a year to pay that $5,000 plus the interest. If you are an established business, it’s easier for you to estimate the risks of doing this. You know how much business you can generate with the new oven. But if you are just starting your company, the risks may be very high. In that case, you may have no idea as to how long it will take to repay that money if ever. As the uncertainty rises, the intelligence of tapping your credit card for this investment falls.

Bottom line – if you can’t say with a high degree of certainty how long it will take you to pay back the money and what the risks are, don’t do it.

4. Do you need to tap your credit card just to stay in business?

You might be in the unfortunate situation of choosing between staying in business and using the credit card or closing your doors. If this is your situation, you have to really put on the big boy or big girl shoes and take a hard look at where your business is. If the nature of your business is cyclical, this could be fine. Again, an established business with verifiable receivables can use credit card financing to get through a rough patch. But if you can’t reasonably foresee the situation turning around, it might be time to do something else. I’ve seen dozens of situations where people keep businesses open far longer than they should. I understand this of course. We often identify who we are with the success of our business. But this is a mistake and a very expensive one.

If you are seriously considering using your credit card to fund your business you may not really like what I’m saying here. I understand this completely. But you will be far better off if you separate your emotions from your logic when you approach this issue. Only use your credit card to fund your business if you know without a shadow of a doubt that the money will be there to pay off the debt in a reasonable time. If you have no basis for thinking that, you have no reason to go further in debt.