At some point, every small business needs extra funds to meet its growth objectives. Purchases, expansions and equipment upgrades are examples of situations where you might need to tap credit to move your business forward.
As the owner, you’re faced with a tough decision: Should you use your business credit card to fill the financial gap, or are you better off applying for a small business loan? There are pros and cons to both options, so take a look at the details below to figure out which is right for your business.
Benefits and drawbacks to using your business credit card
Opening a small business credit card was probably one of the first things you did when you were getting your business off the ground. This was smart move, because there are a lot of advantages to using business plastic when you’re short on funds. For example:
Quick access to cash – Compared to other borrowing options, using a business credit card is a fast way to increase your purchasing power. A simple swipe of your card allows you to get what you need, and you have a few weeks to come up with the money to pay it off. This is especially helpful for new businesses, which often have an unpredictable cash flow.
Rewards – Many business credit cards offer rewards programs that are valuable to entrepreneurs. The more you use your card, the more perks you’ll be able to rack up.
Builds business credit score – Establishing a positive credit history for your business is just as important as establishing a positive credit history for yourself. While business credit scores are determined by a number of factors, one of them is your history with handling credit. Using business plastic carefully and consistently will put you on the path to a healthy score, which will be helpful for future borrowing.
However, before you start swiping, be aware that there are drawbacks to using a business credit card. For instance:
High interest – Just like with a personal credit card, you’ll need to pay off purchases made with your business credit card as soon as the bill comes due. Otherwise, you’ll face steep interest charges.
Few protections – The CARD Act of 2009 put a lot of protections in place for personal credit card users. For example, banks must now provide 45 days notice before raising consumers’ interest rates. However, these safeguards don’t apply to business credit cards – banks can still arbitrarily change the card’s terms if they want to. This means business cards are a somewhat risky way to borrow.
Benefits and drawback to taking out a small business loan
Many entrepreneurs take out small business loans when they need extra funding. This move has a lot of benefits, including:
Lower interest – Compared to most credit cards, small business loans charge much lower interest rates. This is helpful if you know that you’ll need several months or years to pay back the money you’ve borrowed.
Lots of options – Small business loans come in many forms, so it’s likely that you’ll be able to find financing that fits your needs. These days, business owners can use traditional lenders, such as banks or the Small Business Administration, or pursue less conventional options. For example, in March 2014, Lending Club announced it would start offering small business loans.
Builds business credit score – Like using a small business credit card, taking out a small business loan will help build your company’s credit score. Just be sure to make payments on time and in full!
But small business loans also have certain downsides. For example:
Hard to qualify for – Obtaining a small business loan isn’t easy. You’ll have to provide a detailed business plan, financial records, and cash flow projections to a potential lender. If your business is new, you might not have all of this information, or it might not be sufficient for a lender to approve.
Your personal finances are on the line – Typically, part of obtaining a small business loan is providing a personal guarantee. This means that if your business fails, you’re promising the lender that you’ll repay the borrowed funds with your own money. Personal guarantees are required to get a business credit card, too. But since loans are usually for larger sums of money, the personal risk you’re taking is much greater.
The bottom line: which should you choose?
In general, it’s best to use a credit card for short-term cash shortfalls that you know will be quickly resolved. There’s no sense in going through the difficult process of applying for a small business loan if you know that you’ll be able to repay the borrowed money in a short period of time.
On the other hand, if you’re making a very large purchase for your business or funding a major expansion, a small business loan is probably the way to go. This is because you’ll be borrowing at a much lower rate. Since it could take you years to pay back the money for such a large capital improvement, this is an important factor to consider. Also, given the lack of protections on many business credit cards, it’s probably too risky to put a very large expense on your plastic.
Finally, it’s important to remember that borrowing for your business always means taking on some risk. Be sure you have a detailed repayment plan in place before taking on any type of debt.
Small business owners image via Shutterstock