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Author: Dr. Robert J. Lahm
Article source: http://www.paidtobesmart.com/. Used with author's permission.
Credit cards have become an increasingly popular substitute for traditional sources of capital, such as commercial loans from banks and venture capital. More and more new business founders are saying "charge it" to fund their start-ups and ongoing operations.
The Problem with New Businesses and Traditional Sources of Capital
Nascent entrepreneurs without an established business history or a track record of successful financial performance often complain about the difficulty in dealing with banks. It is not easy to appease bankers who want to see three or more years of past financial records, a positive cash flow, an established customer base and other historical indices of performance when a business is brand new.
The alternative for the startup entrepreneur in a formal lending process is to offer substantial collateral. What this means is that the business founder pledges something of value, ensuring that if the entrepreneur's "best laid plans" fail to come to fruition (which is a good bet, based on high business failure rates), the bank has something to fall back on and a means to collect. To thicken the stew even further, one might consider that the liquidated value of some forms of pledged collateral may be far less than the value of the collateral under more favorable circumstances. An example of the above would be inventory or office furniture. How much can you get when you sell used office furniture at an auction? Suffice it to say that the bidders are at that auction as compared to an office furniture showroom for a reason: they don't want to pay top dollar for anything that they buy.
Slip on a Pair of Banker's Shoes
Chances are good that if you were wearing a pair of banker's shoes, you would be reluctant to lend money yourself. After all, what is the "upside" for the banker? At best, a loan will be repaid in accordance with the terms and conditions set forth in the lending agreement, with added interest at whatever rate the market will bare. Moreover, within the banking industry, there is a major obligation to thwart risk. After all, it's not the "bank's money" that is being lent—it's depositors' money, which has been placed under the care of the bank for safe keeping. Hence, if we are borrowing money, we want banks to be "easy"; if we're depositing our money, we want it all back, and we want interest, too (sound familiar?). Venture capitalists, by contrast, might enjoy a better upside as they get to demand a "piece of the action," if the business happens to take off. However, whether or not that will come to pass is still a big gamble, not too different than betting on horses at a race track (as some have suggested).
Stage Right, Enter: Credit Cards
The vast majority of businesses are formed by entrepreneurs who use some form of bootstrapping as a means to mitigate their need for startup capital (or because of limited access to traditional forms of capital). Bootstrappers have been known to utilize a variety of techniques such as bartering, drop-shipping, sharing space, locating in austere facilities (including homes, which has become a significant trend unto itself), negotiating, and "do-it-yourself" methods for accomplishing just about anything related to launching or running their respective businesses. These business founders have raised cash by mortgaging homes, using severance and retirement packages, negotiating payment terms, "paying Peter with Paul's money" (e.g., by juggling internal cash flow), using personal savings, borrowing from friends and relatives, and using personal as well as business credit cards.
According to a Small Business Administration (SBA) Office of Advocacy report, 71 percent of small firms obtained credit from non-traditional sources, mainly owner's loans and credit cards. Another report published in U.S. Banker cited industry research commissioned by MasterCard, which found that almost two thirds (64 percent) of small business owners use "plastic for business expenses." Office of Advocacy senior economist Charles Ou was quoted as having indicated that in the category of loans for $100,000 or less (known as micro-business loans), the increasing use of credit cards may account for nearly all of the growth in that category. It should also be noted that small women-owned firms, as well as those owned by minorities and Hispanic-owned firms, tend to rely on credit cards as the most often used type of credit.
Pros and Cons
Credit cards are a competing choice among others that may be available to someone who is starting a business. Abstinence is a choice as well. If one does not have the wherewithal to start a business, perhaps he or she should refrain from doing so. Analysis is divided on the issue. On the one hand, the popular and business press has advanced stories of entrepreneurs who have leveraged multiple credit cards to launch businesses that sometimes turn out to be highly successful, despite naysayers. Within the banking industry, small business credit card lending has become an attractive new market; this was enabled by new techniques which established a connection between one's personal credit worthiness, and small business credit worthiness. On the other hand, bankruptcies have increased, businesses to continue to fail at very high rates, and the practice is risky, at best. Dr. Robert Lahm is the founder of several businesses and Web sites, an entrepreneurship professor, a public speaker, and a writer. His typical topics include creativity and innovation, careers, start-ups, and small business marketing. Webmasters and other article publishers are hereby granted article reproduction permission as long as this article in its entirety, author's information, and any links remain intact. Copyright 2005 by Dr. Robert J. Lahm, EntrepreneurshipClearinghouse.com.
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