When it comes to starting a new business, funding often comes from family, friends, or a small-business loan from a lender. When these funding options prove to be unavailable, you might turn to credit cards to fund a small business.
According to a 2012 study by Pepperdine University, 40 percent of business owners seeking financing said they'd use business credit cards. However, this option poses its fair share of dangers.
Here are some things to consider if you’re thinking about using a credit card to fund your new business venture:
Business credit = personal credit. If you're starting a business as a sole proprietor, getting a credit card in the name of your business is not much different from having a credit card in your name. It might be called a business credit card, but it will show up on your personal credit report, and as a sole proprietor, your business debt is the same as your personal debt.
If you should fall behind on the credit card payments, your individual credit rating will take the hit and you will find it hard to get credit with the lower score. Additionally, business credit cards have fewer protections since they aren’t covered by the Credit Card Act of 2009.
Some banks require a personal guarantee. If you have a limited liability company (LLC) or corporation, you might think getting a credit card in the name of the business automatically means the debt is kept separate from your personal debt.
In theory, this is the entire reason for setting up an LLC or corporation in the first place, but if you are a new business, the credit card issuer may require a personal guarantee on the business credit card. If you sign and personally guarantee the business credit card, you are responsible for the debt on that card and your personal credit can still be affected if something goes wrong.
Credit cards give you quick access to money. One of the biggest benefits of using credit cards to start a business is the ability to get going right away. If you already have a credit card, you don’t have to wait. Even if you need to apply for a new credit card, you can get approved instantly.
If you want to get a loan, there is usually a waiting period to see if you are approved, and the issuer often needs a lot more information than a credit card application requires.
Potentially costly form of financing. Keep in mind if you use credit cards to your business expenses, you're probably going to pay higher interest than other sources of financing—unless you qualify for a low-interest card or a zero percent APR credit card offer. In the event of a late payment on a credit card, you’ll wind up spending even more in late fees and seeing a possible increase in your interest rate, so make every effort to pay the bill before the due date to avoid increases in your interest rate and having to pay late fees.
Debbie Dragon is a contributor to MyBankTracker.com, where she writes about savings rates, personal finance, and banking.