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The Pros and Cons of Financing Your Startup With Credit Card Debt

Posted In Business - By Techtiplib on Sunday, December 3rd, 2017 With No Comments »

Managing a startup in its initial stages can be a nightmare. Not only that entrepreneur has to constantly monitor economy news (for example, on this site), but also it’s commonplace for startup entrepreneurs to wake up to unexpected expenses staring them in the face. Marketing budgets tend to always prove insubstantial, raw material rates tend to suddenly go up, and you’re never too far from an employee looking for a pay raise. Then, payments are hard to come by, and raising product prices is hardly an option.

Tech Debt

All these financial uncertainties can make it extremely challenging for startup managers to run the show. This is where smart financing comes to the picture. The equity and debt financing you’ve already taken up could prove inadequate, leaving you to fend for yourself with unconventional financing options. Among these, credit card financing is one of the first preferences for entrepreneurs. Whereas some choose credit card financing because they just don’t know about any other short term financing options, there are others, much smarter entrepreneurs who choose credit card debts for their unique benefits.

In this guide, we will tell you the major pros and cons of credit card debts as a source of financing business expenses.

Pros of credit card debt financing

Let’s begin with the reasons that make credit card financing a lucrative option for startups and small businesses.

Retention of Equity

Often, equity retention becomes the biggest concern for a startup entrepreneur. Strong belief in one’s idea easily translates into an unflinching desire to retain as much equity in the startup as possible. Credit card debt helps entrepreneurs get the money they want to pay for working capital without dilution of any equity. Also, this means that there’s no more oversight on the way the borrowed money is spent. Also, for entrepreneurs who wish to overcome an immediate financial challenge without getting the current group of equity investors involved (primarily to prevent loss of confidence in the operational management of the startup), credit card debt financing becomes a good idea.

0 percent interest charge offers

The competition in credit card lending space, particularly for merchants targeting small businesses and startups, often results in some irresistible offers. Among these, 0 percent interest charge for limited periods is by far the best offer a startup entrepreneur can hope to find. Credit card providers are willing to offer very low interest rates, or even 0 interest rates, up to a threshold debt amount, or for a threshold period, to incentives startup entrepreneurs and small business into opting for such cards. One fee, however, you need to watch out for, is the balance transfer fees. Some cards waive off this fees, while others can charge up to 3% fees.

Perks

Using your credit card regularly comes with a lot of perks. It’s almost commonplace for credit card services to offer payback and cash back points on every dollar you spend using your credit card. You might even be able to qualify for free fuel, significant discounts on air-fares, and exciting offers from the issuing bank’s merchant partners by using your credit card regularly for business payments.

No collateral

If you go to a bank for a loan to finance your startup’s cash needs, it’s likely you will be asked to keep some assets as collateral. Whereas it’s commonplace enough for startup entrepreneurs to use personal assets as collateral, there can always be situations wherein you will need more money without any more collateral to put in. To manage such a tricky situation, you could always turn up to your credit cards.

Zero Wait Loan

Essentially, your credit card lets you enjoy the privilege of a loan, without having to wait even a single minute for it to be approved. As long as your credit card usage is within the set limits, your payment requests are honored by the bank immediately. For an entrepreneur in an environment where he needs to make quick purchases to secure a deal with a potentially high-value partner (for instance, in a coveted trade fair or exhibition), a credit card can serve well. Of course, entrepreneurs also need to be wary of the tendency to overspend with their credit cards, even if the expenses are purely for the business’ betterment.

Cons of Credit Card Debt for Startup Financing

No Isolation Between Your Personal And Business Credit

Credit cards get tricky when it comes to financing your business expenses via them. That’s because in most cases, even for a business credit card (issued to sole proprietorship firms), it’s the businessman’s personal credit score that is impacted by the use of the card. So, for each minimum monthly repayment you make, each skipped payment, and each default, it’s your personal credit score that’s going to take a beating. Business finance is best managed as that of a separate entity from yourself. This makes entrepreneurs reluctant to opt for credit card debt for startup financing.

Expensive Debt

It’s a no-brainer – the convenience of credit card debt comes with the downside of hefty interest rates, potential hidden and ambiguous costs, and risks of penalties. Unless you have qualified for a preferential interest rates card, or are availing a limited period interest waiver offer on your credit card spending, be prepared to spend significantly more on interest payments on credit card debt as compared to conventional bank debt.  Also, it’s a well-known fact that credit card companies don’t really go out of their way to explain the terms to you, so unless you are smart financial planner, you can’t downplay the risks of hidden costs and unexpected penalties.

Invisible Ceiling on Loan Amounts

It’s alright if you depend on credit card debt to get your startup out of sticky situations every now and then. However, you can’t really depend on credit cards as a sure shot way for startup financing. That’s because you’ll only be able to get a certain limited amount of money as debt, restricted to a few thousand dollars. Even if you have a strong credit score and great relationship with your bank, you can expect to hit a ceiling around the $50,000 mark. To be able to finance raw material payments, new equipment and property purchases, and to pay monthly staff salaries, you need more reliable financing options in hand, assuming your current cash flow can’t support these expenses.

Discipline is the Key

It’s clear, if you have the right reasons, credit card debt could be a smart choice for your business, in spite of the risks of high interest rates. However, entrepreneurs need to thoroughly understand and appreciate the need to stay on top of repayments of credit card debt. As obvious as it sounds, it takes a lot of organization and financial discipline to keep a tab on credit card debt. Make sure you don’t get more than a couple of credit cards. Always remember the date before which your outstanding credit card payments need to be cleared; missing them by even a day could result in additional charges, and could negatively impact your personal credit score.

Concluding Remarks

Your credit card could be a useful source of business financing, provided you use it after carefully considering the potential downsides covered in this guide.

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