Credit cards can be a viable funding source for start-up entrepreneurs who are unable to secure other types of funding because of their short operating history or lack of collateral. They can are also be useful for businesses with significant seasonal financing pressures.
The major advantage of using credit cards is the ease with which you can secure funding. Credit card companies don’t require collateral and typically personal credit is not necessarily a limiting factor. The danger with credit cards is using them if you are not able to pay off the debt by the time it is due. For the credit card company, the ease with which you can secure credit cards is offset by the high interest rates charged on the money used. Therefore, if you are unable to pay off the balance in a timely fashion, you will begin to incur significant interest charges quickly, going deeper in debt, and in most cases hurting your personal credit score. Annual interest rates can exceed 20% with some credit cards. This makes credit cards good for short term expenditures or immediate, short-term cash flow needs, but a risky strategy for those entrepreneurs in a cash crunch without a foreseeable resolution. They are a useful tool for supplementing funding needs that can’t be provided for through alternative sources of funding such as customer and supplier financing.
Revolving credit cards
In the past, some entrepreneurs employ a strategy of using multiple credit cards and taking advantage of the initial grace periods offered on each card to secure low interest financing for longer periods of time. They achieved this by paying off each card at the end of their grace period with a subsequent, new credit card and associated grace period. However, eventually the balance will need to be paid and in the event the entrepreneurs cannot pay, they will again, incur significant and costly interest charges at a very high rate. Since the recession of 2008, as lending requirements have tightened and fees now charged for rolling over balances, these strategies no longer make economic sense for most business owners.
Credit Card Fees, Benefits, and Awards
Another advantage of using businesses using credit cards can be, assuming they are able to pay off the balance, can be the benefits and awards accrued through use of your credit card. There are hundreds of cards offering many different variations of benefits, but in general credit card users typically benefit in the form of miles or cash back. Cash back percentages can be added up to significant savings depending on the monthly purchase volume.
When considering using a credit card, be sure to check the terms and associated fees. Some credit cards have annual fees and variable interest rates and transaction fees depending on the type of transaction. All these increase the real cost to the business owner of borrowing money from a credit card.
Card Processors and Issuers
The 4 major credit card processors are Visa, MasterCard, Discover, and American Express. There are many different credit card issuers (typically banks) who offer cards from these processors. Some of the biggest issuers of credit cards are Citibank, Capital One, Wells Fargo, Bank of America, Chase, and Barclays. In some cases, as with Discover and American express, the processor can also be the issuer.