Credit cards are extremely convenient to use, but there are several things you should consider before using them to fund your small business.
Even though credit cards have higher interest rates and annual fees, they're commonly used to bankroll businesses, particularly small ones. Just like with any loan, there are risks associated with using your credit card for business funding. But if you act responsibly and take advantage of rewards, it can be a viable way to get your business up and running or keep it humming along.
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What is credit card funding?
Credit card funding is when a small business owner uses a credit card to pay for business expenses. Credit card funding gives the business owner access to a source of money that can be used to purchase equipment, spend on marketing or pay for a host of other business expenses.
The interest rates on credit cards tend to be higher than what banks charge for a business loan, but since the Great Recession of 2008 and 2009, banks have been reticent to lend to small businesses. That's forced small business owners to find alternative funding sources, and credit cards are one of them. At last count, 65% of small businesses in America regularly used credit cards.
Credit card funding isn't only used for startup expenses. A business can use credit cards to purchase inventory, cover rent or pay for marketing expenses. Some business owners prefer this way of funding, while others choose it after getting turned down for a small business loan. "Credit cards offer quick and easy access to funding, particularly if you are able to pay it off," said Brooklyn Lowery, a credit card expert at CardRatings.com. "It can even out cash flow if you have inconsistent revenue streams."
What is required for a business to set up credit card funding?
Credit cards are a viable funding option for small businesses in part because they are easier to obtain than business loans. Decisions are made quickly, giving you speedy access to credit. Business credit card issuers expect a minimum credit score of around 670, but there is a handful that will accept scores lower than that. The higher your credit score, the lower the interest rate and the more you can borrow. The lower the credit score, the higher the interest rate and the lower amount you can borrow. [Read related article: How to Apply for a Business Credit Card if You Have Bad Credit.]
It's important to think about how you'll use the business credit card when shopping for one. Many come with cash back and reward points on certain purchases, as well as 0% introductory interest rate, signup bonuses, and other perks. If you use a rewards business credit card strategically you can save serious cash on business expenses.
For example, let's say you spend a lot of time in your car for work. You'll want a credit card that offers the best rewards at the gas pump. Or, if your office goes through a lot of supplies each month, a credit card that gives you a high cash back percentage on office supplies may be more advantageous. The idea is to rack up as much cashback reward as you can in a month, being careful not to overspend and to pay off the balance monthly. If you carry a balance, the interest will cancel out the rewards.
How can business credit cards be used to set up other bank accounts?
Credit card funding isn't reserved only for the costs associated with your business. It can be used to open other bank accounts.
Some business bank accounts have a minimum balance requirement. If you don't have the cash on hand, some banks will allow you to use a credit card to meet the minimum deposit. Check with your bank to determine if your credit card company considers credit card funding a cash advance. The interest rate on cash advances is typically higher than for a credit card transaction.
Should you use credit card funding for your business?
Whether or not credit card funding makes sense for your business depends on your cash flow, business situation and the amount of money you need to borrow. In some instances, it can benefit your business, but in others, it could be the beginning of your business's demise.
When does it makes sense to use credit card funding?
Here are four situations where it can make sense to use credit card funding:
You have uneven cash flow. A credit card can fill any gaps while you await payments from your customers. "With credit cards, if you know you have money coming in the middle of the month and you have expenses at the beginning of the month, you can handle those expenses," said Lowery. "That's a huge pro of using credit cards."
You need a funding reserve. Credit card funding also makes sense if you want to use it for emergencies, to purchase new equipment or to chase a growth opportunity. "Many small businesses have a credit card for additional liquidity, to cover inventory, equipment and marketing," said Ken Alozie, managing director at Greenwood Capital Advisors and a SCORE mentor. "Ideally you aren't using it to fund the entire business."
You don't need too much cash. Credit card issuers aren't going to give you an unlimited line of credit. They are going to cap it, typically around $50,000. If you need more than that, you'll have to apply for multiple credit cards or consider alternative funding. But if you need less than $50,000 and can't get approved for a bank loan, a credit card is a viable option.
- Your business will benefit from the rewards. Business credit card issuers are vying for your business and will throw generous rewards your way to get your business. As long as you pay off your balance each month, those cash back percentages and reward points can make your money stretch a little further. [Ready to shop for a credit card? Check out our guide to choosing the best business credit card]
When you should rethink credit card funding?
Credit card funding is a quick and easy way to access capital for your business, but it doesn't make sense for every business. Here are three instances when credit card funding isn't your best option:
- You carry a balance or can't pay back what you owe. If you're unable to repay your balance in full, the fees and interest you'll incur can create a debt trap that can be extremely difficult to get out of."Interest rates on credit cards are incredibly high, much higher than a traditional loan with a bank," said Lowery. "If it's not for something you can pay off right away a credit card is not the right thing for you."Business credit card APRs range from a low of 14.21% to a high of 22.16%, which is quite a bit higher than Small Business Administration loans that have APRs ranging from 7.75% to 10.25%.
You need more money. Business credit cards have lower lending limits than loans. If you need more than $50,000, a business credit card may not be a viable funding option. Also, if you're using credit card funding for payroll or to keep the lights on you may want to consider other options since you don't want to accrue debt that you can't pay back.
- You don't have collateral. Business owners may be required to put up a guarantee which could include a home, vehicle or real estate property."If things fall apart and your business fails, your business isn't on the hook for the credit card, you are," said Lowery. "That changes as a business gets bigger but not for most small businesses."
What are the alternatives to credit card funding?
If credit cards don't make sense for you, there are several other funding sources. Here's a look at five popular options:
- Business loans. Offered by banks, credit unions and online lenders, small business loans are term loans that have either a fixed or variable interest rate. Loans can have terms of as short as six months to as long as five years. The interest you pay depends on your credit score and your business's finances.
- Venture capital: If you're operating in a high growth industry and are doubling – if not tripling – your revenue, you could raise venture capital. With this form of funding, venture capitalists invest in your business in exchange for a minority stake in the company. Technology draws the lion's share of VC interest, but other high growth industries can raise venture capital dollars.
- Crowdfunding: Crowdfunding platforms enable individuals to invest in a startup business in exchange for merchandise or a piece of the business. Crowdfunding is a great way to raise a small amount of capital or test out a business idea or product. Be mindful of the fees and rules of the platforms; some won't let you access any money unless you raise the total amount of your campaign goal.
- Invoice factoring: With invoice factoring, you sell your invoices to a factoring company and get immediate access to cash. You don't have to wait days, weeks, or months to get paid, but it does come at a cost. Factoring companies charge either a variable or fixed rate, depending on the industry you're in.
- Merchant cash advance: A merchant cash advance is a loan that you repay through your with a percentage of future credit card and debit card sales or via daily or weekly fixed payments.