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Credit cards and business debt

Louise Crowley in her Freelance Writer Journal has an excellent summary piece on getting credit cards if you’re self-employed. Money quote:

The solution lies in your status as a business in your own right, believe it or not. When self employed individuals apply for credit cards, they are much more likely to meet with success if they do so through their business.

This is true (it has to do, of course, with the risk that’s underwritten for business credit). When I read Ms. Crowley’s post, I realized that, even though Shoestring Venture has an extensive section on debt, its place in a business’s capital structure, and how to manage it, we never talked about credit cards, an oversight that will be corrected in the next edition.

In the briefest possible terms, credit card debt should never be considered debt, at least in the capital structure of your business. Even if you’re a solopreneur. I’ll explain after the break.

Even if you’re operating out of your home, it behooves you to think of debt in the same way the biggest corporate bashers on the block think of debt: as capitalization of the business. Seen this way, debt (and other liabilities) as part of the capital structure of your business is just another investment in your business, an investment by the lender (just like a mortgage is a capital investment in your home, but an investment by the mortgage company, not by you).

Businesses, including solopreneurs, use debt in their capital structure because a.) they pay a fixed price for the debt (interest) and b.) they expect to earn more money than the fixed price. So if you take out a mortgage of $100,000 at 6% interest and then lend it to your business, the business needs to pay out a return greater than the interest you pay on the loan in order to justify lending it to your business. If the business earns 6% on the borrowed money, you breakeven (which means you stay in business, which is an achievement). So the 6% interest you’re payings functions as what finance folk call the “cost of capital” or a “hurdle.” (Usually the “hurdle” is much higher than the interest on the debt in order to adjust for the increased risk of the activities that the business is investing in — so borrowing money at 6% might have a hurdle of an 11% return in order to justify both the cost of capital and the potential risk of the business activity).

It only takes a millisecond of reflection to see why credit cards make bad debt. Outside of the criminally usurious cost of capital (18%, 24%, even as high as 36%), credit card debt is volatile, meaning that you can never set a proper hurdle.

Unless you think God created your business on the seventh day, there is no rational expected return on debt that can clear the cost of credit card debt. There was a time, a long, long time ago in a galaxy far, far away, when credit card debt was reasonably priced (single digits, even) and entrepreneurs, home-based business, and Spike Lee could finance their business or their first film entirely from MasterCard and Visa, but that time has passed away into legend.

But it’s the volatility of credit card debt that makes it bad for business, at least as far as long-term debt is concerned. Credit card lenders have built into their agreements a blank check for charging you whatever they please for the loan. They can charge you any fees they please and any interest they please. Miss your utility bill one month, your credit card company can double your interest.

They also have very liberal and arbitrary call provisions (that is, they can “call” the debt by demanding full payment); most people aren’t aware of these call provisions because credit card companies like to keep super-high interest-paying balances on their books. Other debt, such as small business loans, have call provisions that are precisely spelled out and closely tied to the business’s (or person’s) revenues, capital, or payment history on the loan.

Business finance is about planning. Credit cards are about “gotcha! Didn’t see that one coming, didja!”

Finally, in America, there are liberal bankruptcy protections for all sorts of personal and business debt except for credit card debt. The credit card companies, in their infinite nefariousness, paid the tuition of more than a few congressman’s brats to get a law that essentially (not quite) exempts credit card debt from bankruptcy protection. Even if you or your business files Chapter 7 bankruptcy (total liquidation bankruptcy), you may still emerge from the process with much or all your credit card debt still due.

However, you need a credit card for your business. Honest, you do, no matter how much they scan you. It’s for short-term debt, the once-in-a-while-you-don’t-have-the-money-in-the-bank moment. But, like everything else, it has to be planned so that you never carry revolving debt. Some cards, like American Express, will not allow you to carry revolving debt; I know small business owners that will use nothing other than AmEx for that very reason.

Now, believe it or not, if you are really good at paying off your debt so that you never carry revolving debt, that actually makes it harder to get a credit card. Well, not harder to actually get the card, but the card company probably won’t give you a huge credit line. Why? Because you lose money for them. Credit card companies make money on bad payers, the folks who carry over big balances month after month.

In addition, if you faithfully pay off your full balance every month, a credit card is an excellent tool to establish your and your business’s credit record making other loans, including small business bank loans, more available and affordable.

Don’t: ever finance your business with credit card debt, i.e., don’t ever have a revolving balance.

Do: use a credit card for the occasional pinch and always plan your finances so that you can fully pay the credit card balance each month.

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2 Responses to “Credit cards and business debt”

  1. lorie says:

    This advice is really going to help, thanks.

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  1. [...] readers of this blog are well aware, I’m not a fan of using credit cards to borrow money for a business. First, the cost of capital is too high. Since most small businesses operate on slight to negative [...]


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