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As if small business weren’t hard enough, now the credit card squeeze is on

The credit card grave
The only good credit card . . .

In a previous post, I discussed how the new credit card regulations would affect small businesses and entrepreneurs, but solely from the customer side. But not only has the recession squeezed small business from the demand side, it’s actually tightening the noose from the supply side, as well, since so many businesses use credit cards for what amounts to short-term business loans. And, as outlined in today’s New York Times, the credit card squeeze is having a signficant effect on the economies of small business and startups.

As 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 profit margins, borrowing money at 14%, 18%, or as high as 36% interest is a money-losing proposition. Most importantly, however, the terms of credit card debt is subject to change at will by the debt issuer. To requote myself:

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. . . .

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

Outside of temporary cash crunches where you need the debt and plan to pay it all off within a few weeks, there is no compelling reason to rely on credit card debt to finance operations.

If you don’t believe me, the New York Times tells the cautionary tale of home decor manufacturer in Florida:

Traditionally, she has relied on her credit cards to purchase inventory, which she then paid off as her customers settled their accounts.

But last fall, Ms. Macone, who took out a credit card with Advanta, opened her bill to find the company had raised her interest rate above 30 percent. A short time later, Advanta reduced her spending limit from $30,000 to $5,000. “When you have a business, it’s like, ‘$5,000? Please, what good is that?’ ”

There is no rational way to finance a business when your cost of capital is around 30%. Operating margins would have to be somewhere in excess of 60% or more. And there’s no possible way to plan a business when the capital rug can be pulled out from under you . . . sometimes without you even knowing it!

And just in case you thought the Democrats and the Obama Administration were rushing to your rescue with their credit card reform legislation, that bill applies only to consumers. None of its provisions limiting interest rates or credit card terms applies to small businesses (unless, that is, you’re running your business on a personal credit card, something that your lender, if it found out, would probably put a stop to).

All the more frightening, then, that according to Nielsen Research, over 59% of small businesses rely on credit cards to fund their daily operations, up from 44% just a few months ago. Over 12% of small business credit card loans are now in default and lenders are severely contracting credit limits. Over 75% of small businesses have seen their credit limits reduced — many of them are still good payers and borrowers. As the percentage of small businesses using credit cards as loans increases, the credit limits will shrink further.

And just in case a small business owner turns to a small business loan — where money is drying up, as well — they find themselves with a lower credit score. Why? Because their credit card issuer lowered their credit limit, automatically pushing their credit score down.

There are legitimate uses of credit card debt in running any business, from a home-based business to a Fortune 500 megalodont. But actually your financing your business by regularly purchasing inventory, regularly making payroll, or financing a growth project, puts the business on very thin ice.

For many, then, the credit card squeeze can be a good thing, weaning their business off of credit cards. The woman featured above, for instance, has cut back her staff. She and her husband do most of the work — in the long run, that will help increase her margins and stabilize the financial health of the business. If, that is, she survives the recession.

As for consumers who’ve been caught in the credit card bear trap, credit cards are “too good be true” for small businesses. If you’re finding yourself squeezed, don’t give up. Just get even.

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