Should you use credit cards to fund your small business?

Have an idea for a business, but not sure how to handle the financial side of launching your own company?

Whether you want to create a product or offer a service, finding funding for your initial costs to get started can present a challenge. You may feel like you have to find investors or a bank (or perhaps even a family member) to grant you a loan. But there are other options, including using a small business credit card to get your small business up and running.

Business credit cards give you benefits that other funding options, like loans, may not offer. But they can also become a burden if you lack a plan to pay off the balance. Here’s what you need to think about before using a credit card to fund your small business, including how it can help you and how to avoid some common pitfalls.

A small business credit card success story

Donovan Brooks used a credit card to start his business, a financial planning practice that serves millennials. Storyline Financial Planning launched in January 2016, soon after Brooks left his previous job.

“Utilizing the [card] for financing allowed me to launch my business as soon as I left my prior firm,” Brooks says. “It also gave me the flexibility to charge what I needed to at my discretion.”

Brooks used a credit card to launch his business because there wasn’t enough time to save for his initial costs, which included a laptop, a website and membership fees to professional organizations.

(Keep in mind that, while he didn’t have the money on hand at the time, he still had a plan to pay off his balance responsibly and before accruing heavy interest charges.)

So why not simply get a small business loan instead of charging these necessary expenses to a card?

“I initially did some research on traditional small business loans,” explains Brooks, “but in the end, I didn’t want to pay the interest on a loan or go through the loan origination process.”

The card Brooks chose offered a 0% introductory annual percentage rate on purchases and balance transfers for the first 12 months, which allowed him to finance his business start-up costs without paying a fee or interest for borrowing money. After the first year, the APR rose, as is often the case when introductory periods end.

He also says the card offered an initial cash back bonus, which a small business loan would not have provided.

Other reasons to choose a business credit card over cash or loans

If you want to launch a small business but don’t have the cash on hand, credit cards can help you finance those first few months — assuming you have a plan to pay off your balances responsibly, of course. But there are other reasons to choose a business credit card over other financing options.

• It may be faster to apply for a credit card. In some cases, you can apply for a business credit card and receive approval within minutes. In comparison, the time it takes to finalize a small business loan depends on the lender’s timeline, and experts suggest planning for a minimum of 60 to 90 days.
• It may be easier, too. When applying for a business loan, you may need to show more documentation than is required for a credit card application. Typical items required for many small business loan applications include personal credit reports, business credit reports, income tax returns, financial statements, bank statements, collateral and a number of legal documents depending on the loan’s specific requirements. While a credit card application will likely ask you for information about your business, it may not go into such depth.
• A credit card offers a revolving credit line. Starting a new business can mean dealing with an unpredictable cash flow. Business credit cards can help because they offer a revolving line of credit; in other words, the credit limit is the maximum that you can use at once, but the credit can be used repeatedly over time. A business loan, on the other hand, offers a fixed amount of money that you pay off in installments. Once you repay the loan, you’ll have to apply for a new loan if you need additional funding.

It’s important to note that a small business loan will likely give you easier access to cash, which you might need to pay your employees or vendors. Business credit cards typically charge a fee for cash advances. Cash advances are also subject to hefty interest charges with no grace period and should typically be considered a last resort.

Assuming you have plenty of cash on hand and don’t need a loan, credit cards can still be the way to go.

“I chose a small business credit card over a loan because I already had the cash I needed to launch the business, but I wanted to take advantage of the perks a reward card offers,” says Dan Kellermeyer, CFP.

Kellermeyer also says relying on a credit card instead of another financing method increased the efficiency of his accounting workflows — which is significant when you operate as a solo business owner in the early stages.

“Everything is online, and my card account even links up to Quickbooks,” which is a big time-saver, he says.

Potential pitfalls of using credit cards to get started

All the upsides of using a credit card to fund a small business don’t count for much, however, if you never generate the cash flow that can eventually repay the balance you put on your card.

“The downsides and pitfalls of using a small business credit card are the same as with personal credit,” says Brooks. These may include the following:

• High interest rates
• Added expenses through late fees
• Potential damage to your credit from carrying a balance or failing to pay your bills on time and in full

“If you don’t have a detailed exit strategy for revolving credit card debt, you could be setting yourself and your business up for failure,” Brooks warns. In his situation, he took precautions by first creating projections to determine if he could feasibly repay what he charged to his card.

He ran the numbers to check if his business could generate enough revenue in its first year to pay off the initial start-up costs placed on the credit card as well as the additional overhead to run the business on an ongoing basis.

What to keep in mind before using a small business credit card

Before following in the footsteps of entrepreneurs like Brooks and Kellermeyer, you should determine if using a credit card to fund your small business makes sense for you. You need a few important things in place before you consider using a credit card over other alternatives:

• First, map out a business plan and financial projections. These should show realistic estimates of the kind of revenue you can generate (and a timeline for doing so).
• When you have this information, you can plan what you can afford to put on your business card.
• Then, you’ll need to craft a debt repayment plan. This is just a way of understanding exactly how and when you’ll pay off your card’s balance after you launch your business.

You should also set aside time set to research all your options for funding your business. You can use anything from credit cards to loans, so you’ll want to compare the pros and cons of each and determine the best resource for your situation.

How to pick a small business credit card

If you do choose to fund your initial costs by charging them to a credit card, you’ll need a card that allows you to make the most of using it.

Look for credit cards that offer a low or 0% introductory APR on purchases and balance transfers. You’ll want to note when that introductory rate expires, and ask yourself whether you can pay off the initial expenses in that time to avoid being charged interest.

You may also want to look for a rewards credit card that offers cash back in categories you spend the most on for your business. This way, you can make the most of every dollar you spend.

Bottom line

When used responsibly, credit cards can be an appropriate option for short-term financing. But due to high interest rates that can cause debt to snowball quickly, racking up a big balance that you don’t repay can be too costly for your new business to handle.

To put it simply, you need a business plan in place before you make charges on a business credit card. Without seeing the projected revenue numbers, you may struggle to figure out how you’ll repay your start-up costs down the line.