We all hear about, and read the success stories of, entrepreneurs who maxed out their credit cards to fund their start-up costs. But the reality is, these are edge cases. In fact, research has shown that, for every $1,000 increase in credit card debt, the probability that a start-up will not survive increases by 2.2 percentage points.
In the video segment below, The Motley Fool analysts Michael Douglass and Nathan Hamilton talk more about small businesses and credit card debt, including tips on smart ways to secure growth capital with the right small-business credit card.
Michael Douglass: A really strong indicator that your start-up is going to fail, amount of credit card debt.
Nathan Hamilton: If you look at some of the statistics out there in research, I came across a really interesting tidbit when you look at entrepreneurs and credit card debt. I'm going to read this off here just to make sure that we get the exact details here. Prior research has shown that for every thousand dollar increase in credit card debt for a start-up it increases the probability that it will not survive by 2.2 percentage points.
You look at it with the different forms of capital available for a start-up. Sure, credit cards can serve their purpose. If you have an entry PR or so forth you can float business purchases for that promo period and not pay interest. In that case ...
Douglass: A useful tactic perhaps?
Hamilton: Makes perfect sense, but if your business is relying solely upon credit card debt to fund it, that's a very dangerous scenario. I think most entrepreneurs know this.
Douglass: But it bears repeating.
Hamilton: It does. If you look across the internet what we see are always the success stories. You always hear about that entrepreneur that leveraged their business and said, "I maxed out my credit cards. Look where I am today."
Douglass: Had 30 cents left and then they got their first sale and everything just went from there.
Hamilton: Of course, you're hearing about that because they are successful, they're more popular say on the internet, they're going to get more in front of more people. You don't hear about all those non-successful stories where people did max out their credit cards and then went bankrupt.
Douglass: This brings us to a really important point, which is that usually there's a personal guarantee attached here?
Douglass: Card holders are personally liable for the debt on a business card in almost small business instances, meaning that you leverage yourself to the hilt with this small business. This is false.
Hamilton: Not your LLC that earns it.
Douglass: You're still paying.
Hamilton: Yeah, there's personal guarantee on it, so regardless you almost will get it as consumer debt, though. It's not legally classified as that. It is something to consider and place it in context. We've got some numbers here worked out. If you have a $25,000 balance, that would take you about five years to pay off and interest charges will amount to about $18,127. That's out of 25% APR, which is on the higher end of credit cards, but it is something that entrepreneurs that maybe have a higher risk profile, that maybe the APR that they are receiving with a credit card.
Douglass: Of course that's assuming that you're making the minimum payments to pay it off in those five years?
Douglass: The other piece is you hear $25,000 and you say, "Oh, that seems like kind of a lot of money." The average business, the average start-up takes like $29,000.
Hamilton: Not enough to get you started.
Douglass: Exactly, and particularly if you're in restaurant or retail or something like that, it's a lot more than that. That $25,00 is probably conservative, and turning $25,000 into over 43 grand that you end up having to pay, particularly if the idea doesn't pan out, it's a big, big risky proposition.
Hamilton: It is, absolutely.
Douglass: Again, like we said earlier, it does make sense in certain cases to perhaps have a 0% APR intro card. Maybe you can float for 12 months you can float certain purchases on that while you're kind of getting your cash flow setup and going. That's debt you're generally going to want to pay off first if you can because it's going to just go from zero to 20% or 25%.
Douglass: Or whatever, some really high number as soon as that promo period ends. We've got a lot more information about business, about small business, about credit cards, about small business credit cards at fool.com/businesscreditcards, so check us out there. We've got a lot more information sort of to help people as they're thinking through potentially this encore or different career and this opportunity. It's a really exciting thing here at the Motley Fool. What we're really excited about is making sure that people are doing it as intelligently as possible.