When it comes to financing a brand-new startup, most founders find themselves stuck between the proverbial rock and hard place. While some lucky startups attract angel investors or have access to money from friends and family, the vast majority are on their own, at least at first. That’s why it’s so tempting to use credit cards to jumpstart your business. Entrepreneurs who’ve maxed out their cards warn that while it may be necessary, it can also be dangerous.
The relatively low cost of starting a tech business today has made this choice more enticing than ever. If you need only $5,000 or $10,000 to get going, is it worth the risk to put it on your cards? “I’m seeing more people using credit cards for financing,” says David Worrell, founding partner of Rock Solid Finance, which helps business owners find solutions to their financing problems. “These days nobody’s got any collateral, so it’s a choice between cash and credit cards.”
Beware Revolving Credit Charges
When Bob Herman founded Tropolis Group in 2010, he decided to finance with credit cards so he could take advantage of a cash-back rewards program and use the bounty to buy supplies for the business. So far, Herman has put about $60,000 on his credit cards, using them mostly to finance software development.
To ensure he didn’t get in over his head, Herman says, “I only put monies on the credit cards for which I know I have corresponding payments due from customers. I then pay off the cards in full each month to avoid the high interest on revolving credit.”
It hasn’t all been smooth sailing. “At one point, we had a customer not paying their bills on time for which we had already placed funds on a card,” Herman says. After diligently following up for payment, eventually he got the customer to make most of the payments. “I did have to write off a portion of the receivables but was able to recover the following month using revenues from other projects.”
“I advise using revolving credit only if you will receive value from a cash-back or points program, and if you’re sure you can pay off the balances in full each month to avoid high interest charges,” says Herman. The strategy has paid off for Tropolis Group, which now includes AppTropolis, BagTropolis, IT Tropolis and ShipTropolis. Sales have doubled year-over-year since launch, and Herman expects them to double again in 2012.
Don’t Forget to Pay Off Your Cards
Vincent Turner, founder and CEO of Planwise, a startup that helps people better visualize the future financial impact of their life plans, learned the risks of financing with credit cards the hard way from a previous startup. Before getting venture funding, Turner had used a personal credit card to get the company going. When a group of investors bought out the original investors in 2010, he recalls, “they raised heaps of additional money, but were never prudent enough to pay off the $8,000 debt on my credit card.”
As the company began to flounder, Turner stepped back, not realizing the investors had never paid off his card - they were just servicing the debt. When the business went bust, responsibility for the card debt ended up back with Turner: “Now the bank is hounding me for full repayment.”
The experience shaped how Turner funded Planwise. “We never make any commitment to spend money unless it is fully funded,” vows Turner, who financed the startup himself and then secured angel investors. He does have a business credit card, but its credit limit is $5,000 and he uses it only for small purchases.
Both Turner and Herman are playing it smart, according to Worrell. “As a tool to help you grow or manage your finances, I think a credit card is even more essential than ever,” he says. But you need to be careful about how much you spend, and never charge more than you can afford to pay off.
Also important: “Always match the source of money with the use,” Worrell advises. “For example, use a credit card for short-term [needs] and pay it off in the short term.” You shouldn’t use credit cards to pay salaries or rent, but you could use them to buy supplies or finance a short-term project.