Getting ready to launch a startup can be an exciting venture — a time filled with grand expectations and a flurry of activity as you work to get all the details in order, including how to cover your business-related expenses.
According to a 2020 survey of 501 startup business founders by market research firm Clutch, 13% financed their initial expenses with a credit card. But is this a good idea? Although paying with plastic has its advantages, it also has its drawbacks.
Pros of Paying for Startup Expenses With a Credit Card
“There are a few key benefits to funding a startup with a credit card,” said Michael Ryan, financial coach and owner of MichaelRyanMoney.com. “First, it can be a quick and easy way to get the money you need to get your business off the ground. Second, it can help you build up your credit history and establish a good credit score, which can be helpful in the future if you need to take out a loan for your business. Finally, using a credit card can help you keep track of your expenses and budget for your startup more effectively.”
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Cons of Paying for Startup Expenses With a Credit Card
“However, there are also a few drawbacks to using a credit card to finance a startup,” Ryan said. “First, it can be difficult to qualify for a credit card with a high enough limit to cover all of your startup expenses. Second, if you are not careful, you can easily rack up a large amount of debt on your credit card, which can be difficult to pay off. Finally, you may be charged higher interest rates on your credit card debt than you would on a loan, which can add to the cost of your startup.”
Rachel Burk, financial advisor and financial planning specialist with Offit Advisors, offered these cons of using credit cards to pay for startup expenses.
“Credit cards have high interest rates,” Burk said. “Even credit union cards have rates of 7%, which means it’s much easier to get into exponential debt more quickly. Credit cards are also likely to be in the business owner’s name, as new businesses don’t get extended a high limit very often, which means you are racking up personal debt, not business debt. Personal debt cannot be discharged later, even if the business fails.
“Another real drawback isn’t in the idea to fund with credit cards, but what it signals about the underlying business model. This means the model doesn’t have anyone who is willing to sign off it — not the business owner, not his friends or family, not a bank. If someone told me they were funding an initial business idea on credit cards, I would suspect the idea of not having enough solid ground or legs to get funding from a bank or business loan funding source.”
The Bottom Line
Now that you’re aware of the pros and cons of using a credit card to pay for startup expenses, should you? Here are some final thoughts from financial experts to help you make up your mind.
“I think you can get away with funding some of your business expenses on a business credit card,” said Jake Hill, CEO of DebtHammer. “Be sure to get one that gives you cash back or some other perk for use, then you can use it for purchase orders, equipment and other business expenses.
“I would never use a credit card to cover payroll unless you’re desperate. And use of a credit card should be contingent upon being able to pay off that card regularly. If you think you’re going to need to rely on it long term without paying it off (and you have a high interest rate), you’re better off getting a business loan.”
Carter Seuthe, CEO of Credit Summit Consolidation, had a similar take: “The answer to this question really depends on your turnaround time,” he said. “If you’re going to be building out your business for months or years before you can expect reliable returns, that’s simply too long to carry large balances on your credit card with the interest rates you’ll be paying. They’re much better suited to being a bridge option to let you make up-front purchases when you’re expecting more income within a month or two.”
Jay Zigmont, Ph.D., CFP(r) and founder of Childfree Wealth, leaned heavily toward not using a credit card to fund your startup expenses. “In general, you should be starting a business with cash, not credit or loans,” he said. “When you start a business with loans or credit cards, you are responsible for the debt, even if the business does not succeed.
“While using a credit card might look like a simple solution, it is one of the highest interest rate debts out there. If you can pay off the credit card completely each month, you might be able to use it to float a purchase, but be very careful.
“If you must take a loan to start your business, look at options provided by the Small Business Administration (SBA) as they will have a much lower interest rate.”
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This article originally appeared on GOBankingRates.com: Should You Pay for Startup Expenses Using a Credit Card?