In most circumstances, an entrepreneur should not use a credit card instead of a loan to fund a startup and its expenses because the drawbacks of using a credit card usually outweigh a credit card’s benefits.
The major benefit of using a credit card instead of a bank loan is that a credit card makes it easy to obtain about $10,000 of credit without having to go through a cumbersome and restrictive bank loan approval process.
Another benefit is that the credit card will be widely accepted by suppliers of products and services needed by the entrepreneur. Also the credit card will allow the entrepreneur to initially just make small monthly payments so that they have time to start generating a profit to repay the credit card.
The major drawback of a credit card is the extraordinarily high interest rates that accrue if the credit card balance is not paid off in full each month.
The annual interest rates on credit cards are generally 10-18 percent higher than the interest rates on a typical bank loan. Also, if any credit card minimum payment is not paid on time, the credit card company will usually charge a late fee of about $25 for every late payment.
The extra 10-18 percent of interest and late fees are very expensive for the entrepreneur. Having to pay the interest and late fees results in the entrepreneur not being able to use those amounts to hire employees, make investments, or to take a salary.
Another drawback of a credit card is that the available funds are too limited, as most entrepreneurs will need much higher available funds to start a business, so the entrepreneur will still need to obtain bank loans or other types of funding.
Therefore, for entrepreneurs who just need about $10,000 of cash and will be able to repay the $10,000 in a few months, the benefits of using a credit card will probably outweigh the drawback of the high interest rates.
For all other entrepreneurs, however, the drawbacks of the high interest rates and limited funds will outweigh the benefits, so financing a start up with credit cards should be avoided.
Donald Williams is the founder of Williams Accounting & Consulting.