Everyone loves a good entrepreneurial “I started my business by maxing out my credit cards and investing in my dream” success story. But is that really the best way to begin your new career?
In 1987, actor/producer Robert Townsend was lauded for his breakout film “Hollywood Shuffle.” To get it made, Townsend maxed out his credit cards to cover about $50,000 - $60,000 of his $100,000 production costs. All the traditional sources – bank loans, small business loans, private investors, private equity, etc. – were closed to him, leaving credit cards his only choice. The result? The film made $5 million and launched what has become a very successful career for Mr. Townsend.
There are hundreds of stories of energetic entrepreneurs taking the leap and hitting it big via this method. Unfortunately there are tens of thousands of small business owners who end up ruining their businesses, and sometimes their financial lives by misusing credit cards as a business funding source. Credit cards can be useful tools, but carry great risk.
We’ve guided many small business owners through the process of figuring out creative funding sources, and every business and person is different. Critical factors one should consider (beware of) include:
Personal liability: What happens if you default? Is the debt confined to your business assets? Or your personal assets, too?
Introductory rates: 0% sounds awesome and rolling credit card to credit card looks enticing, but some firms charge 3-4% transfer fees and those rates can skyrocket after the introductory period.
Credit rating: What could it do to your credit rating? Even if you use the cards carefully and pay off the debts, rolling up credit card debt and opening several accounts can impact your scores significantly.
Management: Is this a controlled, short-term bridge, or a hopeful stretch? Credit card debt can compound quickly if not managed carefully.
While small business funding via credit cards sets off a lot of alarm bells for us as consultants, they may be a viable option in certain cases. Our advice? Have a plan – a specific plan – for quickly paying down the debt, and even then only when you have a relatively certain cash inflow coming that bears little risk. Credit cards, in our opinion, should only be used to bridge timing of flows – not used as investment vehicles. Our other advice? Discipline, discipline, discipline. Make a plan, stick to it, and make credit card funding a rarely used tool.
But we’ll be the first in line for your movie premiere.