Mohnish Pabrai reached an impasse in his corporate career in 1990. As a single guy with few fiscal responsibilities, it seemed the best time to start his own business. He collected $45,000 in credit on 14 credit cards and started TransTech Inc., an IT consulting firm in Downers Grove, Illinois.
After two years in business, Pabrai had clients--but no cash flow. To keep his tech venture going, he dove deeper into debt by convincing four friends to lend him $5,000 each from their credit cards. "And they were insane enough to do it," jokes Pabrai, 34. "When minimum payments came due, I would go to the next card and take a loan. I never missed a payment, so there were never any credit [problems]."
Pabrai's gamble paid off: He cleared his debts, and today, TransTech is a $30 million company with 250 employees. But not all entrepreneurs are so lucky. Credit cards may be the easiest attainable form of financing, but they come with a price: hefty interest rates, dozens of bills to juggle, and a possible 10-year purgatory of bad credit reports if you get in over your head.
"Entrepreneurs need to be careful they don't confuse their hopes with the true likelihood of growth in a business. When you get a loan from a bank, [you have] to develop a business plan with clear objectives and you go through it with somebody else," says Todd McCracken, president of National Small Business United, a small-business advocacy group. "That's usually a reality check people who use credit cards don't have."
But when banks say no and credit card companies say yes, should you go for it? "Many start-ups today don't have enormous capital needs. If you need a computer and some office furniture, it's not worthwhile to go to a bank," says McCracken. "But if you're going to be operating at a loss for some time and you're making upfront investments, you're going to have to get a pretty high rate of return on those investments to pay off 18 percent [interest on credit cards]."
Establishing debt seems to be an easier task than establishing credit, so before you fill out any of those ubiquitous card offers, plan your expenses and potential cash flow carefully to see whether the downsides of credit cards (interest rates of 18 percent and higher) are worth the upsides. ("You're breathing? Here's your platinum card.")