Using Credit Cards to Fund Your Business

Know the risks you face before you take the plunge into credit-card debt.
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Most surveys of entrepreneurs show that are among the most popular sources of startup financing. The Pioneer Institute , for example, found that loans from relatives and borrowing against credit cards were the two most common financing techniques used by startups with less than five employees. Despite this high rate of usage, the terms of credit-card financing are poorly understood. How many entrepreneurs take the time to read the card issuer's Terms of Use when they respond to a new credit-card offer in the mail? This month's column provides some guidance to entrepreneurs who plan to use credit-card as a financing technique and wish to understand the implications of its personal guarantee.

Most entrepreneurs shudder when faced with signing a personal guarantee for a for the first time. I've never really understood how banks can market a product as a "business line of credit" when it's really a personal line of credit. However, since the vast majority of businesses in the country are sole proprietorships, the difference between personal credit and business credit is murky from a bank's perspective. Unless your business is incorporated, you're the de facto guarantor of all business debts. So if your business has a slow sales quarter and you fall behind on your credit-card payments, your personal credit rating and your personal ability to borrow are at risk. (For more information on how to build your business's credit score, read " Do You Need Excellent Credit to Start a Business? .")

Even if your business is incorporated, your bank or credit-card issuer may still require you to guarantee the business line of credit. In practice, most banks require shareholders with significant ownership in corporations to guarantee business lines of credit--typically owners with more than a 25-percent stake are required to sign guarantee forms when credit lines are more than $5,000. Moreover, most guarantee forms require joint and several liabilities, implying that all guarantors are responsible for the whole amount of the debt, even if they're not full owners of the business. The guarantors can be sued individually or all together. (This tends to vary from state to state, so check with your attorney for details.)

If you're attracting new partners to your business, be sure to include a provision in the partnership agreement that commits them to accept a personal guarantee on all existing business debt. In many states, new partners aren't automatically responsible for previous debts, so this issue must be addressed specifically. The goal is to spread the liability as widely as possible to reduce the risk to any one individual.

Keep in mind that if you're establishing a credit line with a community bank or local small-business lender, there may be some room for negotiation. For example, it's possible to request that certain personal assets be excluded from the guarantee or that the guaranteed percentage of the loan declines as the business matures or surpasses a certain net-worth threshold. Private loans from relatives and other business associates are also subject to negotiation. However, for credit-card issuers, the offer for business credit is usually a take-it-or-leave-it proposition--and you must accept the personal guarantee if you want the card.

For small businesses struggling to find funding, borrowing against a credit card can be an attractive--if not the only--option. Plunging further into credit-card debt is a scary proposition, but for many the outcome has been rewarding. If you feel using a credit card to fund all or part of your business is the best option for you, be sure to read the fine print before responding to your next credit-card offer in the mail. Understanding the risks before you accept the offer can save you a lot of financial pain in the future.

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