You have a great idea for a business, now how do you pay for it? Financing a startup requires some important decision making, and the choices you make now are likely to impact the business (and your personal finances) for years to come. As banks give out fewer loans, entrepreneurs are increasingly turning to credit cards for business owners to finance their endeavors.
But before you dash out and apply for a new credit card (or three), take a close look at your options, the risks you’re willing to take, and the ways your business can benefit if you use credit wisely.
What are your options?
Financing your new business with a credit card comes along with a number of risks. Make sure you consider your options before taking the leap.
Among the options out there are investors, government grants (if you’re starting a nonprofit organization), and small business loans through banks and credit unions.
If your business is for-profit, and you don’t want to go the investor route, take a look at the possibility of a small business loan. While large banks’ approval rates have dropped into the single digits since 2008, community lenders and credit unions have much higher approval rates, at around 40%. If you can get a loan, you may be able to snag lower interest rates, but you’ll also likely be forced to borrow a set amount of money. If you borrow more than you need, you’ll end up paying more in interest.
Is financing with credit right for you?
Some people are better candidates for financing with credit than others. Take an honest look at your financial history and where your personal finances stand. If you already have an excellent credit score, you’re more likely to have access to great interest rates, something that will be critical to the success of your financing endeavors.
Are you financially stable? If you’re currently in debt, or you anticipate having large expenses come up in the near future (do you need a new roof? Is your kid headed off to college?), you should probably avoid adding more financial liability to your plate.
If your finances are in order, ask yourself what you can really afford to pay each month. Really. Then stay below that amount no matter what.
Anticipate the worst
I hate to be a downer, but it’s true. Expenses will sometimes be higher than you bargained for; clients may pay late, products may fail, interest rates may rise, and credit limits may suddenly drop. It’s absolutely critical to be prepared. If you’re financial stability rests on an ongoing best-case scenario, you’re in for some unpleasant surprises down the line. Ideally, come up with a plan that allows for unexpected cost increases, and save an emergency fund to cover the business if things go wrong.
Use the card to your benefit
If you do decide that financing with credit is the right choice for your business, there are steps you can take to minimize the risk and maximize benefits. Make sure you read the fine print, so you know how long the rate is fixed for.
If possible, get a small business credit card, as opposed to a personal one. This will likely give you access to lower interest rates and may also offer rewards on business-related expenses. For example, you may be able to snag 5% cash back on certain business purchases, or earn miles or free hotel stays that will help cover business travel costs.
Using separate credit cards for business and personal expenses makes it easier to keep track of what’s what in your finances. You’ll have an easier time when tax season comes around, and you won’t have to disclose your personal finances if the business gets audited.
Applying for a business card instead of a personal one may also allow you to avoid making a personal guarantee, thus protecting your own credit and assets should something go amiss with the company. Keep in mind that this is only likely if your company has already built strong credit, or if it has substantial revenues.
Tim Chen is the CEO of NerdWallet, an unbiased resource for business and personal credit cards.