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As banks battered by risky mortgage loans tighten lending standards, small businesses are financing their operations with credit cards rather than fixed-rate loans.
James and Heather Hills turned to credit cards in early 2006 to get their Elgin, Ill., startup -- MHN Internet Marketing and PR -- off the ground after three loan officers told them that they wouldn't qualify for a bank loan without capital equipment to put up as collateral.
So the Hills, who have no outside employees, took out two personally guaranteed small-business credit cards as well as a $50,000 home equity line of credit.
The Hills had a handle on their debt until a partner abandoned a planned joint venture in March 2007 and the couple were left with almost $10,000 for the project on their Advanta card.
Since then, they say they've been late on a couple of payments, and their interest rate has steadily increased from 11.74% to 30.99%.
"It suddenly starts being several hundred dollars' worth of interest charges," James Hills says.
Even without new purchases, they don't expect to pay off the remaining debt, still more than $6,000, before 2009. (Advanta, citing privacy laws, declined to comment.)
While figures on small-business borrowing are scattered, indications are that entrepreneurs are increasingly relying on credit cards to finance their businesses, especially early-stage companies.
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A Federal Reserve survey showed that the percentage of firms using business credit cards jumped from 34% in 1998 to 48% in 2003. And numbers from the NSBA and the Fed show that between 20% and 30% of small businesses carry a revolving credit card balance, rather than paying their bills in full each month.
"We don't have an alternative right now," says NSBA chair Marilyn Landis, a former bank executive who now runs Basic Business Concepts, a financial consulting business. "If there were alternatives, business owners would go there."
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Fed floats credit card reformThe proposal, unveiled in May, would restrict rate increases on outstanding balances and revamp other lending practices. But banks and other card issuers vehemently oppose the plan.
In testimony before the Senate Small Business Committee in April, Landis described applying for bank lines of credit and receiving credit cards instead.
But relying on cards, rather than on fixed-rate loans or credit lines, can saddle small companies with unexpected and expensive debt.
Over the past decade, credit card companies have courted small-business owners as issuers try to expand beyond the saturated consumer card market.
Some 12% of the 6 billion credit card offers mailed each year promote small-business credit cards, according to Mercator Advisory Group, an industry researcher. That's 720 million offers, or roughly 26 for each small company in the United States.
"As issuers have discovered the small-business segment, they have become fairly aggressive about getting small-business cards into the hands of some very early-stage businesses," says Mercator analyst Ken Paterson.
Continued: Small businesses are a fertile market
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