Should you fund your startup business with a credit card?

As any entrepreneur knows, one of the most challenging aspects of getting a new business off the ground is having adequate cash flow for growth. Securing financing can be a struggle, which is why many small-business owners turn to their credit cards as a significant source of financing.

“I’ve heard a lot of stories about startups that were floated on credit cards,” says Paul Downs, author of “Boss Life: Surviving My Own Small Business.” “But that’s survivorship bias. No one pays any attention to the people who went down that road and didn’t succeed. I’d imagine there are a lot more stories like that than the huge success stories.”

Credit card financing, despite its popularity among startup founders, does carry some risks. Here are the benefits, drawbacks, other financing options and what you need to know if you charge ahead:

Benefits of using a credit card to finance a startup

The most obvious advantage of credit card financing your startup is that it’s easily obtainable if you already have good credit and credit cards in your name. But there are also some other not-so-obvious benefits:

All you need is a good credit score

“Credit card financing is low-doc,” says Dallas-based small-business funding expert Myra Good. Issuers “don’t care if you started your business yesterday. They’re looking solely at your credit score. A lot of business owners like that.”

If you’re able to pay off your balance in full each month, a business credit card also can provide lucrative rewards. These cards typically have higher credit limits than personal cards, and they often allow you to add employees as authorized users.

You can use credit cards as a strategic tool to manage cash flow

Ken Wentworth, owner of Wentworth Financial Partners, advises small-business clients to wait until the due date on an invoice and then pay it with a credit card.

That could potentially provide you 60 days after a purchase until you need to pay for it, assuming a 30-day invoice period and a 30-day credit card statement cycle.

Wentworth also has worked with clients who use 0% interest credit cards with long introductory periods to provide startup funds for new businesses.

“You can have interest-free money for over a year, but you have to build the payments into your budget so that it’s paid off before the introductory period is over,” he says.

Drawbacks of using a credit card to finance a startup

For many entrepreneurs, using credit cards as a main form of financing is risky. Learn what the risks are and if you’re up for the challenge:

You could end up personally responsible for your business’s debt

If the business fails, you’ll be saddled with debt for which you are personally responsible – regardless of whether you have taken out business or personal credit cards.

That’s because both types of cards normally require a personal guarantee.

If you’re using credit cards for long-term expenses, it can be an extremely expensive way to access cash. The average annual percentage rate on credit cards is about 16%, which is around double what you’d pay for a loan backed by the Small Business Administration.

Using credit cards could foster sloppy financial habits

If you’re prone to putting off payments, using credit cards to finance your business could negatively impact your not-so-great financial habits.

“If you don’t pay the card off in full, that just compounds the cash flow problem,” says Krista Tuomi, expert on entrepreneurial finance.

When you take out a business loan, in contrast, you need to set aside a certain amount every month to pay it – and you don’t have the option of making a minimum payment when cash is tight. That forces you to maintain adequate cash reserves.

Tips for using credit card financing responsibly

If you do decide to finance your startup with credit cards, keep in mind these “musts” for doing it responsibly:

• Make your payments on time, every time.
• Try to pay more than the minimum amount due whenever you can – and ideally pay off your entire balance each month – to avoid interest charges and fees.
• Read your credit card agreement carefully so you are aware of its terms.
• Stay below your credit limit to keep your credit utilization ratio (the amount of credit you’re currently using divided by the total amount of your available credit) low.
• Review your monthly statements to make sure they are accurate and dispute any charges that aren’t.

Other startup funding options to consider

Using a credit card isn’t the only way to raise capital for your startup. A few other options include:

Peer-to-peer lenders

This is an option to consider if you don’t have strong enough credit to get a bank loan.

In peer-to-peer lending, the money comes from investors who make money by receiving interest on the loan. Prosper and Lending Club are two peer-to-peer lenders that offer small-business loans, and the sites offer tools you can use to ascertain what your interest rate would be.

For example, a business owner with excellent credit seeking a $40,000 loan for his or her business on Lending Club might be offered an interest rate of 6.83% and an APR of 9.61% (which includes a one-time origination fee of 4%, or $1,600, collected out of your loan proceeds and used to pay Lending Club as a fee for its services).

A bank loan

You’ll go through a more rigorous credit check than you’d need for a credit card if you apply for a bank loan, and you’ll need to provide some sort of collateral to secure the loan. The bank also may require a business plan to evaluate your business potential.

For example, to qualify for a Bank of America Business Advantage credit line or term loan, you’ll need satisfactory personal credit (typically defined as a FICO score greater than 670), at least two years in business under existing ownership and at least $100,000 in annual revenue.

Sell equity

Angel investors may provide funding, but they also typically want some say over business operations. That can benefit you if they bring valuable business knowledge to the table, but it can backfire if you end up clashing.

There’s also the risk of giving up too much equity in exchange for investors’ money. Getting good financial advice is a must if you go this route, and that often means springing for a lawyer with experience in startup financing.

Borrow against your receivables

If your customers pay you after you have worked with them, such as a professional services firm, you may be able to borrow against your receivables.

If you go this direction, it’s important to understand that the company will deduct its repayment amount directly from your business bank account in set amounts each week until the loan is repaid. This can leave you in a situation in which you are low on cash for the duration of the loan unless your future cash flow is steady.

Crowdfunding

Running a campaign on a site such as Kickstarter or Indiegogo is another option, particularly for product-selling entrepreneurs who are very active on social media and can generate interest quickly.

Such sites rely on donation-based crowdfunding, so you don’t have to repay donors. However, it’s common for companies to use the cash as preorders for products.

Bottom line

If you do decide to charge ahead, consider opting for a small-business credit card instead of a personal credit card. A small-business credit card will make it easier for record-keeping and tax purposes to separate your business expenses from your personal charges.

The downside of business credit cards is they don’t offer the same consumer protections offered by personal cards. So, if you consider a business card, make sure you shop around to find the best one for your business’s needs.

“If you think you’re going to carry a balance from time to time, look at the interest rate,” says Gerri Detweiler, head of market education at Nav, a credit service for small-business owners.

“If you’re someone who hates debt and is going to pay in full, go for a card that offers rewards. Sign-up bonuses can be very good on business cards,” she added.