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Credit Cards Increase Risk of Failure for Startups

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iStock_000004542387XSmallIs your startup carrying a balance on its Visa? If so, you’d be well-advised to get it paid off. Credit card debt reduces the likelihood that a new business will survive its first three years of operation, according to a study released today by the Kauffman Foundation; it found that every $1,000 increase in credit card debt increases the probability a firm will close by 2.2 percent. However, to be clear: No relationship was found between using credit card debt to start a business and that business’s survival or closure.

The key appears to be how startups handle their debt, in particular when they’re able to pay it off. Of course, the ability to repay debt has always been tied to the overall health of a business, but the report makes clear that a higher balance is linked to outright failure. And it comes just as venture firms are putting less money into startups and banks are shying away from small business loans — forcing entrepreneurs to turn to credit cards. About 58 percent of the firms in the survey sample used credit cards in their first year of operations.

A June report published by the U.S. Small Business Administration Office of Advocacy notes that small business lending has decreased for loans between $100,000 and $1 million in value. Between 2007 and 2008 (the time frame measured in the most recent report) the number of loans fell by 23.3 percent, to 2.2 million from 2.9 million. When it comes to those under $100,000, the number of loans actually rose, by 15.7 percent, but the group believes such an increase can be attributed to continued efforts to promote small business credit cards. Which makes this research even more relevant.

6 Responses to “Credit Cards Increase Risk of Failure for Startups”

  1. I always tell startups, get an American Express. It forces you to pay the balance at the end of the month. This is good fiscal training for you to keep your balance sheet healthy.

    Also if you have high expenditures in the long run make sure the “runway” (dollars in bank) can cover them. Borrowing or acquiring a balance on a credit card can help with interim cashflow issues but over time that boulder of debt goes fast and faster as time progresses.

    Be lean and innovative. Make more with less.

  2. Is anyone surprised that businesses that fail have higher debt? Shouldn’t you even _expect_ a struggling business to have higher debt? If they have zero debt, in all likelihood the business isn’t struggling or they’re funded externally. Let’s not put the chicken before the egg when trying to draw conclusions from these expected (newsworthy?) correlations.

  3. Good post, but you’ve got to do what you’ve got to do – including chaining yourself to a boulder. Beans, rice, and Visa if what you’re working on is worth it. For my friends and I, it is.

    Of course, be smart about it. And don’t bury your head in the sand about the costs. imo, CC costs are going to increase dramatically in the next months — so watch for that and track it closely. Use low purchase APR, pay off high — pay just above min if you haven’t a big enough buffer in your bank. Horde cash.