More than half a million new businesses are created each year, contributing greatly to the health of the U.S. economy. Unfortunately, the survival rate of business start-ups is not that great. Three out of four make it past the three-year mark, however, less than half (45 percent) make it past the first five years, according to data from the Kauffman Firm Survey.
The most common reason new businesses fail is financial. It is more difficult for start-ups to get access to traditional forms of financing, such as bank loans. Not surprisingly, as a result, many new small businesses turn to credit cards to finance their business ventures. This has become even more so during the recent credit crunch, where even established businesses have faced difficulties in getting credit, not to mention new business ventures.
However, according to a recent study by the Ewing Marion Kauffman Foundation, while business credit cards provide an easily accessible source of financing, credit card debt may be a two-edged sword, possibly hurting small start-up businesses as much as it helps.
The study looked at whether using credit cards for financing had any impact on the survival rates of business start-ups in the first three years of operation. Data from both personal credit cards and business credit cards was included, since most business owners use both, and there is no difference between the two in terms of interest rates and fees. The study looked at credit card usage during the period from 2004 thru 2006, during which period almost six out of ten of the businesses included in the study (58%) used credit cards to help fund their operations.
The study found that while credit card usage in itself wasn’t linked to a business’ survival rate, carrying credit card debt was. According to the study, the survival rate of the businesses included in the study was correlated with the amount of credit card debt carried. For every $1,000 increase in credit card debt, there was a 2.2% increase in the probability that the company would close, compared with companies that had no credit card debt. The higher the level of debt, the greater the likelihood that the new business would fail.
In evaluating the study, it should be born in mind that correlation is not causation. There may be other reasons why higher levels of credit card debt were associated with a higher failure rate. For example, businesses not generating the expected revenue from their operations would be more likely to accumulate more credit card debt and would have more problems paying down existing credit card debt. In such instances, the business failure would be correlated with higher levels of credit card debt. However, there is no telling whether the real cause of the failure was the inability to generate sufficient business revenue, the burden of expensive credit card debt, or a mixture of both.
Still, there is no arguing that credit cards have numerous disadvantages as a source of financing. Credit card debt is generally more expensive than a bank loan, and worse, they are an extremely unreliable source of financing. The terms of small business credit cards can change at any moment: credit lines may get slashed, interest rates hiked, and monthly payments doubled or more. All of these factors make financial planning difficult and cause businesses relying on credit cards for financing to be more unstable and vulnerable. And, while the recent Credit CARD Act of 2009 introduces new protections for consumers, none of the new provisions apply to small business credit cards.
This is even more so the case in today’s economic environment of steadily tightening credit card interest terms. Unfortunately, at the same time, a shortage of funding is making even more small business owners rely on credit cards to fund start-ups or existing operations.
For small business owners with little other recourse than financing operations in part or completely through credit cards, the study is a sobering reminder to navigate carefully through the murky waters of credit card debt.
