Credit cards offer perhaps the most tempting form of debt available, particularly after your loan applications have been turned down by half a dozen banks. The interest on the balances, however, nearly always cancels out the income the funds produce. Whether the card is used to fund the company's opening, an expansion, or an individual client's project, the interest on the balance averages around 17 percent per year on new purchases and as high as 25 percent on cash advances, according to DCA statistics. Most often, says accountant Ed Slott, the optimistic small-business owner will take on credit-card debt hoping to pay off the balance in two or three months, once he or she generates enough sales. But if the sales don't come in as high as projected, the owner is lured into taking on more debt to pay off the old. "And that can be the beginning of the end."
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As an alternative, talk with your banker about a loan or a line of credit that's guaranteed by the Small Business Administration (SBA). About 30 percent of SBA-guaranteed term loans -- offered for periods of up to 10 years -- are given to start-up companies that can demonstrate a good credit history and a decent cash-flow forecast. These loans are best for longer-term needs; if, for example, you are manufacturing a product that won't get to market for two years or you have to line up subcontractors, which could take time, you may need a loan to cover yourself while receivables are few. Lines of credit -- which the SBA offers through banks at rates of around prime plus two -- are best used for short-term working capital or to weather a temporary slump.
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To determine which is better, a loan or a line of credit, you'll have to get a good handle on your business cycle. Those entering seasonal businesses, for example, should know when to expect a windfall and when things will be tight, and they should manage cash flow accordingly. Here is where your business plan -- a necessary document if you hope to have any chance of receiving a loan -- will support your rationale for your requesting cash.
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If you have a temporary but immediate need for equipment or supplies, try getting materials on credit. You can often get a 30- to 60-day extension on payment; and if the companies do charge interest, you can be sure it will be less than what your credit-card issuer charges.
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Should your business experience a downturn, think about expanding your product line rather than trying to skate by through assuming additional debt. Ask your existing client base what else they might buy from you if you offered it. "Most people are not tapping all the ways to sell parts of themselves," says Slott, who supplements his own accounting business with a newsletter about IRAs. "Anthony Robbins says that success comes from two things: inspiration and desperation. And that's true; that's when you either get creative or you die."
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