Business owners are often working without a safety net — there’s no guarantee you’ll succeed, your income is almost entirely dependent on you and you’ve likely given up things like health insurance and a 401(k) match to make the plunge into entrepreneurship. But that doesn’t mean you’re entirely out of options.
Just like in your personal finances, having an “emergency fund” for your business is an ideal backup plan. But, generally, it’s not feasible. You’re pinching every penny to use them on things that really matter to the success of the business like creating a business plan with your accountant, acquiring new customers, perfecting your product and purchasing supplies.
So what can you do when you have a big order to fill and are out of cash for materials? Or when a major client decides not to pay on time and you’re going to be short on payroll? That’s where business credit cards and lines of credit can come in handy — if you can get them. Here’s how they work, the risks you should understand before you use them in a pinch and how to actually get your hands on one.
Business Credit Cards: How to Use Them As a Backup Plan
Before you can use business credit cards and lines of credit as a backup plan to fill in the gaps when capital just isn’t easy to come by, you should understand how they work so you can use them wisely.
These two financial products are similar in that you’re only charged interest on what you borrow — that’s one of the features that makes them ideal as a backup plan vs. a traditional bank loan, which gives you a set amount of capital upfront that you begin paying off immediately. Credit cards and lines of credit are known as “revolving credit,” meaning you are given a set limit you can borrow by the lender, but you don’t have to borrow anything.
You can get your hands on a business credit card or a business line of credit before you actually need to use them, and the cost for acquiring one is relatively low — free in some cases. Some business credit cards carry annual fees, though those cards generally offer significant perks and rewards for spending that can balance out the annual fee. For example, the Business Gold Rewards card from American Express has a $175 annual fee that is waived the first year, but it offers rewards points on common business purchases like shipping and gas stations, which can earn you back that annual fee and potentially more if you use it wisely.
There are business credit cards that have no annual fee as well — ideal for new business owners who want that safety net without any upfront cost. The Ink Business Cash from Chase, for example, has aannual fee and you can get employee cards at no additional cost.
Before you apply for a business credit card, make sure you understand the risks of using them as a backup plan. Here are a few things to consider:
- The most obvious — if you need the money in a pinch and can’t pay it back quickly, business credit cards can put you in debt. Be sure to understand the card’s interest rate and how much borrowing will cost you if you can’t make that statement due date.
- If you default on the card or miss payments, it can impact both your personal and business credit scores, depending on how the card issuer reports negative information to the credit bureaus (you can see a quick guide on this here).
- If you need cash to help with your business and can’t charge something (i.e. you need money to make payroll), cash advance APRs are almost always higher than purchase APRs and there is generally no grace period — interest begins accruing immediately.
Business Lines of Credit: How to Use Them As a Backup Plan
Business lines of credit are especially handy in solving cash-flow problems — an extremely common issue for small businesses. Roughly half of small businesses have experienced cash-flow issues, in fact. Having a business line of credit can act as your emergency fund for rainy days at the office.
If you’re struggling to pay a vendor bill on time and are worried about hurting your business credit score, for example, having a line of credit in place could provide a lower-interest option for paying that bill and keeping your good business credit score intact, as well as maintaining a good relationship with an important vendor.
Lines of credit come in two forms — secured and unsecured — and both can be acquired from online lenders or traditional banks (bank lines of credit tend to have lower costs, but may be more difficult to qualify for). A secured line of credit tends to have a lower interest rate since you put up collateral to secure the debt that the lender can collect if you default. Unsecured lines of credit are available as well, though you will likely need a great business credit score and solid cash flow to get the best interest rates. Some lenders may even require a specific business age. For example, a line of credit from Kabbage, a major online business lender, requires 12 months of time in business for applicants.
Before you apply for a business line of credit as your backup plan, make sure you understand how it will impact your business. Here are a few things to consider:
- If you secure the line of credit, defaulting can sink you. In addition to damaging your business credit score, a default can mean losing valuable assets like equipment to your lender.
- A line of credit may charge maintenance fees if you don’t use the account, so it could end up being a bit more expensive than a business credit card for use as a backup plan. Be sure to check the fine print before you apply.
- APRs can range up to 90% if you have bad credit, much higher than even the highest interest business credit card APRs.
How to Actually Get Approved for a Business Credit Card or Line of Credit
Business credit cards generally require a personal guarantee (this can vary by issuer) and your personal credit history will most likely be used to approve you for the card. Credit card issuers generally don’t look at cash flow during the business credit card approval process, which can help a younger business get the financing they need (whereas a lender looking at a line of credit application will examine cash flow closely).
Business lines of credit require more paperwork (tax returns, etc.) than business credit cards and generally have time in business and annual revenue requirements. Those hurdles may be difficult for some new business owners to cross, so be sure to read through the available qualification info before you apply.
Knowing where your personal and business credit scores stand before you apply for either a business credit card or a personal loan is vital to understanding what products you’re most likely to qualify for. You can check your personal and business credit for free at Nav to see where you stand.