During the recent study, questions asked over budding entrepreneurs, “What is the most prevalent method of financing a new business? Most replied, “credit cards.” They were surprised to learn that the correct answer was personal savings and kindness of friends and family.
More recently, however, times have changed and credit cards are used more often. Even mature businesses use credit cards to survive during the sick economy because traditional bankers are not willing to lend to struggling enterprises. You may recall the New Jersey business owner described in my column last week trying to restructure $100,000 of credit card debt because he was paying double-digit interest rates. It was part of a larger refinancing package.
Similarly, at Manasota SCORE, we see clients in Southwest Florida who are over-burdened by high-cost credit-card debt because they are unable to reduce the balance they owe. Low teaser rates and ease of borrowing, compared with applying for small-business loans, are other reasons small-business owners incur large credit-card balances. Sometimes they are unaware of better alternatives for their long-term borrowing needs. Whatever the reason, credit-card debt becomes more difficult to repay when the economy slows and cash flow decreases.
To help small-business owners, the U.S. Small Business Administration partially guarantees bank loans to refinance burdensome credit-card debt and replace it with five- to seven-year-term, working-capital loans. Current interest rates are approximately 51/2 percent and are limited by the SBA to 23/4 percent over the prime rate.
In many instances, however, small-business owners have not bothered to get separate credit cards in the name of the business and much more documentation is needed. That is because SBA’s standard operating procedure is very clear. Even if the prospective borrower is a sole proprietorship and certifies that all expenses incurred were for business that is not enough. In addition to the certification, the lender is required to obtain “a copy of the credit-card statements evidencing the charges to be refinanced,” and also obtain “individual receipts for any business expenses in excess of $100.
Study advised lenders that if a prospective borrower is unable to produce the receipts, they should exclude any part of the loan request that is meant to refinance credit-card debt. She warned lenders that SBA’s loan guarantee will be in jeopardy if the borrower defaults.