Advanta closes all accounts; where do small businesses turn for credit?

A few weeks ago it was announced that Advanta would be leaving the credit card business.  This notice was particularly difficult for many small business owners, since Advanta typically considered small businesses to be their primary market focus.

The Wall Street Journal article goes on to say the following (emphasis mine):

Small-business owners have been among the most severely hurt by the credit crisis and recession. Banks have pulled back on small-business loans in recent months, forcing company owners to rely more heavily on plastic for many of their expenses. Card issuers are leery of small businesses because of their volatile revenue streams.

According to a recent survey by the National Small Business Association, credit cards are the most popular form of financing used by small business to finance their capital needs. One-third of small businesses reported that their credit lines had been reduced in the past six months.

Using credit cards to finance a small business is an easy solution when no other options are available, but I highly caution all owners to avoid this step without a very firm process in place.  I have seen (many times) how easy it is for a small business to spin out of control when credit card interest rates and finance charges go through the roof.  Credit card companies only make money when customers carry a balance.  This ensures a steady stream of revenue in finance charges.  Since each month's bill uses the previous month's balance as the new baseline, charges are quickly compounded to the point where after a number of months, the total in finance charges may be greater than the original cost of items purchased!

To avoid falling into this trap, I suggest the following recommendations:

1) Focus your energy on building the best business case for why your business should exist.

If you cannot develop a plan that clearly articulates how you will be profitable, and the steps you will take to reach profitability, it will be a hard sell to financiers.  There are always banks and investors willing to give money to worthy opportunities.  However business owners must be able to explain what makes their offering unique.

2) Create an initial business budget, with a steady plan for growth.

Too many small business owners push forward with a business and assume costs can be managed on the fly.  This can be a recipe for disaster.  I have seen situations where businesses are selling product and significantly growing monthly revenue, but are not keeping track of their business costs.  Very quickly it is realized the business cannot turn a profit, and severe changes are necessary.

In other situations business growth becomes very disjointed, such that monthly cash flow causes problems in paying the bills and salaries.  Taking time in advance to develop a budget will help you to better understand your needs, and will also ensure you can convey to a bank why a small business loan is needed.  It is not necessary to plan a budget for the next five years -- there is no way to know where the business will be after that length of time.  Focus on a six to twelve month horizon for creating an initial budget.

If this is even too far into the future, create a plan that covers the next 3-6 months.  Something is better than nothing, and it serves as a "stake in the ground" for future comparison.

3) Avoid using credit cards as a way to finance the business.

The lure of using credit cards is strong, but the end results can be disastrous.  Before using credit cards, I would contact friends, family members, former co-workers, acquaintences, and even local small business groups.  Pitch your ideas to them and see if they are receptive to offering assistance.  Ask them to critique your pitch so you can improve the message for those you meet in the future.

If you receive financial help from friends or family members, go the extra step by having an attorney write a formal agreement.  A failed business can lead to highly strained relationships with friends or family members who are also investors.  Let them know you're serious about their financial commitment by having a contract drawn up.  Even if they resist ("you're my friend, I know you'll repay me"), still do it.  Everyone will feel better knowing a legal document is in place.  Always remember, business is business, and personal is personal. 

Treat a loan from a family member just as you would if you received a loan from the bank.  You may even want to consider giving them a stake in the business

4) If you must use credit cards, make sure you have a solid plan and have someone other than you administer the plan.

If credit cards must be used to finance a business as a last resort, a very detailed plan must be in place in advance.  The plan should clearly state for what reasons the cards will be used, the approximate amount which will be billed to them per month, how much is expected to be paid each month, and when the debt is expected to be paid off. (Remember, the amount paid on credit cards must always be at least the minimum balance due.  Never EVER let cards become past due!)

If you will be carrying a monthly balance, make sure cards with the lowest possible APR are used, preferably those with an extended period of time at 0-2% APR.  Most importantly, the plan should be administered by someone other than the business owner or others in the company who are using the credit cards.  An independent third-party, or a financial analyst, should be put in charge of the plan and have the authority to stop all future purchases if the terms of the plan are no longer being followed.  If the business owner creates the plan and administers it, there is far too much temptation to casually "bend the rules just for this month," knowing full well it is the start of a regular bending of the rules.