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The COVID-19 pandemic has left budding entrepreneurs feeling uneasy about launching new ventures. As a potential recession seeks to emerge from the shadows, banks and financial institutions are tightening the reins on credit lending. According to The Wall Street Journal, big lenders like Chase, Bank of America and Capital One are updating lending requirements to stricter standards due to the uncertain financial climate. Many are asking for higher credit scores and boosting income verification. 

But this doesn’t mean future business owners don’t have any recourse. This guide examines the various financing options available to new entrepreneurs, as well as general financial tips for launching a small business in a troubled economy. 

Options for financing

When it comes to financing a start-up, entrepreneurs pull money from a variety of sources. Some popular options include:

  • Personal or business credit card: Use credit cards you already have or apply for new ones.
  • Personal savings: Crack open the piggy bank and access your existing funds.
  • Bank loan: Use your business plan to ask for a traditional loan.
  • SBA loan: Receive a loan guaranteed by the Small Business Administration.
  • Local angel investor groups: Reach out to local investors wanting to trade money for a percentage of ownership of your company.
  • Crowdfunding: Have potential customers fund your venture without having to give up equity.

If you think a loan or a credit card is a viable path for your business, check out the interest rates presented below on the most common types of financing entrepreneurs use to launch a business. Notice that during tough economic times, interest rates tend to lower as the government decreases the prime lending rate to stimulate the economy. 

 

Small business financing APRs
Type of financing Typical APR range APRs during COVID-19
Personal credit card 11%-25% As low as 7.49%
Small business credit card 13%-24% As low as 10.24%
SBA loan 4.71%-11.5% As low as 3.2%
Personal loan 6%-30% As low as 3.49%
Equipment financing loan 2%-20% Unchanged
Commercial real estate loans for small businesses 3.5%-8.5% As low as 3.5%

 

During times of economic growth, small business owners often have little trouble obtaining credit cards with agreeable terms and conditions. But financial crises disrupt the credit market and make it challenging to get any type of financing precisely when newly established businesses want it the most. 

While many credit lenders make adjustments for current business owners, borrowing and securing funding as a nascent business could prove difficult. During the Great Recession, for example, banks dramatically tightened standards for obtaining credit cards.

Credit cards: The most commonly used financing option during tough economic times

Brand-new businesses have fewer financing options than more established ones. Small companies routinely rely on a business line of credit, but you won’t be approved for one unless you’ve been in business for at least six months and are already generating revenue. It’s the same with term loans, the type of loan people usually think about when going for a small business loan at the bank. Term loans require extensive business and personal documentation, good cash flow and use of company assets as collateral.  

Many starting entrepreneurs don’t meet the requirements for a business line of credit or term loan. Instead, they turn to private funds and existing lines of credit, such as personal savings and credit cards. Then as they grow and establish themselves, they apply for a business line of credit or loan. By then, their company has the financial profile it needs to be approved.

The only difference during a financial crisis is that small business owners feel more pressure to rely on their own finances, since banks up the bar on approval requirements and change credit terms. Consequently, entrepreneurs have to be more vigilant about how they manage their finances. 

During the Great Recession, lenders hesitated to lend to small companies for fear they’d lose their investment if the business failed. And because an economic downturn trickles down to everyone, entrepreneurs also couldn’t rely on home value, personal funds, or friends and family to secure financing. 

That’s why from 2007 until 2009, the years of the Great Recession, there was a marked surge in credit card use by small businesses. In fact, back in 2009, 86% of small business owners reported using consumer or business credit cards primarily or exclusively for business purposes, with 33% using four or more credit cards for financing. 

The benefits and drawbacks of using a credit card to launch your business

Credit cards can swoop in and save the day if you don’t qualify for other types of loans. They’re also an excellent alternative for people needing to borrow less than $50,000 or who don’t want to go through the nerve-wracking experience of meeting with loan officers and drafting an airtight business plan. 

Most credit cards today also have a rewards program attached to them, unlike traditional loans. You probably have a few already in your wallet and can start using them right away to fund your ventures and earn rewards. The more you use rewards credit cards, the more you can rack up points, cash back or miles to help offset other business expenses.  

Credit cards users also benefit from:

  • A revolving credit line
  • Introductory rates like 0% APR for nine months or more
  • The ability to efficiently cover cash flow gaps
  • A dashboard to automatically track and categorize expenses
  • Credit card interest deductions on business taxes

During tough economic times, credit cards become even more enticing for their lower APRs. It’s also a type of long-term financing that can see you through uncertain times. For example, revolving credit lines are crucial to the life of the business and in keeping operations running until money comes in again. 

Your credit card rewards also offset the cost of essential business expenses like office supplies and travel. If you open a new credit card, introductory rates let you pay off your debt faster without interest slowing your progress. The quicker you pay off the balance, the more cash flow you’ll have available to keep the business afloat during lean weeks and months. 

That’s not to say using a credit card to launch your business doesn’t have its drawbacks. Credit card interest rates tend to be higher than personal loans or traditional bank loans, and uncertain revenue can make it hard to meet minimum monthly payments consistently. 

The higher-than-average business failure rates that accompany a difficult economy may also be a source of worry for entrepreneurs with a personal guarantee on business credit cards. That guarantee means they’re personally responsible for paying the debt — even if their business fails.

Other considerations when using a credit card for business are:

  • Credit cards don’t build up your business credit score if you’re using a consumer credit card.
  • Credit cards offer low funding when compared to other types of financing, such as SBA loans, which provide up to $5 million, and SBA start-up loans, which give up to $250,000.
  • Card terms can change during a recession so that minimum payments are higher and credit limits are lower.

Credit cards may be a wonderful solution for some small businesses, while for others, alternative financing is ideal. To find out which is true for you, do some research on the best kind of funding for your type of business and circumstance. If you’re ready to start using a credit card, see our guide on the best business credit cards and how you can use them. 

Personal credit card vs. business credit card

People starting a business have the option of using a personal credit card or signing up for a business one. While they both give you the revolving credit you want, they’re catered to different customers. 

Personal credit cards are designed for the needs of consumers, so they have lower spending limits. They also report credit card activity monthly to the three major consumer credit bureaus — Equifax, Experian and TransUnion — and reward cardholders for purchases at the places they shop most, like grocery stores. Card issuers also look at consumer credit scores when you apply, and a multitude of consumer credit cards offer a 0% intro APR for 12 or more months to attract potential cardholders. 

While you can use personal credit cards for business expenses, the opposite isn’t true of business credit cards. Doing so could violate your agreement terms and cause your lender to close your account. You’ll find that when you apply for and use the Capital One® Spark® Cash for Business*, for example, you’re expressly agreeing to use your card and any associated convenience checks for business only.

Business credit cards also have shorter intro APR periods, if they have one at all, and aren’t protected by the Credit Card Act of 2009. Among other things, this means your business credit card’s APR can rise dramatically overnight. 

But these credit cards do help you build your business credit score. Typically, start-up owners don’t have a business credit profile established yet, so they rely only on their personal credit. They can decide to use personal credit cards or sign up as the personal guarantee of a business credit card. Personal guarantees on business cards are usually unavoidable, but if you build up your business credit score, you can later apply for other types of lending that don’t require this option. 

 

Personal credit cards Business credit cards
  • Protected by the Credit CARD Act (offers legal protections for consumer credit cards)
  • Long intro APR periods
  • Can use cards you already have
  • Quick to apply and be approved for
  • Lower credit lines
  • Can negatively impact personal credit scores if credit utilization ratio is too high. 
  • Has a higher credit limit allowing for more purchasing power
  • Offers special business rewards (travel rewards, cash back, loyalty points)
  • Potentially protects the personal credit of the business owner
  • Establishes a business credit profile
  • Fewer legal protections
  • Simplifies business bookkeeping
  • Rewards types of spending more important to businesses
  • Come with business-centered features (year-end summaries, employee cards, receipt storage, etc.)
  • Only usable for business expenses

 

Financial tips for launching your small business in a tough economy

Knowing a few critical points about starting a business during a tough economy can help ensure a successful launch and recession-proof your business. Here are seven tips for wading through challenging economic environments.  

1. Tighten up your business plan

Credit lenders want to see established figures and projected business earnings, particularly during a recession. A thorough business plan presented to lenders and investors can help get the funding you need. Before submitting your business plan, get professional feedback from an accountant or ask a loan officer for guidance. 

2. Find ways to cut or lower costs

Mitigate potential risks by reducing operational costs, signing up for 0% APR cards and utilizing small business financial relief programs.

3. Adjust your business model to the current market

It’s essential to evaluate the needs of the market during pandemics and recessions, and then find ways to match it. If your business can fulfill a new significant need, consider pivoting to provide that. Some clothing companies, for instance, transitioned from making uniforms to producing surgical masks during the COVID-19 pandemic. 

4. Market strategically

Investing money in marketing efforts during a crisis can boost your brand recognition during a time where the competition may be silent. Low-budget marketing tactics like social media marketing, local events, giveaways and coupons can reap big returns. 

5. Keep the cash flow going

Forecasting your expenses is essential to make sure you have enough money coming in. Your business accounting software can do the heavy lifting for you, but only if you use it diligently. Also, knowing how much time you have to pay credit cards or suppliers can let you strategically plan how you use your cash. 

6. Start small before going big

Keep expenses low during lean times by always analyzing which costs are justified. Rather than spreading the business thin, focus on core competencies and serving a niched-down segment of the market. 

7. Guard your personal credit

Your consumer creditworthiness may be your only source to borrow from when banks tighten the belt and raise the bar on approval requirements. Protect your credit scores by paying your credit card bills on time and keeping your credit utilization ratio to 30% or less. 

The bottom line

Every small business owner feels a mix of nervous energy and anxiety at the prospect of launching a business. During a tough economy, those feelings can become amplified as start-up owners face greater uncertainty. But you can calm your fears and fund your business dreams through various financing options — even when banks aren’t lending. Options like credit cards can quickly secure the cash you need to confidently start your next business. Even if hard economic times cause your business to stumble during its first few steps, economies always recover after crises, and your small business will too.

*Information regarding the Capital One Spark Cash for Business was prepared by NextAdvisor.com staff. Opinions expressed therein are solely those of the writer and have not been reviewed or approved by any advertiser. The information, including card rates and fees, presented on this page is accurate as of the date of the post.

Disclaimer: This content is not provided or commissioned by the credit card issuer. Opinions expressed here are author’s alone, not those of the credit card issuer, and have not been reviewed, approved or otherwise endorsed by the credit card issuer. This content was accurate at the time of this post, but card terms and conditions may change at any time. This site may be compensated through the credit card issuer Affiliate Program.