Credit Card Nation, Part I

A look at the impact of plastic on small businesses and how well they dance the credit-card hustle

This excerpt is taken from a chapter of the new book, Credit Card Nation: The Consequences of America's Addiction to Credit, by Robert D. Manning, outlining the story of America's present and future dependence on credit. The book extends beyond credit cards themselves, as he details the last 20 years of U.S. credit history since 1980 and the beginning of deregulation of financial services. The following is an excerpt from his chapter on how small businesses fit into the credit picture. It has been edited for length.


The Commercial Credit Crunch and the Crisis of Small Business

Small Business and the Credit Card Hustle: "Democratizing" Credit or Price Gouging?

Recent U.S. business history is replete with examples of billion-dollar companies whose entrepreneurial seeds were nurtured with bank credit cards during their formative start-up years. For example, Computer Associates International (CAI) Inc., the third-largest independent software company in the world, was founded by Charles Wang in 1976. A Chinese immigrant, Wang started with three employees and boasts that his initial financing consisted of "maxing out credit cards as fast as [I] could order them. [I] took no [bank] loans or venture capital." In 1999, with software sales of over $5.6 billion, CAI ranked behind only Microsoft and IBM. Its national and international expansion was fueled by over 200 corporate acquisitions, including the five largest in the history of the software industry.

Some banks have begun reconsidering their commercial lending policies toward the rapidly expanding small business sector. Between 1995 and 1998, small business loans increased 22 percent to a record $186 billion. Even so, this amount is dwarfed by the escalating credit demands of small businesses; nearly 2.5 million new enterprises were founded between 1995 and 1997. As Todd McCracken, president of National Small Business United, explains, "Relying on credit cards is a 'quick fix' for many small business owners -- demonstrating their ingenuity in finding ways to help their business move ahead."

If ingenuity is the mother of invention, then it should not be surprising that credit cards have become the number one source of financing for small businesses -- supplanting bank loans in the late 1990s. Indeed, the breakneck pace of the Internet industry is incompatible with the dilatory loan process of commercial bank lenders. Imagine if Jerry Yang had to spend several months collecting financial documents for a bank loan before launching the Internet search engine Yahoo in 1994. Or, if Jeff Bezos had to spend afternoons on the phone tracking the status of his loan applications rather than embarking on his revolutionary concept of selling books directly to consumers via the Web. Significantly, as begins a second decade with spectacular sales growth, its financial balance sheet would make most bankers leery of offering Bezos a loan -- especially during Amazon's infancy. This underscores a crucial issue confronting the small business sector. The business media lavish praise on successful companies that were launched with credit cards. These reports present a Horatio Alger image of hardworking entrepreneurs that ignore the more common experience that high-interest credit is a serious obstacle to small business prosperity.

Today, most business start-ups owe their early survival to plastic money. According to a 1998 Arthur Andersen/National Small Business United report, based on a survey of 504 enterprises, 47 percent of small and midsized business owners use credit cards -- nearly double the proportion of only two years earlier. This source of financing exceeds commercial bank loans (45 percent), leasing (which nearly doubled to 36 percent), vendor credit (17 percent), private loans (14 percent), inventory used as collateral (13 percent), and personal/home equity loans (12 percent); Small Business Administration (SBA) loans account for only 2 percent followed by venture capital at 1 percent. The majority of credit card users (62 percent) do not pay off their balances. This trend shows little evidence of subsiding, as 43 percent of the respondents indicated that they intended to use credit cards to boost their businesses over the next year. It is supported, moreover, by the research of PSI Global. This study found that the use of credit cards by small businesses climbed 10 percent between 1997 and 1998.

Data from the 1994 National Survey of Small Business, cosponsored by the SBA and Federal Reserve Board, confirm these patterns. For example, personal credit cards were most common for small firms (fewer than 10 employees) at 40 percent, compared with 22-24 percent for larger firms (50 or more employees). Significantly, 16 percent of small businesses reported that bank mergers had negatively impacted their ability to secure commercial loans. This trend is consistent with the recent experience of Eric Rosenfeld, who founded Adoptive Creative Partners (a research/consulting firm) in 1997: "I haven't found many banks that are interested in small-business loans." His experience with corporate vendors has been equally frustrating. Dell rejected his application to lease $5,000 of computer equipment, which contributed to the $25,000 in start-up costs that are being financed on his three credit cards.

For new entrepreneurs, credit cards are their most reliable source of start-up funds. As Rosenfeld explains, "Everyone respects Visa." And, unlike bank loan officers, private angel investors, or SBA bureaucrats, credit cards do not require extensive documentation or entail second-guessing of business decisions. Furthermore, borrowing from friends, family members, or professional associates often leads to unexpected social costs such as stressful personal conflicts and intrusive inquiries. For those committed to blazing their own entrepreneurial paths, the limited financing options invariably lead to bank credit cards. In fact, their use is touted in the business press as evidence of entrepreneurial daring: "If you have confidence in your business, using your credit cards should not be an issue. Go ahead and open as many [credit] card [account]s as you can, and charge whatever you need to make your business run."

Excerpted from Credit Card Nation: The Consequences of America's Addiction to Credit, by Robert D. Manning. Copyright 2000 Robert D. Manning. Reprinted with permission of the publisher Basic Books, a member of the Perseus Books Group.

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