The Benefits of Tougher Access to Credit CardsScott Shane
Editor's note: This is the first column in a new series that challenges commonly-held myths about entrepreneurship.
The myth: Reducing entrepreneurs' access to credit-card lines of credit is a bad thing
The reality: Over the past 15 years many small businesses have become reliant on credit cards as a source of business financing. Economists believe that most business loans of $100,000 or less (micro business loans) are really credit-card lines of credit. And over the past 15 years, the number of companies holding these loans has exploded. Data from the Office of Advocacy of the U.S. Small Business Administration shows that the number of micro business loans has gone up much faster than small business loans—defined as $100,000 to $1 million. (For a look at the trend from 1994 through 2008, click on the chart to the right).
Moreover, the number of micro loans has grown much faster than the number of small businesses. From 1994 through 2006, the number of establishments with fewer than 20 employees and the number with fewer than 500 employees both increased only 13%.
Unlike in the 1990s, credit-card lines of credit are now available to a wide variety of businesses. And like consumers, many small businesses have come to rely on freely available credit-card debt. But since the recession began, banks have cut lines of credit on business credit cards, and have made it harder for business owners to get those cards.
Squeezing Out Unprepared Startups So what happens now that businesses are finding it harder to finance operations using credit cards? A lot of businesses are facing or are going to face a credit squeeze. Some will find other sources of financing, but borrowing has become tougher for small businesses, forcing them to change how they operate. Now that the era of easy access is over many small business owners are rethinking their business models to make them less reliant on credit cards.
While this shift is painful for many entrepreneurs who have to redesign their business models, it's probably a good thing. When people could easily finance their businesses by tapping a credit-card line of credit, a lot of entrepreneurs whose business ideas didn't justify borrowing money at a high rate of interest started companies. Those startups were almost set up to fail because they couldn't generate the cash to pay the interest on their debt.
In addition, in the easy-access-to-credit-card era, too many entrepreneurs defaulted to using credit-card financing. This type of revolving credit is expensive. The ease of tapping these lines of credit probably burdened a lot of entrepreneurs with capital costs much higher than what they would have paid if they'd gotten the financing they needed some other way.
The problem isn't that business credit cards have gotten much harder to get. It's that they had been too easy to access over the previous decade. Now that the spigot has been turned off, adjusting is hard to do. But that adjustment is definitely needed.