A new study of the use of credit card debt to fund new businesses has found that reliance on this form of financing increases the likelihood that a new business will fail during its first three years of operation.
The study, The Use of Credit Card Debt by New Businesses, conducted by Robert H. Scott, III, assistant professor of economics and finance at Monmouth University in Long Branch, N.J., for the Ewing Marion Kauffman Foundation, was based on data from the Kauffman Firm Survey, a panel study of new businesses founded in 2004 and tracked over their early years of operation. Almost 60 percent of the firms in the KFS panel relied on credit cards to finance operations during their first year of business.
The Kauffman study found that every $1,000 in credit card debt increases the probability that a new firm will close by 2.2 percent. No relationship was found, however, between using credit card debt to start a business and that businesss survival or closure.
Many factors explain why new businesses succeed or not, said the study. The growth in credit card use among small businesses has raised the question of whether firms with credit card debt were less likely to survive during their beginning stages of development. This study shows that credit card debt does play a role in business closure in the first few years of operations. And, while it is not the only determinant of a businesss stability, it appears to be an important factor in a firms likelihood to survive.
The study suggests that, during many firms' first few years of operation, their credit card debt increases and then eventually stabilizes to manageable levels, while firms with high credit card debt close, and successful firms start paying off their debt.
More than half of all new firms rely on debt financing when they begin operations, and a vast majority of these businesses rely on credit card debt to fill any equity gap. Credit cards tend to appeal to small businesses for several reasons. They help small businesses manage their finances and streamline payments, and they are easier to get than traditional bank loans or government business grants. Credit cards smooth revenue streamsespecially at the startup phase of operationsand, unlike other types of loans, credit card companies will never ask where their money went.
As Robert E. Litan, vice president of research and policy at the Kauffman Foundation, noted, Numerous factors affect whether or not a new company survives Credit card debt alone doesn't determine how stable a business will be, but it does appear to be a significant influencer in the company's probability of survival.
The study underscores the need for small-business credit-card reform, as unfair and deceptive practices within the credit-card industry undoubtedly have played a part in the debt examined in the study, said the National Small Business Association, which highlighted the study on its Web site. The NSBA said it continues to advocate for small-business credit-card reform.
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