1 Reason to Avoid a Small-Business Loan

While credit card debt can become a burden for small-business owners, credit cards can be a better option than a small-business loan to secure growth capital, particularly when used intelligently for short-term needs. One decision to make is picking the right small-business credit card, and our list of the best small-business credit cards can be helpful.

But before applying for a new card, it's important to understand one instance when it could be cheaper to avoid a small-business loan. The Motley Fool analysts Michael Douglass and Nathan Hamilton talk more about this topic in the video below, highlighting when each option makes sense and the associated costs.

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Michael Douglass: Starting a small business is expensive. Usually you're not getting into running a small business because you've got a ton of money. Usually you end up taking on a lot of debt to make that happen, to take that dream and turn it into reality and hopefully be able to make the revenue and the cash flow and turn that into something that you can get paid to do. Usually, that involves debt, and usually when folks think about debt they want to avoid credit cards. But there are certain instances where it actually could make, and depending on your personal circumstances, a lot of sense to float business expenses on a credit card.

Nathan Hamilton: Yeah, if you look at it, a credit card versus a loan. Where it's going to make sense for the loan is going to be your longer term investment needs, be it three, five, seven years, because you can get a small business loan or a bank loan for those terms. But one reason that it may make sense to avoid a business loan is if you can essentially pay off that purchase or whatever working capital needs, whatever it is, within a short time frame, because with certain small business credit cards, you can get a zero percent promotion rate, and a lot of them will extend for a year or longer. In those instances, it doesn't make sense. Even with the lower rate of a business loan compared to a credit card, it can't compete with zero percent.

Douglass: Right.

Hamilton: So if you are able to do that over that say, 12 month period, it's going to make absolute sense to do so on a business credit card, not only because it's no cost to open in many cases, in terms of an annual fee, but you don't have the transaction costs, and of course you're avoiding interest, which is the most important.

Douglass: Absolutely we're all about lowering fees at the moment. Really any way we can figure out without sacrificing quality. I think one of the key points here is that these are probably going to tend to be smaller purchases-

Hamilton: Yeah, absolutely.

Douglass: ... if you were buying, I don't know, a restaurant grade massive freezer or something like that, probably doesn't make sense to put this here because that's going to be a longer-term capital expense that will often take time to pay off. Maraschino cherries, maybe. Sorry.

Hamilton: Working capital.

Douglass: Yeah, that's something that you could probably pay off pretty quickly once you sell a couple of drinks. The other thing is you need to be really careful about paying off that debt first and so you need to be a really good budget-er, which hopefully if you're starting this whole business you're really thinking about that already. Otherwise, it's very easy to end up in a lot of hot water and a lot of debt very quickly and just have this dream kind of tank a lot of other things in your life.

Hamilton: You hit a good point there, talking about the limits, because with a business loan, you could be several hundred thousand dollars or higher, you know, you present your business plan to the bank, go through the SBA, there are options out there and [crosstalk 00:02:51] equipment backed loans, [inaudible 00:02:53] loans, all of those options, but in the scenario with a credit card, you simply go online, apply for it, enter a few basic details, your EIN number, or even your social security is all you need for many business credit cards.

Douglass: The thing is, we're all about the idea of people following their dreams and finding this great opportunity to build a small business, we just want to make sure everyone does it [crosstalk 00:03:18] yeah, exactly and the good thing about it is that there are lots of tactics and lots of things that can help make that a little bit easier. This could potentially be one of them. Again, depending on your business and your needs and how good of a budget-er you are, among other things. We've got a lot more information about business credit cards and a lot more just about small business in general at fool.com/businesscreditcards, so check us out there. Thanks.

Hamilton: Thank you.

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