Friday, February 2, 2001
The Perils of Plastic in a Downturn
Entrepreneurs can cite any number of reasons
for borrowing against credit cards. With the
economy cooling, however, high-interest debt
can be a lethal liability
Starting her fourth year in business, Sheryl
Woodhouse-Keese is planning to hire employees
this spring and outgrow the space in her home
devoted to designing and producing handmade
invitations, cards, and other paper goods. But
she's not so successful that she has the cash
to pay the $4,000 it will cost to attend a trade
show in Philadelphia. That expense is going
on her credit card. With the proceeds from the
sales she makes at the show, she intends to
hire some help and pay off -- or at least pay
down -- the credit-card bill.
Last year, the profits from her business, Twisted
Limb Paperworks in Bloomington, Ind., were "about
$20,000" on sales of "about $40,000," says Woodhouse-Keese.
That represents double the sales of the year
before, and she expects to see her figures double
this year, too.
Like Woodhouse-Keese, most self-employed people
are optimists. Also like her, many finance their
businesses, at least partially, on a personal
SCARY STUFF. Debt,
both the corporate and consumer variety, is
seen as the bogeyman waiting to pummel this
economy into a recession. Corporate bond defaults
are expected to reach a record high this year.
Bad loans on banks' balance sheets are regarded
by some as the reason behind the Federal Reserve
Board's aggressive interest-rate cuts in January.
Credit-card debt is pegged at a record $500
billion-plus. Where is small-business debt in
"We can't really get a handle on the consumer
debt that's feeding small businesses," says
Robert D. Manning, an economic sociologist and
author of the new book, Credit Card Nation.
Now that many small businesses are financed
with credit-card debt or home-equity loans,
rather than traditional loans from a local lender,
it's difficult to measure both small-business
debt load and the perils it implies as the economy
cools. But anecdotal evidence suggests cause
-- At the "Shoptalk" phone line operated
by the National Association for the Self-Employed,
members frequently request advice about getting
a loan to consolidate debts. It's a much bigger
topic than it was 10 years ago, says Gene Fairbrother,
the consultant who has been answering members'
questions for more than a decade.
-- The percentage of self-employed households
carrying credit-card debt was 47.5% in 1998,
up from 29.4% in 1989, according to a Federal
Reserve study of consumer finances.
-- A 1998 Arthur Anderson/National Small
Business United report cited by Manning notes
that 47% of small and midsize businesses financed
expenses with credit cards. Nearly twice the
level of two years earlier, it surpassed commercial
bank loans, private loans, and SBA loans.
-- When the Texas legislature was considering
changes in lending laws last year to permit
home equity lines of credit, documentation in
support of such a move cited the fact that 56%
of the state's small businesses were financed
with credit cards and needed the lower interest,
Economists who work with small-business organizations
see several reasons for the increasing use of
credit cards. Begin with the consolidation in
the banking industry, which has eliminated many
local lenders. Next, in a service economy, there
is the likelihood that a small-business owner
will lack the inventory to serve as collateral
for guaranteeing a bank loan. Finally, many
entrepreneurs have little training -- either
in college or from working in a family business
-- and are ill prepared to lay out the sort
of business plan that lenders require.
WHAT, ME WORRY?
Lack of a business plan is one of the reasons
Woodhouse-Keese never looked into getting a
bank loan. "Several times I sat down to create
one," she admits, "but then I would look at
my to-do list...I can barely keep ahead on creating
my products." Her relatively small credit-card
debts don't bother her, she says, because she
takes advantage of the low "teaser" rates issuers
offer, and because the interest is tax deductible
as a business expense. Besides, says Woodhouse-Keese,
her sister applied for a small-business loan
to finance her publishing company, and was offered
rates of 12% to 13 percent. "That's worse than
a credit card," she sniffs.
"What's really tragic is that they're making
it sound like these credit cards for small businesses
are a special service," says author Manning,
who notes that the cost of borrowing on credit
cards (17% on average) has doubled over the
past 20 years.
Small-business owners pay an average 10.4% for
short-term commercial bank loans, according
to the monthly survey by the National Federation
of Independent Business. The majority of entrepreneurs,
however, don't get such loans: one-third of
small businesses received bank financing in
1999, vs. better than half in the early '80s.
"I won't even go to the bank and go through
all the rigmarole," says dietician Kevin Kelly,
who started his nutrition-counseling and food-safety
business, Forever Healthy, four years ago in
Fargo, N.D. At the time, he had trouble refinancing
his mortgage because of some $20,000 in student
loans. So he put "$2,000 here, $2,000 there"
on his credit cards to cover business expenses.
He knew debt would be part of the picture when
he quit his job to return to school with the
idea of becoming a self-employed nutritionist.
"My wife and I talked for six months about what
we were going to do," he says. "We knew we would
get into debt. We knew our savings would take
a beating." Kelly shrugs off the possibility
of an economic downturn, explaining that his
business has diverse sources of revenue and,
if things turn really sour, he can always get
a job working for someone else.
Many small-business owners, though, are very
reluctant to work for wages. "If the spending
decreases within the general economy, the small-business
owner will go to large extremes to keep their
doors open," says Fairbrother. "That means credit
cards, home equity, whatever it takes."
Otherwise-prudent spenders tend to justify business
expenses as investments -- even if they don't
have a clear means of paying them off. Someone
who wouldn't put $15,000 worth of home furnishings
on a credit card may be less reluctant to spend
the same amount on office equipment, says Kevin
Scott, spokesman for the National Foundation
for Credit Counseling. "Even though we caution
people not to mix business debt with personal
debt, it's not uncommon for our counselors to
see serious debt load on credit cards because
[clients] have financed their business with
The Small Business Administration office in
San Antonio, Tex., formed an alliance with the
nonprofit Money Management International, parent
of the Consumer Credit Counseling Service, because
it was seeing so many small-business owners
with too much credit-card debt.
BOOM AND BUST.
"I feel bad about saying this, but business
is getting better with these mouth-dropping
layoffs in the economy and the overwhelming
debt that consumers have accumulated in the
past five years," says Rudy Cavazos, a spokesman
for Money Management International in Houston.
"We are seeing a lot of self-employed people
coming in with high credit-card debt." After
dropping slightly in 1999, personal bankruptcies
are expected to reach a record high of 1.4 million
next year, according to SMR Research in Hackettstown,
"Five thousand, 15,000 on a credit card is inconsequential
as long as the economy is doing well," says
Manning. But if a recession hits, "We don't
know how strict, and how panicky, banks are
going to be. If a bank is looking at a family
with $25,000 in credit-card debt, will they
raise the limit?"
In this economic climate, with growth nearly
nonexistent and consumer optimism at the lowest
point in eight years, Manning and others advise
small-business owners to pay down debt and compile
a business plan so they can see their finances
more clearly. "The whole credit situation in
this country is like an athlete on steroids.
It was never as good as we thought it was,"
If the economy dips into recession, many small-business
owners may decide that their credit-card financing
isn't the good idea they once believed.
Forsman in New York
Edited by Robin J. Phillips