Business Intelligence

SMBs: Hooked on Plastic and Headed for a Fall?

Like most other Americans, I am addicted to plastic. Given our consumer society, it should come as no surprise — especially with the rise of online shopping — that we all have one or more credit cards.

But my love/hate relationship with consumer credit took a turn for the worse recently when I opened one of my statements. I discovered that the credit card company had raised the interest rate from 8.75 percent to 19.75 percent without cause or explanation. If I had not happened to glance at the fine print, I never would have known.

Of course, the credit card company was fully within its rights (it's also spelled out in the fine print), but I could immediately see the implications. If this was happening to me, it was likely happening to millions of other Americans as well.

This cautionary tale is particularly important for small business owners, because they make up one of the fastest growing segments of credit card users. Banks and credit card companies have been marketing aggressively to them for the past few years with spectacular results.

Small business card transactions rose 10 percent last year, to $348.5 billion, and are projected to skyrocket by 23 percent both this year and next, almost double the growth rate of consumer card transactions, according to a study by Packaged Facts (PF), a publishing division of MarketResearch.com.

It's easy to understand why credit cards are so appealing. Gaining access to credit is one of the biggest hurdles facing startups and firms with fewer than 10 employees. As for credit card companies, while the consumer market is fairly saturated, the market for commercial cards is largely untapped.

Of the $17.3 trillion in commercial spending last year, business made less than 3 percent of the transactions with credit cards, according to separate surveys by Visa and Packaged Facts.

For small businesses that often operate on tight margins, the trend is disturbing. A recent study by the TowerGroup found that U.S. small business loan balances increased at a compound annual growth rate of nearly 7 percent between 2001 and 2005. In short, small business owners are becoming increasingly hooked on debt.

And when it comes to credit cards, they may not realize how vulnerable they are. Yet another recent survey by New York-based Capital Access Network, Inc. (CAN) found that 72 percent of small business owners use personal or business credit cards for purchases of $5,000 or more at least twice a year. But 50 percent said they were unaware of the potential cost of their credit card transactions.

For example, a $5,000 charge at 18 percent interest paid at the minimum monthly rate would actually end up costing you $18,000 and take nearly 46 years to pay off.

Fees and penalties are another major problem. In 2005, more than 35 percent of active accounts were assessed late fees and 13 percent were assessed over-limit fees. As a result, some credit cards were charging penalties in excess of 30 percent of the balance, according to the federal Government Accountability Office. That doesn't include the extra costs of sudden interest rate increases, and I'm not just talking about teaser rates.

Ever since a U.S. Supreme Court ruling in 1996 (Smiley v. Citibank), credit card companies have been free of any restrictions on late penalty fees and interest rate charges. Thus, credit card companies can change the rate at any time they choose. (I had my card at the lower rate for several years.)

At this point, it would be premature to say the situation has reached a crisis. More than 61 percent of small business owners say business is good and they are optimistic about the economy. An equal number plan to increase their overall business expenditures this year and, for the moment, show no signs of kicking the credit card habit. About 64 percent said they would use credit cards for business expenditures in 2007, according to the CAN study.

But should the economy take a turn for the worse, small businesses could face a severe credit crunch. Credit card companies would likely hike rates to make up for their own revenue shortfall, and late fees and penalties would undoubtedly rise as small businesses fall behind on or miss payments.

Meanwhile, the major credit card companies — American Express, Visa, MasterCard, and Discover — continue to market aggressively to small businesses. In fact, Discover boosted their ad spending by 34 percent last year just to promote their small business card. They are sweetening the deal with all kinds of specialized services, including low teaser rates. But if you read the fine print, you'll find out that the sky is the limit on interest and fees.

The good news is that other banks have stepped up their small business lending as well. The Wall Street Journal recently reported that major institutions like Bank of America, which once ignored small accounts, has stepped up its micro-loan offerings.

The trend is in step with the rising tide of available capital, which is now a global market. The availability of capital has encouraged banks to loosen lending standards and make more loans available to borrowers who might not have qualified before. The subprime mortgage lending market has been riding the same wave, and as it has demonstrated, the good times are not likely to last forever.

In my case, I simply paid off my new high-interest card and stopped using it. And small business owners should do the same. Now is the time to wean your business off credit cards and establish solid banking relationships while money is readily available and banks are willing to lend it. Even if you've been turned down before, or don't need the money, try again. Remember, it's always easier to borrow when you don't need it.

Otherwise, you may find yourself at the mercy of sky-high credit card rates and fees in a down economy, when you are least able to pay them. And that would be a recipe for disaster.