Bootstrapping Your Startup off a Credit Card is a BAD Idea

Brad Gets Ready to Hit the Pinata

When you bust it open, bills and angels’ tears come out.

“Many have changed so much that they have lost the magic of the dream that carried them on their own bootstraps.”
–Peter Abrahams

31% of entrepreneurs should never have started their companies.

Impatience, misinformation, and delusion overcame these founders and convinced them to run full steam ahead with a bad idea.

What was this bad decision?

Read on to find out more.

For those of you who are new readers, before I became a financial planner, I co-founded, built, and sold a software development company.

Yes, the sale is glamorous. Heck, being a business owner and having people actually recognize who you are in your small(ish) town is pretty cool. Being able to finish the phrase “hey, you’re the guy who…” with something other than “was on TV last night getting arrested for singing to that tree while drunk as a skunk” (never happened to me, I swear) is neat, gratifying, and fairly self-fulfilling.

However, there is also a lot of work that goes into it. There’s sacrifice. There’s stress. There’s concern. There’s waking up in the middle of the night because you’re worried about how you’re going to make payroll next week.

When we started, each of the co-founders pitched in $400. That was to cover 3 months of rent for the postage stamp office we had.

Everything else came as a result of hustle, networking, and lots and lots of conversations.

I also didn’t draw a salary for the first 18 months the company was in existence. Even then, the salary I drew was over a 50% pay cut from the salary I’d received at Capital One.

My wife and I had saved up religiously during my two years at Capital One so that we could pay off my business school loans and have enough money in the bank to give me the time to make a true run at entrepreneurship.

Why were we so diligent about saving?

I knew that I wanted to try entrepreneurship. It was something that I’d spoken with classmates at business school about. I took classes on the subject. A friend and I had actually won an entry into our business school’s startup incubator, but we both wanted to get paid internships instead. The entrepreneurship bug had bitten me, and, in a fit of what was likely self-fulfilling prophecy, I wasn’t particularly happy at Capital One because it wasn’t entrepreneurial, despite what the CEO had said during the recruiting talks.

I also knew that I didn’t want to make the mistake that 31% of startups make.

I didn’t want to finance the startup using credit cards.

I’d been in credit card debt before. It stunk. It was embarrassing. It was soul-sucking. Not to mention, it was a financially poor choice. I had nothing to show for all of that spending but a few good stories.

Experiences are great, but they’re even better when they don’t come with a debt hangover.

Also, as a part of my job at Capital One, I listened to collections calls where Capital One call center representatives called people who were overdue in their credit card payments. Blech.

Since I’m a risk-averse person – I’d argue that most smart entrepreneurs are – all I could think about when I envisioned trying to fund a startup on credit cards was:

What happens if I don’t succeed?

The image in my mind was of enormous credit card bills that I’d have to pay off. Well, more specifically, my wife and I would have to pay off. OK…even more specifically, my wife would have to pay off. She was the one working and earning the income while I was trying this entrepreneurial venture. If it didn’t succeed, I’d have to find a job, which would take goodness knows how long. I imagined as a failed entrepreneur, it would be more difficult than usual. I figured, realistically, it’d take another 3-6 months before I could even find another job. That would have been 3-6 months that she’d be bringing in income and helping pay off that credit card debt.

Did I mention blech? I hated that vision.

But all of those entrepreneurship gurus tell you that you should only picture success in your mind, and if you think of success, it will come to you.

To quote Colonel Sherman T. Potter in M*A*S*H*, “Horse hockey.”

The realistic entrepreneur knows that 50% of startups fail within 5 years. I’ve spoken with enough accountants and attorneys to know that many of the businesses that are ongoing are actually zombies. They’re not earning money. At least, they’re not earning enough money so that the founder(s) don’t have to put in more money. So, the doors may be open and the license valid, but as businesses whose purpose is to make profit, they’re dead.

A smart person, before he or she starts a company, will ask the question: “What happens if this doesn’t succeed?

Let’s play out that question if the venture is funded by credit cards.

Here are the things which I see happening:

  1. Work your butt off, taking extra jobs, living like Benedictine monks, and pay off the credit card as quickly as possible. This is the right answer, by the way, to the wrong situation. Think about the opportunity cost of that money. It could have gone to retirement accounts, the mortgage, paying off school debt, putting a down payment on a house, you name it. Instead, it will have gone to Visa or Mastercard.
  2. Deal with it, struggle, potentially make some late payments, and finally get rid of it in 7 years (or more). This is how most failed entrepreneurs will handle the steaming pile of garbage that the credit card debt leaves behind. It becomes a legacy. Instead of moving on with your life, trying something else, learning the lessons, and putting it in the past, the credit card bill is like that festering sore that just won’t go away. Plus, it will probably hammer your credit score. While I don’t give much of a hoot about what FICO has to say about me, since the measurement metrics are screwed up, others do, including your insurance agency, your mortgage lender, and your landlord. Blast your credit score, and, no matter if you never borrow another dollar again (a good idea, mind you, regardless of your situation), your finances will suffer.
  3. Declare bankruptcy. You throw in the towel. Your credit is trashed even worse than scenario #2 with all of its appurtenant pain. That’s no free ride either, as you actually have to pay to declare bankruptcy. A bunch of your assets will get wiped out. You’ll get to check “Yes” on the boxes for employment and credit applications as to whether or not you’ve ever declared for bankruptcy. Don’t count on getting a job involving security or a clearance. Also, you’ve impugned your integrity. You made a promise to the credit card company that you’d pay them back. You didn’t. You went back on your word.

Recovering from an unsuccessful startup is difficult enough as it is without needing the extra anchor of a bunch of credit card debt tied around your ankle.

You can plan for success while still planning in case of failure. No business idea is so great that it can’t wait for a few months while you save up money to intelligently fund it. Use other people’s money if you must. Sell equity shares. Don’t use credit cards, though. It will change how you run your business. It will make you desperate. It will make you chase revenues that you might not want simply because you’re afraid of not being able to make it past the next credit card statement.

We only hear of the success stories of companies who used credit cards to fund themselves. They’re sexy. They sell advertising. People like to read of the underdog who was so scrappy and determined that he maxed out his credit card, came darn near having to shut down, and then pulled it out and became successful. They like those stories.

Those stories are not representative of the truth. Most of the time, the entrepreneur who funds his business on credit cards goes through that same part about almost closing, except, in reality, he does close. And then his life is miserable. He’s a failed entrepreneur (an emotional shock in itself) AND he has a metric ton of credit card debt to deal with.

Don’t compound the risk.

Would you start up a company on a credit card? Why or why not? Let’s talk about it in the comments below!

This article appeared in the Don’t Quit Your Day Job Weekender. Fitting title of the website given the subject of this article!

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About Jason Hull

Jason Hull is a Fort Worth financial advisor. Before becoming a Fort Worth financial planner, Jason co-founded, built, and sold a software development company. He is a CFP candidate, has a MBA from the University of Virginia, and a BS from the United States Military Academy at West Point. He is the owner of Fort Worth financial advisor Hull Financial Planning.

Comments

  1. The cynical part of me thinks it might be a savvy move, since CC debt can be cleared in bankruptcy. As you noted, this is not an easy path to go down and it does have consequences, but it does mean someone else’s money was lost.

    Saving up your own money might be better in some respects, but it also means your own funds are at risk.

    • In general, if you’re not willing to put your own funds at risk in a venture, you shouldn’t start the venture in the first place. Of course, if you have specific skills, e.g., you understand chemistry and biology like nobody else and can make a better blood clotting agent for battlefield injuries, and you meet someone who has lots of money but no skills, e.g., an accredited angel investor, then there’s a match. However, very few investors, and for that matter, banks, are going to be willing to provide you money for your venture if you don’t have your own funds at risk. They’re going to want to see that you’ve already put your own money into the venture.

      Unless you already have significant assets in retirement accounts (which, if you plan on being done by 40, might be problematic), you’ll be wiped pretty clean in bankruptcy. If you don’t have much in the first place, then it’s probably not that big of a deal, especially if you don’t plan on moving any time soon.

      There are better ways to build a business than off of the back of a credit card or a SBA loan. (cough)(ahem)(Lesson 19 of the Winning With Money Course(cough)(ahem). I’m living proof that you can build a multi-million dollar business and not have to go into debt to start it.

      Thanks for the thought-provoking comment!

      • All good points, Jason. I’m only half serious when suggesting that, as we are so debt-averse that we won’t even keep a mortgage around. Using a CC to fund a business is our worst financial nightmare.

        But, when I see entrepreneurs with good ideas but not a lot of money, whose only assets are their home and a 401k, the evil side of me thinks, man, they could take a handful of credit card companies for a ride…

        • Don’t think that I didn’t consider whipping out the credit card when we were just starting. I’m glad that we didn’t. When we got a huge contract and had to nearly quadruple the number of people we employed, I made the mistake of getting a small business loan to pay the contractors early (so they’d prefer us as opposed to someone else) rather than just negotiating timelines with them. That loan hung around like a raccoon that loves your garbage can, long after we’d received payments on the contract and could have paid it off. We wound up making it, but when I think of the number of times in the first few years that we came close to shutting down shop, it makes me shudder to think about what it would have been like had we also piled on maxed out credit cards to the situation. Even though we were pretty much in the situation you described – with assets that mostly wouldn’t be touched by a bankruptcy – the mere thought about what might have been makes me shudder a little.

          Were I 19 years old with a full college scholarship, I might be a little more risk seeking.

          Still, if you don’t have the patience, as a prospective entrepreneur, to wait to save up the money to get your idea off the ground or to hustle to get some beta clients, then it probably doesn’t bode well for your long term prospects anyway. Very few entrepreneurs will succeed without a shedload (or a few shedloads) of hustle, so you may as well start hustling for revenues rather than buying yourself a perception of more time by creating a false sense of security that a line of credit via Visa or Mastercard will offer.

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