Credit Basics
Plastic May Be The Only Way To Go; But It Comes With a High Price
Monday, November 29, 2004
The Wall Street Journal
Sam and Renee Beckley also ran up thousands of dollars in credit-card debt to start their own business, a recording studio in Aurora, Ill. But they aren't quite millionaires yet. Although their business is growing, they're so mired in bills that they signed on with a debt-consolidation firm earlier this year. Between the debt and a hefty hospital bill, they expect it will take four years to pay off the $40,000 they owe.
These are the potential risks and rewards for entrepreneurs who lean heavily on credit cards when starting up a business. Plastic can be useful for people who can't get loans from banks or family, or who are sitting on a can't-miss idea and just need some help getting over one big hump. But owners of less explosive businesses can get bogged down quickly in debt, especially if a missed or late payment prompts the card company to ratchet up interest rates. And even though entrepreneurs can open up card accounts in their business's name, they are usually personally liable for bad debt.
"The issue is that almost all credit-card agreements have fine print with very sharp teeth," says Fred Wainwright, executive director of the Center for Private Equity and Entrepreneurship at Dartmouth's Tuck School of Business. "If you miss even one payment, the attractive terms can convert to over 20% annual interest rates and outrageously high penalty fees."
Lewis Mandell, a professor of finance at the University of Buffalo School of Management, agrees. The only situation where you might consider gambling and racking up lots of debt on a corporate card, he says, is "if you have an almost- sure thing and just need to finance a couple months of credit in order to do production and finance receivables."
Sam and Renee Beckley certainly thought credit-card debt was the only reasonable way to finish building their recording studio, Gremlen Studios.
The couple met while studying audio engineering at the Conservatory of Recording Arts and Sciences in Tempe, Ariz. After graduating in 2001, they moved back to Mr. Beckley's hometown of Aurora, Ill., to start a studio. Mr. Beckley, now 25 years old, got a $15,000 personal bank loan, and the couple signed a five-year lease for 2,000 square feet of studio space, paying $500 a month. Mr. Beckley says he had "pretty much perfect credit" at the time.
The space they leased was "just an empty room," so they had to start from scratch to turn it into a recording studio. They put up multiple layers of drywall and foam insulation for soundproofing and acoustics. Some 3,000 feet of audio cables were strung behind the walls. Mr. Beckley already owned some studio equipment.
They also wanted to distinguish Gremlen Studios from its competitors by offering clients an analog tape machine -- which many musicians think has a unique sound -- in addition to digital recording. Many rivals only offered digital recording. Price tag for the hardware: $4,000.
They spent the $15,000 bank loan within a few months and still hadn't finished the studio. They decided to tap plastic to finish the job, "or we would have lost a lot of money," Mr. Beckley says. He had about five or six cards in his name, he says. Eventually they put more than $20,000 on Mr. Beckley's cards, including the prized analog tape machine.
The studio opened in March 2002 and did well, attracting amateurs and professional musicians. An eclectic mix of music reverberates in the studio, from rock to rap to traditional Irish music.
They managed to pay off the bank loan. But the credit-card debt was "really holding us back," Mr. Beckley says. Moreover, they added to their load by buying a house in 2002. And last year, Ms. Beckley, who is 26, gave birth to a girl, but insurance didn't cover the hospital bills. That pushed their debt close to $ 40,000. Ms. Beckley hasn't worked at the studio since the baby arrived.
By last spring, the Beckleys' debts were "out of control," Mr. Beckley says. The minimum payments on their credit cards added up to more than $1,000 a month, not to mention their mortgage and hospital bills. Because of late or missed payments, the interest rate on some cards rose as high as 20%. They initially didn't pay their hospital bills, so the hospital referred the debt to a collection agency.
Soon after, the Beckleys sought help from Consolidated Credit Counseling Services Inc., of Fort Lauderdale, Fla. Consolidated was able to negotiate lower rates with the Beckley's creditors, and now they make a single monthly payment to Consolidated of about $1,260, which Ms. Beckley says is more than their mortgage payment. Consolidated pays the creditors.
They've been told it will take about four years to pay off their debt. "I don't believe it," Ms. Beckley says. Mr. Beckley is more optimistic: "Before, it would have taken years and years" to pay off, he says.
To help improve their finances, Mr. Beckley took a full-time job this fall teaching music at an elementary school. On top of that, he works about 30 hours a week at the studio. He has one employee and plans to hire another. The studio's revenue has grown by about 20% a year. Mr. Beckley charges clients about $35 an hour, and he thinks he can raise rates early next year.
"Right now, it's tough, but I think four to five years down the road, it's all going to pay off," he says.
Mr. Beckley admits he made missteps. For instance, he says he should have looked into funding, such as Small Business Administration assistance, before the couple signed the lease for the studio. But once the lease was signed and the bank loan ran out, he felt credit-card debt was their only option -- since they had to get the studio up and running fast to start bringing in money.
"I do feel it was worth it," he says. "If I didn't have the credit available, we might have lost a lot of money. We taught ourselves a big planning lesson on this one."
