Credit Basics
Plastic May Be The Only Way To Go; But It Comes With a High Price
TEN YEARS AGO Jason Olim and his twin brother, Matthew,
took a gamble and racked up $64,000 in credit-card debt to expand their business:
an online music retailer called CDnow. The Olims paid off the debt quickly, took
the company public, and later sold it to Bertelsmann AG, the German media giant,
for $117 million.
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.
