In recent months, the credit card industry has been subject to intense scrutiny regarding the use of ‘impenetrable’ disclosure language provided to consumers, many of whom are entrepreneurs running their own businesses. This criticism highlights a potential negative to what is otherwise seen as a safe, fast and secure method of financing.
    Each year the credit card industry distributes more than six billion offers for pre-approved cards and the average household receives 6.5 offers each month ¹. With many of these offers in the hands of small business owners, entrepreneurs are faced with more choices than ever that effect how they manage their cash flow. Although they have certainly helped entrepreneurs manage their businesses, use of credit cards as a means of accessing financing may not be the best choice for all, especially those that pay their bills late.
    So what does this mean to small business owners who consider using a credit card as a financing tool? And armed with this information, what is the opportunity for ISOs to expand their product line-up?

Entrepreneur’s Outlook on Credit Card Usage

    According to the results of an early 2007 survey of small business owners, 61 percent entered this year with increased optimism regarding the health of the economy and their 2007 business outlook. These survey respondents anticipated increased business expenditures (61 percent) and indicated that they plan to use credit cards to make these purchases (64 percent). The survey results also indicated that half of small business owners are unaware of the potential costs of financing their businesses with credit cards. As a result, they may be using this convenient financing method instead of using other products that could be more beneficial for their businesses in some cases.
    The research report is the second in a series titled “Capital Access Network Small Business Barometer” and was commissioned by New York- based Capital Access Network, Inc. (CAN). The survey itself was conducted nationally among small business operators who accept credit cards as a form of payment. It revealed compelling data about entrepreneurs’ outlook on spending as well as a lack of understanding regarding minimum monthly credit card payments and cumulative long- term costs.

True Costs of Using Credit Cards

    One objective of the CAN Small Business Barometer survey was to determine how the use of personal or business credit cards fits into the overall financing decisions of small and mid-sized businesses. The results indicated that 77 percent use their personal or business credit cards for purchases over $5,000 two or more times a year. Survey respondents also said they thought they had a strong understanding of their current interest rates and knew they might be subject to increased rates after only one late payment (92 percent awareness). According to a recent report from the US Government Accountability Office, 35 percent of active US accounts were assessed late fees and 13 percent were assessed over-limit fees in 2005, causing some credit cards to charge penalty interest rates in excess of 30 percent. These costs can be significant. A 2004 bankruptcy case in Virginia showed that over a two year period, the debtor made only $236 in purchases on the account while making $3,058 in payments including finance charges, late charges, over-limit fees, bad check fees and phone payment fees.
    Although business owners may know that these charges can occur, they might not understand how much they will actually pay over time. One half of the small business operators surveyed in the study responded that they did not understand the actual long-term implications of a $5,000 credit card charge while making only minimum payments over a five-year period.
    According to data from the Federal Deposit Insurance Corporation (FDIC 2003), the true cost of using a card for this type of purchase is extremely high, even though it may seem like a reasonable monthly minimum payment. An initial charge of $5,000 with an 18 percent annual percentage rate can amount to an actual cost of more than $18,000 and would take nearly 46 years to pay off if only the minimum monthly payment was made (assuming that the minimum is two percent of the outstanding balance). Of the respondents in the small business survey, more than half indicated they are currently using a card with an interest rate ranging anywhere from 10 percent to as high as 20 percent, with the median rate falling at 14 percent, which is in line with the current average rate according to Bankrate.com.
    These results suggest that business owners may be foregoing financial options that are more cost effective in the longer term due to lack of information and awareness of alternatives.

Knowledge is Your Biggest Competitor: Awareness of Alternative Funding Options

    In addition to credit card usage, this survey asked respondents to identify preferred methods for acquiring the capital needed to maintain and grow their businesses. Topping the list was a traditional, collateral-based bank loan, (57 percent) followed by obtaining capital based on future sales (23 percent), a Merchant Cash Advance, which involves the purchase of future credit card sales, falls into this category of appeal. At 23 percent, favorability for a product with the features of a Merchant Cash Advance is clear. Other methods, including second mortgages, loans from friends and family and loans co-signed by friends and family were the least appealing choices, accounting for only 20 percent of responses.
    However, the small business market is still not fully educated on alternative funding products such as Merchant Cash Advances. Although it is growing, only 27 percent were aware that they can sell their future credit card sales in exchange for working capital.
    This relatively low awareness rate translates into a unique opportunity for ISOs to work directly with their clients to assess how credit cards figure into their cash flow strategies. If you find that your clients are using credit cards for major expenditures more than two times a year, as 77 percent did in this survey, it might be time to recommend alternatives such as a Merchant Cash Advance for access to working capital. Helping them understand the true cost of using personal or business cards that carry default rates, penalties, late fees or accumulated interest due to minimum payments will position you as a value-added advisor.
    Generally, Merchant Cash Advance providers purchase specified amounts of future credit card sales at a discount. Collection of the purchased credit card sales occurs automatically through the merchant’s credit card processor. The Merchant Cash Advance provider receives a fixed, predetermined percentage from each credit card sale made by its customer until the merchant’s obligation is satisfied. Since it is sent a set percentage and not a fixed dollar amount, the provider only gets paid when the business does, helping the merchants manage cash flow throughout the year. Unlike financing products, the owner knows upfront exactly what the total cost of the funding will be —it will never exceed the amount of the credit card receivables sold.
    ISOs are perfect advisors and educators for this product, since they are already counseling merchants on cash flow through the use of payment processing alternatives and other innovative payment solutions. Because Merchant Cash Advances are integrated directly with the processing stream, discussion of the product is a natural.

¹ Source: CreditCards.com