- Robert H. Scott, III (Monmouth University)
This report uses data from the Kauffman Firm Survey (KFS) to study the credit card debt characteristics of new firms. It specifically investigates whether revolving credit card debt reduces a firm’s probability of survival. More than half of all new firms rely on debt financing when starting operations. A vast majority of these businesses rely on credit card debt to fill any equity gap. This debt financing strategy can be very expensive. While credit card debt provides needed short-term funding, reliance on this type of financing may lead many businesses into a long-term liquidity drain that affects their financial stability—and thus survival.
A multivariate regression model was developed and tested using the KFS data (not shown), which found that credit card debt reduces the likelihood that a new business will survive in the first three years of operation. The results, which were statistically significant, found that every $1,000 increase in credit card debt increases the probability a firm will close by 2.2 percent. No relationship was found, however, between using credit card debt to start a business and that business’s survival or closure.
Many factors explain why new businesses succeed or not. The growth in credit card use among small businesses has raised the question of whether firms with credit card debt were less likely to survive during their beginning stages of development. This study shows that credit card debt does play a role in business closure in the first few years of operations. And, while it is not the only determinant of a business’s stability, it appears to be an important factor in a firm’s likelihood to survive.
A complementary working paper on this topic, Plastic Capital: Credit Card Debt and New Business Survival, is posted on SSRN: http://ssrn.com/abstract=1457744M.