Contact:
Rossana Weitekamp, 516-792-1462, rossana@weitekamp.com
Barbara Pruitt, 816-932-1288; bpruitt@kauffman.org, Kauffman Foundation
Credit card debt often fills startup firms' equity gap, but those with continuing high balances have reduced likelihood of success
(KANSAS CITY, Mo.), Aug. 6, 2009 – Credit card debt reduces the likelihood that a new business will survive its first three years of operation, according to findings from a new study released today by the Ewing Marion Kauffman Foundation.
The study suggests that, during many firms' first few years of operation, their credit card debt increases and then eventually stabilizes to manageable levels, while firms with high credit card debt close, and successful firms start paying off their debt. The study, The Use of Credit Card Debt by New Firms, bases its findings on data from the Kauffman Firm Survey, a panel study of new businesses founded in 2004 and tracked over their early years of operation. The new research was conducted by Robert H. Scott, III, assistant professor of economics and finance at Monmouth University in West Long Branch, N.J.
"New businesses' access to formal credit markets historically has been limited, a situation that has been exacerbated with the recent contraction of credit markets," said Robert E. Litan, vice president of Research and Policy at the Kauffman Foundation. "Consequently, entrepreneurs use credit card debt to finance their new ventures. Credit cards, however, are an expensive way to fund a business, and this new study suggests that escalating credit card debt negatively affects a new company's chance of survival."
More than half of all new firms rely on debt financing when they begin operations, and a vast majority of these businesses rely on credit card debt to fill any equity gap. Credit cards tend to appeal to small businesses for several reasons. They help small businesses manage their finances and streamline payments, and they are easier to get than traditional bank loans or government business grants. Credit cards smooth revenue streams—especially at the startup phase of operations—and, unlike other types of loans, credit card companies will never ask where their money went.
About 58 percent of the KFS firms relied on credit cards to finance operations in their first year of business. The study results found that every $1,000 increase in credit card debt increases the probability a firm will close by 2.2 percent.
In 2004, those businesses that closed had less credit card debt ($2,365) than businesses that survived ($3,638). This average increases 40 percent by 2005 for surviving firms and increases 190 percent for businesses that closed. However, by 2006, the one-year change in credit card debt balances for surviving firms was a marginal 1.8 percent gain; but the average balance actually decreased by 18.5 percent for firms that closed.
"Numerous factors affect whether or not a new company survives," Litan said. "Credit card debt alone doesn't determine how stable a business will be, but it does appear to be a significant influencer in the company's probability of survival."