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Use of your merchant banking account not for personal credit cards

Denver Business JournalOn the Money
From the February 6, 2004 print edition

There was once a small business in need of cash. The business had a merchant banking (so it could accept credit cards) account established with a small Oregon bank.

The business owner decided to provide his business some working capital by running his own credit card through the company’s merchant baking account. The amount was $4,000. The transaction was rejected.

Why? Because according to the merchant banker, using your personal credit card to fund your own business is illegal by virtue of Federal law– 16 C.F.R. §§ 310.3 et. seq.

Is this true? Hardly. But (and it’s a big but), credit card laundering is a crime. If you have a credit card merchant account for your business and attempt to generate some unrestricted working capital cash by tapping your own credit card, don’t do it.

Here are some examples of restrictions on businesses that accept credit cards. Merchants shall not:

  • Submit for payment any transaction representing the refinancing of an existing obligation of the cardholder. This includes dishonored checks and charge-backs.
  • Allow any other person or business to process transactions through their card terminal.
  • Split tickets or process multiple tickets in an effort to gain an authorization for the sale.
  • Give a cash refund for a previous credit card sale, but rather shall issue credit on the same credit card.
  • Offer cash back on a credit card transaction.
  • Under any circumstances, obtain authorization for, nor process sales on any card the Merchant itself is authorized to use. Processing Merchant’s own credit card is grounds for immediate termination.

That’s the restriction that caused the problem for the proprietor above. The trouble was not the attempt to use personal credit to bolster a young business, but doing it by using a merchant banking relationship in a way that was improper if not illegal.

Notwithstanding abuse of merchant banking relationships, Inc. Magazine recently reported that 50 percent of small businesses are financed through personal credit cards. Only 6 percent obtain SBA loans and a mere 2 percent receive funding from venture capital firms.

While credit cards maintain a bit of cultural mystique and magic (generated by the eminence various precious metals), and are extremely convenient to use, they are really nothing more than personally guaranteed lines of credit. Any bank, if they are inclined could issue your young business a line of credit usually under far more favorable terms providing it carriers a personal guarantee.

Nevertheless, half the small businesses today use the owner’s personal credit cards to finance their growth. The primary stipulation being that the owner doesn’t obviously attempt to extract cash from the card into the company’s merchant banking account!

As an example, a small manufacturer of furniture found themselves in a market where demand was soaring. With no assets, they used their credit cards for everything from equipment, raw materials, travel expenses and daily operating costs. After six years, the company found that its cost of capital was an overwhelming 23 percent. But profits and volume growth finally did outrun the credit card debt. The obligation was paid off and today the firm has a much more stable capital structure.

One the other hand, the financial landscape is replete with examples of credit card balances becoming so high that monthly debt service (minimum payments) could not be maintained; eventually leading to not just the collapse of the enterprise, but the ruin of personal credit as well.

Credit cards are easy, but expensive and financially brutal.

For most start-ups, there few friendly financing options. But there are ways to make things easier on yourself if you decide to use personal credit cards.

  • Be sure to use different cards for business and personal expenses. The credit card interest on items you charge for your business is tax deductible, personal interest paid is not. Mixing business and personal expenses on the same card inevitably creates confusion and higher exsposure on your tax returns.
  • Apply for credit cards offered by critical suppliers you use often. Stores such as Staples, Office Depot, and Costco may even issue a card in your business’s name.
  • Pay your bills promtly with these “private” cards, and it will help you establish a solid credit history as a business; making it easier to graduate to a corporate small-business card, such as those offered by Visa, American Express, and MasterCard.

From there it’s just a small step to a truly efficient capital stuctures and untold fame, wealth and fortune.

But just in case, “don’t leave home without it.”

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.