Credit Cards and Financing the Next Big Thing

by on Wednesday, September 8th, 2010

The final provisions of the new regulations governing payment cards (credit, debit and prepaid) are now in effect. The new regulations limit certain penalty and other fees, require a minimum period before gift cards can expire and restrict issuers’ ability to market on college campuses and, in general, to customers under 21.

via adria.richards (Creative Commons)

John Berlau of the Competitive Enterprise Institute made the point that under the new rules Sergei Brin might not have been able to acquire the plastic he is said to have used to start Google. True or not, enshrined in modern folklore are the entrepreneur or filmmaker maxing out their credit cards to fund the Next Big Thing.

Implicit in these stories is that credit cards are the financing vehicle of last resort, something the new rules don’t change. But why should smart, dedicated, creative people ever have to fund business ventures with consumer credit? Why can’t they find more appropriate sources of financing?

Raising money from angel investors makes a lot more sense than using credit cards, but it just got a little harder. Most angels have to be “accredited investors” under the Federal Securities laws. The policy is to permit only the “wealthy and wise” to invest in presumably risky offerings since they are least likely to require protection against either unscrupulous promoters or themselves.

However, the definition of accredited investor was recently changed to exclude the value of the investor’s home from her assets for purposes of the regulation’s $1 million net worth test (an alternative test, which looks at income, has not been changed). Unless one of these tests is met, it doesn’t matter how knowledgeable and experienced a potential investor might be. And although the new rules may put some potential investors on the sidelines, it could have been worse. Proposed rules would have disqualified an estimated 2/3 of angel investors.

A newer alternative is “crowd funding”, in which individuals invest very small amounts to finance a venture (the Securities laws permit this). This model has proven especially popular in film financing, with communities such as IndieGogo and Kickstarter. In the tech world micro-investment communities include Grow.
The Zavee takeaway:

  • Credit cards should be the funding vehicle of last resort.
  • Angel investments are never easy to come by and may have become a bit more difficult.
  • Micro-investment communities are an innovation worth exploring.