Tag Archives: business financing

Note to Merchants: Like It or Not, Chip Cards Are Coming

If you’re a merchant, you’ve no doubt heard of the chip card. It’s a credit card that holds all of the necessary information in a small computer chip rather than a magnetic stripe.

But you may not have seen one. That’s because they’re virtually nonexistent in the United States, even though they’re widely carried in the rest of the world, where they’re regarded as a more secure alternative to the old mag-stripe card.

So why aren’t chip cards more popular in the United States? The answer depends on who you ask. Banks say chip cards aren’t widespread here because merchants won’t invest in the new card readers they need at the checkout counter and this makes the cards impractical for consumers. Merchants say they don’t want to spend on new card readers until the issuing banks commit to investing money in the more expensive chip cards and pushing them out to consumers on a broad basis.

So Who’s Right?

Merchants have a pretty good case. Walmart has gone ahead and spent a lot of money to put chip-card readers at its registers, but the readers don’t get a lot of use because most customers are still carrying traditional magnetic-stripe cards, not the newfangled chip cards.

Issuing banks also have a reasonable argument. Most merchants, unlike big-bucks Walmart, haven’t invested in the new card readers and decline when customers brandish a chip card. And besides, banks ask, why should they put billions into chip cards when more advanced technologies — such as cell phone payment — may soon make chip cards obsolete?

And the winner will be †¦ probably neither merchants nor banks. The card companies, Visa and MasterCard, are strongly behind chip cards, and they have a sweet carrot and a sharp stick to ensure that the cards will soon be accepted. Both the carrot and the stick are aimed at merchants.

Visa, which makes a lot of money not only from its cards but also from its large electronic-payment-processing network, recently announced that it has developed a new countertop terminal that will accept magnetic-stripe cards, chip cards, and cell phone payments.

“We believe that as merchants start to move, the card issuers will see the merits as well,” Ellen Richey, chief enterprise risk officer at Visa, told The Wall Street Journal recently.

Sticking It to Merchants

To shift merchants out of neutral, Visa announced that, starting in October 2012, merchants that are using its new terminal for at least 75 percent of Visa transactions will be exempt from the current Visa requirement that they prove they comply with industry fraud-prevention standards.

And if this isn’t enticing enough? That’s where the stick comes in. Beginning in 2015, merchants that aren’t using the new Visa terminal could have to shoulder the cost of any fraud that results from a transaction in which a chip card is offered but not accepted. (These costs are currently paid by the issuing bank.)

So let’s put that in plain English. You’re a merchant and a customer tries to pay with a chip card. You don’t have the new Visa terminal so you ask for a magnetic-stripe card instead. Then, somewhere down the line, an identity thief gets that card information and goes on a spending spree. Guess who pays the bill? Yup, you do.

Please pass the chips.

Follow Tim and Tom on Twitter @timntom

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USB 3.0: A Quick’Tech Guide for Small Businesses

It seems like Universal Serial Bus (USB) technology has been around forever. That’s probably because compared to many kinds of computer technology, it has been around forever — the first USB 1.0 devices hit the mass market way back in the mid-1990s.

That early version of USB was fine for connecting a mouse or keyboard, but it was unbearably slow at moving data. Then in 2000, USB 2.0 came along and finally made it practical to transfer data from cameras, hard drives, and the now-ubiquitous “thumb drives” that most of us use (and lose!) every day.

Now there’s a new kid on the USB block. And if you haven’t met them yet, it’s time to get acquainted.

Introducing USB 3.0

The USB 3.0 standard was approved in 2008. Like most such standards, however, it took a couple of years for manufacturers and developers to get onboard and start using it. Today, you can find USB 3.0 as a default option on almost every new laptop and desktop PC (with one very notable exception — more on that in a moment).

The biggest benefit of USB 3.0 is by far its speed. On paper, USB 3.0 devices can transfer data at a top speed of 4.8 gigabytes per second, or 10 times faster than a USB 2.0 device and 400 times faster than old USB 1.0 devices! In practice, you’ll never see that top speed, because actual transfer speeds are always lower, and they depend on the hardware, drivers, and other variables.

But the bottom line doesn’t change: USB 3.0 is a huge improvement over its predecessors when you’re doing things like transferring large files to and from portable hard drives. That’s especially true now that today’s “portable” hard drives may have capacities of 2 terabytes or more, and many small businesses routinely work with very large image, video, graphics, and business data files.

There are other benefits to using USB 3.0, including the technology’s ability to deliver more power to connected devices when it’s needed and less power when it’s not. That makes USB 3.0 both more flexible and more efficient.

In one respect, though, USB really isn’t an improvement over its predecessors: cable length. Unless you buy special extension gear, you’re still limited to about 3 meters (10 feet).

Also keep in mind that USB 3.0 is both backward- and forward-compatible with legacy USB gear. In other words, a USB 2.0 device will work fine with a USB 3.0 slot, and a USB 3.0 device will work with a USB 2.0 slot. (You’ll just have to accept the lower USB 2.0 transfer speeds.)

USB 3.0: It’s (Almost) Everywhere

Like I said, if you’re buying a new system, you’re probably all set: USB 3.0 is now standard-issue on most new PCs and laptops. However, there are two big exceptions at this point:

  1. Tablets and smartphones: USB 3.0 is now available on many portable devices, but not all of them. If data transfer-speed is a priority for you, be sure to check whether that new smartphone you’re looking at supports USB 3.0.
  2. Apple hardware: As of August 2011, Apple still doesn’t support USB 3.0 on any of its computers. It’s not clear why, but this may have something to do with Apple’s desire to promote a competing high-speed peripheral interface called Thunderbolt. There’s a silver lining, though: You can buy third-party hardware that adds USB 3.0 support to some desktop Macs.

Does Upgrading Make Sense?

You might also own a PC or laptop that predates USB 3.0. If you want to upgrade an existing laptop, you’re probably out of luck; these systems just aren’t built for after-the-fact modifications. Many desktop PCs, however, have internal PCI expansion slots that can support an add-on USB 3.0 card. These plug in to your PC’s motherboard and add a set of USB 3.0 slots that will be accessible on the back of the PC.

If your PC supports this, adding one of these cards is something most users can do themselves in just a few minutes.

But before you invest in an add-on card, or even run out to buy a new PC, keep in mind that there are cases in which USB 3.0 might be more than you really need. This is a standard that was designed to move large amounts of data; it’s perfect for use with external hard drives, digital video and still cameras, and similar devices. If, on the other hand, all you want to do is connect a mouse and keyboard, USB 3.0 is overkill — and a waste of money. As with all technology, decide what you really need to get the job done before making a purchasing decision for your small business.

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Warren Buffett Speaks the Unspeakable

For years, Warren Buffett has been called the “Oracle of Omaha,” not only because of his business — he built Berkshire Hathaway into one of America’s most successful companies — but also because of his sage investment advice. He was named the third wealthiest person in the world this year, yet still lives modestly. The accolades could go on and on.

He’s like the uncle every family wishes it had; kind, unassuming, thoughtful, soft-spoken, tight with a penny, yet also generous with his advice and time. He also recognizes that not everyone is as fortunate as him and he’s pledged to give 99 percent of his money to charity. But last week, he did the unspeakable: He called for a tax increase on the super wealthy. “My friends and I have been coddled long enough by a billionaire-friendly Congress,” he wrote in a recent New York Times column. “It’s time for our government to get serious about shared sacrifice.”

His words produced an explosive reaction on Fox News. He suddenly became creepy, old, eccentric Uncle Warren, the kind of moocher who always shows up at your home uninvited and always overstays his welcome. He was accused of inciting “class warfare.” (Wait, isn’t he part of that class?) One Fox commentator even branded him a “socialist.” The Daily Show’s Jon Stewart had a field day with that.

The conservative Heritage Foundation was quick to jump into the fray. On its blog, The Foundry, Mike Brownfield reminded us that daffy, old Uncle Warren really doesn’t know what he is talking about when it comes to investing. (Say what?). Among other things, he took issue Buffett’s biggest blaspheme — that tax rates don’t affect investment decisions.

“I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain,” Buffett wrote in his column. “People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.”

But Brownfield was quick to counter: “We’ll take Buffett at his word that he doesn’t consider the tax implications for his investments (even though it is well documented in several books that he does consider them — one of the major tenets of the value investing practice Buffett follows is to hold equities as long as possible to minimize the impact of taxes and therefore maximize internal returns), but the rest of the investing world is solely concerned with after-tax returns to their investments. Tax rates including the capital gains rate, dividends rate, corporate income tax rate, and individual tax rate are major determinants of after-tax returns.”

Brownfield clearly missed the point. Buffett never said he doesn’t “consider” taxes; he said tax rates never stopped him from making a sensible investment — two different things. But what I find insightful about this exchange is about how circular, meaningless, and politically driven the debate over the economy has become in Washington.

The anti-tax lobby is so hardened and uncompromising, it’s become ridiculously self-destructive in these hard times, as the recent debate over the debt ceiling showed. To dismiss Buffett as a socialist or a crackpot, or to claim he doesn’t understand investing only illustrates the point. What I like about Buffett is he began his career on Main Street as a small businessman, and, in a sense, he’s never really left, despite all of his success.

Buffett isn’t minimizing the debt problem or the need to control government spending, but he realizes that it will take both spending cuts and revenue increases to keep the economy moving forward. “For those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains,” Buffett wrote in his Times article. “And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate,” he added.

Any increase in revenues, however, should be directed into a jobs program to put Americans back to work. Right now, ask any small business owner what they want the most, and it won’t be lower taxes or less regulation; it will be more customers coming through the door. And those customers need salaries in order to spend. But where are their jobs going to come from? Business won’t create them, and rightly so. Unless firms see rising sales, no business will hire, no matter how many tax incentives they receive. So where do you start?

President Franklin Roosevelt hired 3 million people through the Works Progress Administration and other programs during the Great Depression. The WPA budget in 1935 was $1.4 billion a year (about 6.7 percent of the 1935 GDP), and it spent $13.4 billion over its existence. At its peak in 1938, it provided jobs for three million workers, from the unskilled to writers and artists. In all, more than 8 million jobs were created by the time the program expired in 1943.

That would be the equivalent of 22 million jobs, adjusted for population growth. Today, some 25 million Americans — 16.1 percent of the work force — are jobless, work part-time, or are under-employed. Put these people back to work and watch the economy blossom.

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How to Determine If Your Funding Deal Can Be Saved

For six months you’ve been carefully nurturing an equity investor and now he’s threatening to back out of the deal.

Despite an endless number of presentations, term sheets, meetings with partners, and expensive legal documents, it looks like the whole thing is going to unravel. And that would probably make your young business unravel, too.

What’s an entrepreneur to do?

Good negotiating might mean you have to walk away. That advice might work well when buying a new car, but it often gets in the way of building a great business. Before you throw in the towel, ask yourself the following questions:

  • What’s best for the business? Often an experienced investor will spot a weakness in the business that you cannot yet see. Take the opportunity to view things through the investor’s eyes. Probe for the real reasons behind the investor’s objections or suggestions. Evaluate whether the business as a whole is likely to be more successful by following his or her advice. Your objective should be to enable the fastest, most profitable, and sustainable growth. If that is not your sole objective, you may not ever come to terms with a potential shareholder; barring rapid and profitable growth, there’s not much else in it for an equity investor.
  • What’s your core skill? Investments often fall apart because of a disagreement over the roles of founders and key executives. Maybe the investor sees a weakness in you and wants to replace you as chief executive. If you simply can’t live another day without being the big boss, maybe you’re allowing emotion to ruin a great opportunity. Step back and decide if you might have more fun, and learn more, in a role other than head honcho. Plenty of founders, including Bill Gates, find they can drive the kind of results they crave from a chair other than the one in the CEO’s office.
  • Does the investor’s personality fit your team? Early disagreements could be the sign of something deeper, such as a cultural or personality mismatch. When a deal is in jeopardy, get back to basics. Spend some time with the person away from the negotiating table. Revisit your background checks and discussions with the person’s references. Is this a person you want to answer to when times get tough? If you can work through the problems by connecting on a personal level, you may be able to form a partnership that will weather the more difficult days ahead.
  • What’s the best-case result? If you’ve come to an impasse on the “down-side� or worst-case scenario, refocus your priorities on incentives to succeed. (After all, the worst case is no fun for anyone. If you can’t build a profitable business, maybe you need to take your lumps.) Instead of worrying about worst case, ask what happens if the company succeeds. Can you and your investor agree on the right incentives to keep the company growing? For you that means getting paid for success. For the investor it might mean allowing new investors to come in. Let go of worst-case nightmares and build a solid case for success.
  • What’s the “and� solution? So many business cases appear to be black or white. Either you accept the investor’s terms or you walk away. Fortunately real life allows for more complexity and creativity. When an investor insists on one thing, find something else to balance the equation: “I’ll give you a board seat if you give me annual salary increases.� Instead of saying “or,� try saying “and.� You may be surprised that the result is stronger than either of you imagined.

Finally, if you have gone through these questions and still can’t see the light at the end of the investment tunnel, perhaps it is time to walk away. Not every negotiation can be saved; there are people who are not meant to be in business together. But be sure you are walking away for the right reasons.

If the investment deal would jeopardize the business, your mental health, or your passion for growing a bigger company, the best deal you can make might be no deal at all.

David Worrell is founder and chief executive at
AmeriStart, and he also writes a blog here on AllBusiness.com about small business money issues.

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5 Employee Issues Your Small Business Should Be Worried About

It may not seem like it, but in some cities and some industries the job market is actually heating up. Last weekend I was talking to my cousin Barry Cohen, one of the managing directors of Rockwood Search Associates, an executive search firm in New York City. His company specializes in financial services, human resources, and marketing/sales positions, and right now he says the demand is climbing for positions in the financial services field.

And though you’re likely in another industry, soon enough you will be facing the challenge of attracting and retaining talented employees. The recently released PwC’s 14th Annual Global CEO Survey contains some interesting insights about the future of talent management. While this survey focused on leaders in big multinational corporations, the trends it highlights can — make that will — affect your small business soon enough.

Here are the surveyed CEOs’ key concerns:

1. Talent shortage. As I said, it may not yet be evident in your community, but companies worldwide are struggling to find the right people. In fact, 66 percent of CEOs are worried that a lack of suitable talent is going to hinder their companies’ chances of growth.

2. Aging workforce. In developed nations like the United States, the aging of the workforce is leading to a brain drain of some of the most skilled and experienced workers. To combat this, many corporations are seeking to retain their workers longer, while at the same time the economy is forcing many of those employees to stay on the job longer as well. But aging workers come with their own issues, like higher health-care costs.

3. New Millennials. The influx of Generation Y workers, or “Millennials,” is changing the way companies operate. Millennial employees have less experience and tend to have less company loyalty. They also have different criteria for what they want out of a job than prior generations did. As the Survey states: “Employers will have to offer greater autonomy, more flexible career options, and more opportunities for peer recognition, basically a mix of face time and Facebook time, to get the best talent from the next generations.”

4. Global mind-set. The CEOs surveyed are expanding their businesses into emerging markets. While your small business is probably not yet operating an office in Mumbai yet, you might already be outsourcing work to contractors there. But whether or not you’re working with businesses overseas, you are definitely competing with them, as increasing numbers of customers look for cheaper sources of whatever your company provides.

5. Collaboration. Today’s employees need to be able to collaborate. For global CEOs, these teams are often dispersed across the world; for your small business, they’re probably not that far-flung. But whether you’re operating in a physical location or running a virtual company, collaboration is more crucial than ever. It’s how you do more with less.

How are the global CEOs planning to tackle these concerns? Most (83 percent) plan to make at least “some” or “major” changes in how they manage employees. Specifically, 65 percent plan to use more non-financial rewards to attract, retain, and motivate workers. Creating a sense of employee ownership is one important strategy; this could be accomplished by employee stock ownership (ESOP) or profit-sharing plans.

Training and mentoring is a key area of focus for the corporations PwC surveyed. And today’s newest employees, Millennials, particularly value training and career development opportunities. When asked which benefit was most important to them, three times as many Millennials said training and development as cited cash bonuses. And a whopping 98 percent said that working with strong coaches and mentors was important to their careers.

If these challenges are throwing huge corporations for a loop, how do you think they’ll affect your business? Don’t worry — there’s some good news for small businesses in this survey. One of the key changes the CEOs mentioned is that their businesses are becoming flatter and less hierarchical. And while that’s a huge change for big corporations, for small companies, it’s business as usual.

Take advantage of your flatter structure to empower your employees. Let them know more about your business’s profits (and at least think about sharing them), provide coaching and mentoring (easy to do when you work closely together), and ensure they get the proper training to help them — and your company — grow.

Follow Rieva on Twitter @Rieva and read more of her insights on

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Benefits of Establishing an Employee Mentoring Program

Employee mentoring programs can be an informal way to improve morale and increase employee retention while helping employees improve their skills and grow within your company. Establishing a viable mentoring program is inexpensive but it  can offer a big payoff.

Traditionally, mentoring has been reserved for introducing promising new employees to company operations and culture. And that still works well. Assigning seasoned staff members to look out for new employees, show them the ropes, and serve as a kind of in-house ombudsman is an excellent way to achieve a smooth acclimation. Many experts suggest that every new employee should be partnered with a mentor for at least the first three months on the job.

But newbies aren’t the only employees who can benefit from mentoring. More and more companies promote mentor relationships for promising existing employees who want to develop additional skills and experience. Creating a formal mentoring program for existing employees and new hires can help you shape not only the future of employees but of the department and even the business as a whole.  

Choosing Mentors

There are a slew of consultants who can come into a company and help delegate mentoring tasks to staff. But small businesses rarely need this level of assistance because owners and managers tend to know firsthand who will likely make a good mentor.

Mentors must be experienced in their jobs and the company so they can impart valuable insider knowledge to their mentees. Equally important is their ability to communicate and teach. But perhaps the most critical trait in a good mentor is someone who is not just willing to do it but actually wants to do it. Incentivizing through rewards and recognition is also a good idea to ensure a mentor’s investment in and commitment to the program.

When choosing effective mentors at your company, look for employees who possess these attributes:

  • Patience
  • Willingness to help fellow employees
  • Strong verbal skills
  • Ability to multitask
  • Good rapport with co-workers
  • Positive attitude
  • Common sense

Establishing a Viable Program

As with any program, mentoring only works when you create clearly defined goals. These should be set for the program as a whole (i.e., the desired outcome for the company), for the mentees (i.e., the kind of growth to be attained), and for the mentors (i.e., successful conclusion of mentoring duties). The methods and makeup of a mentoring system depend largely on what the company wants to accomplish, but every program should have tangible metrics in place to measure success.

Many mentoring programs are geared toward general development, helping employees maximize productivity and potential. This can be an excellent way to boost retention and employee satisfaction. Other mentoring programs are designed for specific purposes, such as the following:

  • Working with mentees while they are in training, as a way to enhance skills and to build knowledge of the company’s direction and objectives
  • Navigating interdepartmental conflicts, company mergers, or other major changes to help make confusing and complicated times less stressful and isolating for employees
  • Prepping promoted employees for their new positions and helping them once they have made the transition

Oftentimes, companies ask all mentors to meet regularly (weekly or biweekly) with management to report back and exchange information. This can be effective for some companies because they can learn what’s working and what isn’t and make corrections along the way. This can also provide a valuable support system for mentors who are often under additional stress.

But while asking mentors to meet regularly can be useful to some, it can be burdensome to others. After all, mentors are already peeling off valuable time from their regular jobs to mentor. They may resent being forced to spend more time away from their jobs. Many companies, therefore, choose to establish the program, give mentors a defined period of time with their mentees, and then check back when that period is up to see if goals have been achieved and if mentees are ready to fly on their own.

In all cases, mentoring programs work best when companies clearly define the program objectives and requirements, select and pair mentors and mentees wisely, and communicate the program goals to all participants.

When mentors and mentees build a successful partnership, it can be one of the most powerful tools a company can use to ensure a company’s long-term health.

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Tech Buyback Programs for Small Businesses: Are They Worth It?

Small business owners are like everybody else. They want (and sometimes even need) the latest technology. But that’s a dangerous game in a world where today’s cutting-edge tech is tomorrow’s white elephant.

Retailers have responded with buyback programs: agreements that allow consumers to sell back products when they’re ready to trade up to a newer model. The amount of money a buyer can expect to get back can vary from less than 5 percent of the original price to up to 50 percent, depending on the type of product, as well as its age and condition.

In theory, buyback programs offer a quick, easy way to unload computers and other high-tech products before they’re outdated by newer models.

Mixed Reviews for Buyback Programs

In practice, however, consumer advocates often take a dim view of buyback programs. A February 2011 article on ConsumerReports.org, for example, noted that Best Buy’s buyback program comes burdened with restrictions and conditions that drive up the true cost of participation.

As a result, according to the report, buyback programs are “not likely to make good economic sense” for most consumers.

Many analysts agree that selling hand-me-down tech products on eBay or Craigslist is usually a much better deal than a buyback program. “I can see why [ConsumerReports.org] would say buyback programs are a bad deal,” says Billy Pidgeon, senior analyst with M2 Research. “I don’t see the upside for most consumers outside of a niche early adopter type.”

However, Stephen Baker, vice president of industry analysis at NPD Group, a market research firm, says that buybacks aren’t always a bad deal for consumers.

“I disagree with Consumer Reports that a buyback program is bad,” Baker says. “It is an opportunity to remind you that your product has value. It is really an impetus to trade in older products, and they make it relatively easy.”

A Better Deal for Small Businesses?

For businesses, the value proposition of a buyback program might actually be stronger than it is for consumers. Many companies have policies against selling used equipment to employees, and they may be unwilling to sell via online auctions and classified sites. In such cases, a well-structured buyback program can solve the problem of recouping at least some of the costs of upgrading technology products.

“For any business, small or large, buyback programs can be a very good deal where consumer electronics devices will be likely to have a shorter lifespan due to heavy usage,” Pidgeon says. “Businesses that need a technological edge on competitors are going to replace devices more often, and buyback programs can mitigate loss and pay forward on the next generation.

“With a buyback program,” Pidgeon says, “business owners can resell the same way they buy — in bulk.”

The True Cost of Tech Ownership

Baker says the time and effort required to deal with technology upgrades represent another significant cost for businesses — one that some critics of buyback programs underestimate, in his opinion.

“What isn’t noted in [the ConsumerReports.org article] is the time,” Baker says. “They don’t value anyone’s time or effort. Selling on eBay takes a lot of time; trading in is easier.”

Experts agree that the vast majority of small business owners may also not be tech savvy enough to know exactly when to upgrade. As a result, a buyback program can actually provide additional motivation to stay current with the latest technology.

Small businesses that rely on technology also manage assets differently, Baker says. For those that need the latest and greatest products, buyback programs ensure that older products have some value — especially when the alternative might be putting the older equipment into storage and forgetting about it.

However, there are reasons why buyback programs might not work for small businesses. That’s especially true when it comes to the question of whether to buy certain types of equipment in the first place.

“Some businesses might be better doing a leasing deal and trading in [their computer equipment] more often,” Baker says.

Who Does the Heavy Lifting?

Home-based workers may also benefit from buyback programs — although here, too, caveats apply.

“There are two kinds of people who work from home,” Baker says. “There are those who telecommute and who often get their equipment from their employer. Then there are those home-based workers who are independent and are more like consumers.”

For those in the second group, a familiar question arises: Do they have the time and motivation to sell used equipment on eBay or Craigslist when it’s time to replace it?

“I think that Consumer Reports assumes that everyone is going to do the heavy lifting,” Baker says, “and I think there is a lot of value to these buyback programs.”

Businesses also need to consider whether to pay for service plans and extended warranties, which raise the cost but may also be tax-deductible. While service plans normally benefit the company selling them more than they do consumers, a very small business that depends almost entirely upon one or two key computer systems may value them as an insurance policy against unexpected downtime.

Disposal Made Easy

Finally, buyback programs can also address the growing problem of what to do with end-of-life tech products that aren’t worth selling but can’t simply be thrown away either. Given new community regulations and issues with recycling and disposing of technology products, many of which contain toxic materials, buyback programs offer a potential solution.

“If you are concerned about recycling, buyback programs [provide a way] to get rid of the product at end of life, and you get money back when you get rid of it,” Baker says. “In the end it takes some stuff out of the disposal chain, too.”

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What Your Credit Score Doesn’t Tell You

“A little knowledge is a dangerous thing.” We’re not sure what Einstein was talking about when he said that, but he could easily have been talking about your credit score. Because, as outlined in a recent report to Congress by the Consumer Financial Protection Bureau, “The Impact of Differences Between Consumer- and Creditor-Purchased Credit Scores,” the document you see when you buy your credit score contains very little knowledge compared to the score a lender sees when deciding whether to grant you credit.

“It is important to note that many of the credit scores sold to lenders are not offered for sale to consumers,” reads the CFPB report.

The two scores may differ in any number of ways because there are so many different scoring models in use these days. The scores used most often by lenders are FICO scores, which are compiled by Fair Isaac Corp. But Fair Isaac alone makes scores using a variety of models — and there are many other scoring companies and models in addition to Fair Isaac.

Suffice it to say, as CFPB does, that the scores sold to consumers by the top three credit agencies — Equifax, TransUnion, and Experian — are “‘educational scores’ either not used by lenders at all or used only infrequently.”

Aside from being annoying, this discrepancy could be costly if you’re seeking credit.

First, if the score you purchase makes you think your credit is better than it actually is, you’re likely to waste your time and money applying for loans you don’t have a hope of getting. And this, in turn, could damage your credit score further, because credit-rating agencies assume that a large number of loan applications on your part indicates that you’re not financially sound.

Second, if the score you buy leads you to believe your credit is worse than it actually is, you may give up on applying for credit altogether. Or you might accept less money and worse terms than you’re eligible for. (In this scenario, the CFPB dryly notes, “a lender may not have an incentive to clear up the consumer’s confusion.”)

Luckily, the financial-reform law that took effect in July requires lenders to pull back the curtain at least a little bit. The law says lenders must supply you with a free copy of your credit score if they deny your loan application, or if they approve your loan at a higher rate than the rate they give their top customers.

The score a lender provides you must be the same score it used in making its decision, not an “educational” version. The lender must also outline the factors that impact your score and tell you where your score ranks overall.

Of course, that information is just a snapshot in time. If you apply for a loan a year later, your credit score could be quite different. For a picture of your credit score before you apply for a loan, order your credit reports from each of the three major credit bureaus. You can do that at AnnualCreditReport.com. These reports won’t tell you what your score is exactly, but they will give you a good idea, because they’re what the various credit-scoring companies use to compile their scores.

The most informative credit score is your FICO score. It’s used by 90 percent of banks when making lending decisions. You can get a free copy at myFICO if you sign up for a trial membership. The trial is 10 days, and there’s no charge if you cancel within that period. After that it’s $14.95 a month.

Confused about how your credit score is calculated? You’re not alone. Be sure to read 5 Common Myths About Credit Scores.

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5 Common Myths About Credit Scores

What’s the Real Story?

Rumors thrive in times of uncertainty, and this is as true in the financial realm as anywhere else. Perhaps more so. We know one business owner who believes to this day that the credit-rating company Fair Isaac is run by a very reasonable fellow named Isaac. (In fact, it was founded in 1956 by engineer Bill Fair and mathematician Earl Isaac.)

We present the five most persistent myths about credit scores and how they’re compiled, along with the truth behind the myth.

— Tom Stein and Tim Devaney

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Places Where You Should Never (Ever!) Use a Business Credit Card

A strip club and a marriage counselor: What do these two things have in common (aside from the fact that a trip to the first may result in a trip to the second)?

They’re both places where you should never, ever use your business credit card. Here are some others: bars, massage parlors, discount stores, pool halls, pawn shops, and tire retreading services.

Use plastic to pay in any of these places — or places like them — and there’s a chance that the card issuer will cut your credit limit, raise your interest rate, hike your fees, or cancel your card altogether.

That’s exactly what happened to Kevin Johnson, founder of Johnson Media, a digital marketing firm in Atlanta. Not long ago, he received a letter in the mail from American Express informing him that the credit limit on his card had just been cut from $10,800 to $3,300.

Why did this happen? “In effect, the letter said I was shopping at places where people with bad credit shop, which means that I too am a greater risk,” Johnson said. “Business owners like me are getting the short end of the stick. This is a problem that’s getting worse and worse.”

The Secret Is Out

All credit card issuers keep close track of your credit score. You knew that. They also keep a “behavior score” on you, which you probably didn’t know. That’s because banks don’t like to talk about their use of behavior scores.

In response to an inquiry from AllBusiness, both American Express and Capital One said they don’t adjust credit limits based on where customers spend, and that adjustments are typically based on debt-to-income ratios. But people who watch the industry have been talking about behavior scoring a lot lately (in articles with titles such as “The Secret Is Out“), and what they describe is a little creepy — and more than a little annoying.

Your behavior score is just what the term implies: It’s the bank’s judgment of what sort of person you are, as depicted by your spending habits. And if your spending habits include, say, visits to a psychotherapist and secondhand stores, your bank may decide you’re not the sort of person who’s a stable credit risk.

Virtually all large credit card issuers in the United States keep behavior scores on their customers. A 2010 survey by the Federal Reserve indicated that issuers review around 35 million cardholders each month based on their spending behavior.

The same study showed that a small percentage of the cardholders whose accounts were reviewed had their credit lines cut. But cutting your credit line is only one way a card issuer can squeeze you if it thinks your behavior makes you a poor risk. It can also raise your interest rate or your annual fee, or it can simply cancel your card. A low behavior score could also make it more difficult for you to get a loan in the future.

Behavioral scoring is a fairly new phenomenon. But why is this happening, and why now? Joseph Paretta, author of Master the Card: Say Goodbye to Credit Card Debt Forever! (Balboa Press, 2010), says it has everything to do with the unstable economy.

It’s no secret that credit card companies are faced with growing delinquency rates. They’re desperately searching for new ways to lower their risk and raise their profits. “As the economy hit the skids in 2008, more and more credit card companies are starting to look at ways to be more careful about to whom they offer credit and what those credit limits should be,” Paretta said. “Behavior scoring wasn’t a big issue before the financial crisis. But now it has become a real factor for the credit card companies.”

The practice may be legal, but is it ethical? Have card companies crossed the line by making judgments about you and your business based on where you shop? The Federal Trade Commission seems to think so.

In 2008, the FTC filed suit against credit card issuer CompuCredit for deceptive marketing practices. One of those practices: not properly disclosing to consumers that they could be punished for certain kinds of purchases, including those made at bars, billiard halls, and tire retreading shops. CompuCredit later settled the suit by agreeing to pay more than $114 million in refunds to consumers.

What’s Good Behavior? Banks Won’t Say

What can you do to improve your behavior score? You can use your common sense and avoid paying with your card at places that might suggest you’re anything less than a perfectly normal, upstanding citizen with a rock-solid financial profile.

But your behavior score isn’t like your credit score. There are no sure steps you can take to improve it because issuers won’t tell you what it is, let alone the methods they use to compile it. You could cut back on your credit card purchases in general, but your bank may also interpret that as a sign that you’re under duress.

So what’s a small business to do? “Use your card prudently in places that you would be happy to have your mom know you are patronizing,” said Frank Gorman, executive vice president of commercial banking for Meridian Bank, a community bank that doesn’t issue credit cards. “And avoid places that can raise a red flag like nightclubs and casinos. Even avoid retread and discount shops. Those kinds of places can lead to lower credit limits.”

Gorman added that business owners should also resist the temptation to use their business cards for any kind of personal or discretionary spending. “Everything purchased on the card should absolutely be for business purposes.”

It’s annoying to know that your credit card issuer is, in effect, following you around and judging your behavior on a regular basis. But with database technology improving daily and computing power racing ahead, it’s inevitable. You’ll just have to get used to it.

And next time you go to Big Lots, be sure to pay with cash.

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