By JANE J. KIM

A credit-card crunch is squelching the dreams of entrepreneurs.

Ryan Grantham

Jack Diamond of Tampa laid off employees after Bank of America cut his credit line.

For two years, Jack Diamond used his Bank of America small-business credit card to finance his plants-and-aquatics nursery business in Tampa, Fla. He would use the credit card to purchase plants, then pay down his balance after he sold lilies, pond plants and aquatic fertilizer to customers.

Last September, Bank of America Corp. cut the $46,000 credit line on his card to $27,200, just a few hundred dollars above his current balance. He couldn't buy the plants, seeds and equipment he needed for his spring selling season. He laid off six of his eight employees.

"I'm almost living paycheck to paycheck," says Mr. Diamond, 55 years old, who is considering filing for business bankruptcy.

Even as wobbly banks tighten up on consumer credit cards, they are also cracking down on small-business owners by slashing their credit lines, closing accounts and raising interest rates. A recent Federal Reserve survey found that about two-thirds of banks' loan officers reported that they tightened terms for business loans in recent months. Meanwhile the National Small Business Association, a trade group, said 69% of 250 surveyed small-business members faced worse terms on their cards, such as higher interest rates, in the second half of last year.

Banks have reason to get tough. In a bad economy, small businesses are usually among the first victims. Credit-card issuers have seen a surge in charge-offs, or debts no longer expected to be paid, over the past year as small businesses fail.

"People are using their credit cards to keep the businesses going, so when that dries up, the businesses go," says Jeanne Marie Cella, an attorney in Media, Pa., who has seen a significant increase in small-business owners filing for bankruptcy.

Indeed, the crackdown on business credit cards is happening just as the federal government scrambles to free up credit for small businesses by raising federal loan guarantees and reducing fees on certain Small Business Administration loans. In an attempt to get credit flowing again, the Treasury said it would buy up securities backed by SBA loans. Meanwhile, politicians in Congress are asking the Treasury to use more bailout funds to guarantee bank lines of credit for small businesses.

Until recently, credit-card issuers avidly courted small-business owners. Visa Inc., American Express Co., MasterCard Inc. and Discover Financial Services had an estimated 29 million business credit cards in circulation in 2008, up from just five million in 2000, according to the Nilson Report. Spending on the cards rose to $296.3 billion from about $70.4 billion over the same period.

Banks began moving into small-business credit cards in the mid- to late-1990s following the creation of credit-scoring models. One factor was a 1995 study by Fair Isaac Corp. and Robert Morris Associates, a trade group for loan officers and credit-risk managers, analyzing the performance of business loans.

The study surprised bankers. It found that a small business's cash flow and financial statements bore little correlation with how the owner would pay his or her bills. A much stronger predictor was the business owner's personal credit score. The banks concluded they could safely issue business credit cards to proprietors with good credit records even if the underlying business didn't appear to justify a loan.

"The credit-card industry noticed that study and that's when they started marketing business credit cards," says Robert Lahm, a professor of entrepreneurship at Western Carolina University. "Credit cards have become probably the most common small-business loan product."

Peggy Durant of Clearfield, Pa., took advantage of various personal and business cards' promotional offers to finance her and her husband's small businesses over the past decade, which include a bed and breakfast, residential and commercial rental projects and a solo law practice.

After J.P. Morgan Chase & Co.'s Chase Card Services in January raised the minimum payments on one of her cards, Ms. Durant decided to take out a first mortgage on one of her rental properties and open a business line of credit with her local bank to help pay off other credit-card balances and reserve a cash cushion in case more banks followed suit.

"It has created a sense of anxiety and made us do things differently than we would have," says Ms. Durant, 60. "That money is no longer there to use."

Credit-card issuers, naturally, see a different picture. The rate of business bankruptcy filings has outpaced consumer bankruptcy filings over the past 12 to 15 months. Average charge-offs for businesses with at least one charge-off jumped to nearly $11,000 from a little above $7,000 over the same period, according to data from Equifax Inc.'s commercial-business group.

Faced with rising losses, financial-services firms last year began scaling back credit lines, products and marketing to small businesses. In January, American Express discontinued its business line of credit and capital line program. Capital One Financial Corp. stopped offering small-business closed-end loans last year. Citigroup Inc. discontinued one of its business credit cards, the Citi Business Premier Pass card, late last year. Advanta Corp., which mainly offers small-business credit cards, raised rates on many last year.

Financial-services firms say they are trying to control their risk in the current environment. "The line reductions that might be made reflect concern about overall debt load relative to one's financial position in this environment," said Tom Sclafani, a spokesman for American Express. He declined to comment on individual customers.

Steve Brumer of Suwanee, Ga., says he has been squeezing his own customers since American Express cut the credit line on his business credit card to $20,000 from $65,000 and pared another line of credit that it later closed. In the past, Mr. Brumer, who sells wireless equipment to businesses, would typically give customers up to 30 days to pay their bills, since he would be able to rely on the cards' credit lines to fund his working capital in the meantime. Now, "I don't issue any lines of credit to any customers. It is all cash or all wire funds transfers for everything," says the 53-year-old.

Some small-business owners find their business-card problems spilling into their personal lives. Because the business owners usually agree to be guarantors for the cards, any delinquencies or other adverse actions are usually reported to their personal credit files, making it harder to get personal loans.

Kristie Jakeman of Jensen Beach, Fla., saw her credit score fall to 680 from 740 in January after Advanta started reporting her business credit card to credit bureaus as delinquent.

Her troubles began last summer after Advanta moved to raise her 7.99% interest rate to 9.9% in September, then to 21.9% in October. She complained to the company and says it promised to lower her rate but didn't. She continues to fight to have the charges reversed.

The higher payments made it harder to keep up, and she says she finally decided not to make her December payments until the company agreed to work with her. Advanta raised her rate to 33%. A spokesman for Advanta declined to comment.

Because of the drop in her credit score, Ms. Jakeman, 42, who runs a racehorse-management business and a company that develops nutritional supplements for animals, says she was turned down for a small-business loan. She is now looking for a business line of credit, which has a much lower credit limit. "We're back to a $50,000 line of credit, which severely limits our growth. I'm certainly not going to go out and hire people."

Write to Jane J. Kim at jane.kim@wsj.com