There is a wide variety of funding available for a startup business, but one of the fundamental decisions which must be made by any entrepreneur is whether or not to seek outside financial help to fund growth or to rely on bootstrapping finance methods to develop the business.
The term bootstrapping finance simply refers to a business using its own resources (and perhaps some short term debt) to fund growth, instead of the alternative, which is to use long term debt finance and outside equity.
Every startup business needs finance to fund its cash requirements. If the business is to be bootstrapped, it needs to find suitable sources of bootstrapping finance, and then, in order to make this funding go as far as possible, it needs to keep its cash requirements down to a minimum.
Sources of Bootstrapping Finance
There any many sources of bootstrapping finance depending on the development stage of the business. In the early days, the main source will be the founders initial investment in the business either by way of capital, loans from personal savings or credit cards. This will be supplemented by revenue (if any) generated by the business, and by other sources such as short term leasing finance on equipment. The following is a list of typical bootstrapping finance sources.
Initial Stage Bootstrapping Finance Sources
- Founders capital
- Personal savings
- Credit cards
- Equipment leasing
- Second mortgage
- Short term loans from family and friends
- Other income (work elsewhere as a consultant)
- Payment in advance from customers for product development
- Borrow against life insurance
- Pawn shops
As the business begins to develop and grow, alternative bootstrapping methods become available to it. At this stage the business might be profitable and in a position to utilize retained earnings to fund growth. Additional forms of short term finance might also be available such as small business loans, asset backed lending, or government grants. In addition the business may now be in position to develop longer term strategic partnerships with larger businesses who are in position to provide funding for development work. Typical bootstrapping finance sources might include the following:
Later Stage Bootstrapping Finance Sources
- Retained earnings
- Accounts receivable factoring and assignment
- Lines of credit
- Small business loans
- Asset backed lending
- Strategic partnerships
- Sort term finance from banks
- Factoring of accounts receivable
- Government grants and subsidies
- Peer to peer lending
Keeping Cash Requirements to a Minimum
Having obtained a suitable source of bootstrapping finance, the business now needs to ensure this lasts as long as possible, in order that it can grow without the need to use outside funding.
There are numerous bootstrapping finance techniques which can be employed by a business to reduce its cash requirements down at a minimum. Some of the methods, such as employing relatives on a non market rate salary, are only suitable in the very early stages of the life of the business, while others, such as speeding up the time it takes to invoice customers, are ongoing techniques which can be employed throughout the life of the business.
The requirement for cash normally relates to either expenditure on fixed assets (capital spending), cash needed to fund working capital (accounts receivable, inventory, less accounts payable), or amounts paid for expenses. Each of these cash requirements will be considered in turn below.
Capital or Fixed Assets Expenditure
A startup business can reduce expenditure on fixed assets using some of the following methods.
- Purchase used equipment instead of new
- Borrow equipment
- Lease or rent equipment instead of buying
- Keep premises space to a minimum, share premises with other businesses
- Share equipment with other businesses
Working Capital Funding
The cash to fund working capital falls into three main types, accounts receivable, inventory, and accounts payable. Each of these can be manipulated to reduce the amount of cash required.
Accounts receivable are amounts owed by customers for goods and services provided to them. The higher accounts receivable, the more cash the business needs and the lower the chances of it being able to use bootstrapping finance. The methods to reduce accounts receivable include:
- Invoice customers as quickly as possible
- Obtain payment in advance from customers
- Offer customers cash discounts for early settlement
- Try and choose customers who pay promptly
- Cease business relations with customers who frequently pay late
Inventory needs to be funded with additional working capital. If the business is to use bootstrapping, it needs to keep the level of inventory held to a minimum using some of the following techniques.
- Reduce the lead time with suppliers
- Buy on consignment from suppliers
- Eliminate product variations
- Improve production scheduling
Accounts payable are amounts the business owes its suppliers for goods and services. The higher accounts payable, the more funding the supplier is providing, and the less cash the business needs.
- Improve supplier payment terms to extend the credit period given
- Negotiate discounts for early settlement
- Delay payments to suppliers (take care not to extend too far)
- Negotiate bulk purchases with other businesses
In a startup business reducing expenditure to a minimum reduces the amount of cash required to fund the business and allows the business to be bootstrapped. The following techniques can be used to reduce startup expenses.
- Run the business from home
- For the first few years founders should view their time as an investment and keep their salary to a minimum.
- Employ relatives and friends at non market rate salaries
- Share premises to reduce rental payments
- Engage students in projects to provide knowledge at low cost
- Hire staff instead of employing them permanently
- Share employees with other businesses
- Use bartering to exchange goods and services
Advantages and Disadvantages of Bootstrapping Finance
The main advantage of bootstrapping is that the entrepreneur founders retain ownership and control of the business free from the requirements of outside investors, and do not have to spend time seeking investment. The disadvantages are that most business’s cannot afford to bootstrap for long so it tends to be short term in nature, and that the business grows more slowly than with outside investment, as it can only grow at the speed at which the available finance allows it to.
Bootstrapping finance methods would not be suitable for a business which needs to grab market share and grow rapidly, or for a capital intensive business which requires large upfront investment.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.