Bootstrapping

The business media is full of stories that the banks are not lending to small businesses. If you have aspirations to start your own business this might put you off. But it shouldn’t. Even in ‘normal times’ banks don’t lend money to start-ups. Banks make their lending decision on evidence that a business has a sufficiently strong cash flow to be able to pay back the loan. Moreover, they have assets that can be used as collateral to secure the loan. New businesses, by definition, don’t have cash flow and have little or no assets. On both counts that makes them too risky for banks.

The challenge for most businesses is therefore not raising money. Rather, it is how to start and grow a business by using a variety of imaginative and creative tools and techniques to obtain the use of resources at below market cost or no cost to the business. This is known as bootstrapping. Many great companies have been started in this way.

It is critical for a new business to keep its fixed costs low. Ways of doing this include running the business from home and using coffee shops for meetings and borrowing or buying second hand or discounted furniture and equipment.

The biggest recurring cost for a business is generally its employees. It is vital to match the head count to the demand as closely as possible. This can be done by using virtual teams, outsourcing, employee leasing and temporary workers. Employee compensation can be linked to the business’s ability to pay, for example, by offering a package comprising a low basic salary and profit-sharing.

Product development can be funded at minimal cost by asking the client for up-front funding from customers, working weekends and evenings while maintaining paid employment, and turning a consultancy project into a product. A more strategic approach is the ‘flip model’ – starting a business in a cash-generative activity, such as consulting or distribution, and using the profits from this activity to fund the intended business.

Cash management is also critical for a bootstrapped business. Outgoings can be minimized by using trade credit and controlling inventory. The payment cycle can be speeded up by efficient invoicing and follow-up of unpaid accounts. Focusing on the fastest paying customers is also sensible.

Other ways of reducing or delaying the need for finance include using personal credit cards (but needs to be undertaken with care), deferring or reducing your personal financial compensation and delaying payments to suppliers (which is questionable from an ethical perspective). Raising loans from family and friends, applying for government grants and soft loans, and entering business plan competitions are all alternative sources of capital.

Finally, you may have assets that you can barter for resources or sell. For example, you may be able to provide information about your customers, provide access to customers or even deliver your customers to other companies who will either pay or provide resources that you need.

Although most entrepreneurs use bootstrapping out of necessity it does bring a number of benefits. First, it enables the entrepreneur to keep 100% control of their business. A bank loan has various strings attached. An equity investor is likely to want to have a say in the running of the business. Second, for businesses that will have to raise equity finance at some point in the future, bootstrapping is a way of building value. This means that at the point when an investor is brought in the business will command a higher value and proportion of the ownership that the entrepreneur will need to sell in exchange for finance will be lower. Third, debt financing can make a business more vulnerable in the event of an economic downturn. Bootstrapping is therefore a way of reducing exposure to risk. Fourth, too much money in a business may create waste and inefficiency and the temptation to ‘live beyond your means’. Bootstrapping creates a discipline of leanness and an attitude that every dollar counts, which helps to keep the business focused on its core activity. The danger of having money is that it is used on things that don’t add value to the firm. Finally, trying to raise money is time consuming. By bootstrapping, the entrepreneur can focus their time and energy on building their business.

But of course bootstrapping can be dangerous if taken too far, for example, constraining growth. And some bootstrapping strategies are either dangerous (e.g. financing the business with personal credit cards), ethically dubious (delaying payments), or both. So it is a strategy that needs to be applied thoughtfully.

Colin Mason is Professor of Entrepreneurship in the Hunter Centre for Entrepreneurship, University of Strathclyde, Glasgow. He can be contacted at colin.mason@strath.ac.uk