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What is Bootstrap Financing?

What is Bootstrap Financing?

Every entrepreneur needs finance to start a business. Bootstrap financing is a popular way to raise capital, as it comes with minimal liability.
Loveleena Rajeev
Bootstrap financing means using your own money or resources to incorporate a venture. It reduces the dependence on investors and banks. While the financial risk is ubiquitous for the founder, it also gives him absolute freedom and control over the management of the company. It's usually meant for small business ventures and is considered as an inexpensive option. The key to succeeding with this type of funding is to ensure optimal management of business finances and maintain adequate cash flow. Let's look at the common sources of such funding.
Sources
Trade Credit
When a vendor or supplier allows you to order goods, by extending credit for net 30, 60, or 90 days, it's called 'trade credit'. Not every vendor will provide you a trade credit, they will, however, make all your orders through c.o.d (cash or check on delivery) or take an advance payment through your credit card. In such instances, it's best to negotiate credit terms with your vendor.
While setting up your order, approach the person who will approve your credit personally. You will be taken more seriously, if your financial planning is sound, detailed, and informative. If your business is successful in its initial stages and has cleared the payments before they are due, then you have generated cash flow, without using your own resources. Your plan should ensure avoidance of unnecessary losses through forfeiture of cash discounts or incurring of delinquency penalties.
Customers
The most important aspect of any business, the customer, can be a source of capital too. You can obtain a letter of credit from them to purchase goods. Since your company's goodwill and ethics play an important role in this, it's important not to default. For example, if you are in a venture for producing industrial bags, you can obtain a letter of credit from your customer, to source the material from a supplier. In this way, you don't have to block your limited capital and still can generate cash flow.
Real Estate
Generating capital using owned assets, by way of refinancing, leasing, and borrowing is another option. You can lease your facility, as it would reduce your startup cost. Negotiate your lease amounts to correspond to your growth or payment patterns. If your business needs you to buy a facility, try to cover the cost of the building over a long-term period. Make optimum use of your loan by having low monthly payments, to help your business grow. You can even refinance it as per your needs. Outright purchase will always provide you the advantage of price appreciation and creation of a valuable asset. Borrowing against its equity can also be an option in future.
Equipment Suppliers
If your equipment will end up locking your capital and leave nothing for the operating expenses, it's best to take a loan for the purchase; that way you would pay for the equipment over a longer period of time. There are two types of credit contracts used to purchase equipment. First is the 'chattel mortgage contract', in which the equipment becomes the property of the purchaser on delivery, but the seller holds a mortgage claim against it until the amount specified in the contract is paid.
Second is the 'conditional sales contract', in which the purchaser does not receive title to the equipment until it is fully paid for. Another way of getting your equipment is to lease it for a certain period of time. Leasing is advantageous for both; the supplier of the equipment (lessor) and the user (lessee). The lessor enjoys tax benefits and a profit from the lease, while the lessee benefits, by making smaller payments and the ability to return the equipment at the end of the lease term; maybe, even move towards better technology.
Joint Utilization
This is a method where you can save the cost of running the business by sharing the facility, supplies, equipment, and even employees with another startup. It's also a great way to build your network.
Angel Investors
Angel investors are affluent individuals, often retired business owners and executives, who provide capital for small business startups, usually in exchange for ownership equity. They are an excellent source of early stage financing as they are willing to take risks, that banks and venture capitalists wouldn't take.
Credit Cards
Credit card limits can also be used as a source of finance. The card offers the ability to make purchases or obtain cash advances and pay them later, the only disadvantage being that it is expensive in the long term.
Peer-to-Peer Lending
This is a method where borrowers and lenders conduct business without the traditional intermediaries such as banks. It can also be known as social lending and depends on your social acceptability. Peer-to-peer lending can also be conducted using the Internet.
Money Pooling
Small sums of money can be borrowed from several family members, friends, or colleagues. They will have no legal ownership in the business, but remember to pay back, as nothing causes more tension in a family than money matters.
Advantages
  • Since you borrow less, your equity will be secured.
  • You won't be losing money in the form of high interest rates.
  • Lesser debt means better market position for dealing with lenders and investors.
  • Complete control of your company will allow you to be free and creative in your dealings.
Disadvantages
  • The complete financial risk lies with the entrepreneur.
  • Raising finance can be time-consuming, which can impact business operations.
  • In the long term, this can be an expensive commitment between you and your supplier.
These methods encourage entrepreneurs to utilize personal resources, and have shown some outstanding results among small setups, that have grown into large companies such as Roadway Express, Black and Decker, Coca Cola, Dell, Eastman Kodak, UPS, Hewlett-Packard, and many more.