Is one option better than the other when it comes to your small business?
Between grants, business loans, utilizing personal credit cards and dipping into savings, entrepreneurs have plenty of options at their disposal when it comes to funding a small business. Two in particular – bootstrapping and bringing on investors – come with their own financial pros and cons.
If you're considering financing your business through either method, here's what you need to know to get started.
What does bootstrapping mean in business?
Bootstrapping is when you completely self-fund your path forward. You don't take out any loans or provide investors with a stake in your company. Most entrepreneurs use their personal savings, charge personal credit cards or budget strategically to finance their business.
Funding any small business comes with its share of pros and cons, and bootstrapping is no exception. Here's the reality of what it looks like to fully bootstrap a business.
Pros and cons to bootstrap funding
Pro: The business belongs to – and is entirely funded by – you.
Seeking investors for a small business generally means giving investors a certain number of shares in exchange for capital. It also means you are no longer the sole owner of the company. It may be difficult to budget and bootstrap a startup, but entrepreneurs who can do it without outside capital enjoy peace of mind that the entire business belongs to them.
Con: You might bite off more personal debt than you can chew.
Some entrepreneurs bootstrap by using personal credit cards to pay for business expenses. It's critical that you can pay off the balance each month or get as close to paying the full amount as possible. Making minimum payments to your personal credit card may cause you to rack up too much debt and potentially ruin your existing credit history.
If you bring on an investor later in the game, they will want to look at your credit. Did you accumulate outstanding unpaid credit card bills? Has your personal credit score sharply declined? Investors may not lend you the necessary funds after uncovering these financial details.
Con: Bootstrapping is (somewhat) limited revenue.
As mentioned earlier, if you bootstrap a business, you're generally using your own savings or funding to do it. Few entrepreneurs have unlimited money stashed away to put toward a startup. It's important that your startup is already generating, or proven to generate, revenue through its offerings and services. This is critical not just to keep the startup financially afloat but also to outline in your business plan. If you seek outside investment for the company later, investors will review how your business earns revenue.
Pro: Bootstrapping is tough but rewarding.
Successful bootstrapping is not for the faint of heart. If you have trouble sticking to a budget or are scared to wipe out a portion of your savings (that you may or may not get back), you might not be able to make the commitment.
If you decide that buckling down and making sacrifices is the best thing to do for your business, I recommend going all in with a bootstrapping strategy. It may be hard work, but it gives you total control. You won't owe anyone anything, and you become the master of your own destiny while bringing the business you're passionate about to life.
Have any businesses successfully used bootstrapping?
It's not bad form to cite yourself as an example of an entrepreneur who used bootstrapping successfully, is it? In 2009, I was a general manager at Intuit. The U.S. economy was going through a financial recession, and the division I ran, MyCorporation, was in danger of being negatively impacted by it. I had the opportunity to buy MyCorporation and run it as a stand-alone business.
While I was in a unique position where I was buying an existing business rather than starting one from scratch, I wasn't off the hook financially. My husband and I met with our banker to assess our funding options. Ultimately, we decided to mortgage our home and put our savings toward the purchase instead of applying for a loan to cover the purchase. This decision turned me into a bootstrapper.
Becoming a bootstrapper taught me a huge lesson in paying attention to return on investment. Every dollar I spent needed to provide some sort of ROI to the business because, well, those were my hard-earned dollars at work. I was fully invested in running this company and seeing it succeed – and fully financially invested in it, too.
In time, the recession ended. We hit monthly revenue goals consistently, going above and beyond, thanks to the hard work of our team. I was eventually able to step away from bootstrapping and feel great pride in how much the business, and I, had grown and thrived.
Should I bootstrap?
Ultimately, this decision may be contingent on your existing financial situation. Bootstrapping might not be your best funding option if you don't have that much money saved up or have assets like a house that you can mortgage.
What are some funding sources to help me bootstrap my business?
Luckily, there are a few funding options available to you. Consider applying for a business grant as opposed to a loan. You will need to meet certain requirements to qualify, but if you are awarded grant money, you're not required to repay it like you would with a loan. Much like bootstrapping, a grant allows you to continue to be the master of your own destiny.
You may also consider crowdfunding a startup. Before you begin, however, it's important to understand the two forms of crowdfunding:
- Rewards: This type of crowdfunding is seen on platforms like Kickstarter. If someone donates to the campaign, they receive a gift – or reward – in return for their donation. The bigger the financial amount, the more rewards are personalized and upgraded for their donors.
- Equity: In equity crowdfunding, donors receive shares in the company in return for financial contributions. If it sounds like the donors are investors in the company, they are considered investors! Equity crowdfunding campaigns cannot be run on rewards platforms, so you'll need to work with sites like CircleUp that specialize in this type of funding for early-stage brands.
There are two types of investment professionals who help fund rising startups. Venture capitalists and angel investors. What does each investor do, and which types of startups are best suited for working with one over the other? Let's take a closer look.
Often abbreviated as VC, venture capitalists back young, high-growth companies with equity funding. These businesses tend to be specialized, "unicorns" like apps and software that show signs of steady growth in an emerging market.
What does it mean to be backed by equity funding? Entrepreneurs, instead of paying or taking out a loan with a VC to get their financial support, give these investors a stake in the company. Generally, this tends to be company shares or an equity position.
Does that mean the VC company owns a portion of the business now? Technically, yes. Venture capitalists are active in your business, and it's a big deal. Being offered venture capital of any kind is a very good sign for your startup. The growth of the startup has the potential to yield huge returns. You may even get the chance to sell your startup and go public with an IPO.
Angel investors are all-around entrepreneurs. These are individuals from relatively ordinary professions, like doctors and lawyers. They see your startup, like it, and want to invest their wealth into it.
What makes an angel investor different from a venture capitalist? There are three major differences between angel investors and VC investors:
- Capital: Angel investors typically invest anywhere from $25,000 to $100,00 per company. They cannot invest millions like a VC firm.
- Startup age: Venture capitalists are eager to work with startups that are young, growing quickly and full of buzz. More established companies may work with an angel investor if they need extra capital. Regardless of the age of your startup, you should still approach an angel investor with your business plan and detail the role they will play in the startup's success.
- Equity: Angel investors, much like VCs, will want equity in your startup.
Should I work with an investor?
This decision can be determined by looking to the long term and considering your own leadership abilities. If you know that you're better at coming up with business ideas than running a company, the insight of investors can help rather than hinder you. But if you'd rather be the boss, you might think twice about working with an outside investor.
Regardless, being approached by an investor is always flattering. Venture capitalists, in particular, watch specialized, young businesses, like software startups and apps. These companies are the rising stars of tomorrow. They show signs of steady growth in an emerging market and have the ability to yield big returns. Even if you decline an investor's offer, having been approached by investors speaks volumes about the nature – and future – of your business.