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Funding a Business From Your Own Pocket

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This post is part of a series called Funding a Business.
Borrowing Money to Fund a Business

In business, is going it alone a good strategy?

All of the other options in our eight-part series on funding a business involve raising money from other people  banks, angel investors, venture capitalists and so on.

But first, we’re going to take a look at funding a business from your own pocket, often referred to as “bootstrapping,” from the famous saying about pulling yourself up by your bootstraps.

Often, businesses bootstrap because it’s the only option. Funding from external sources can be hard to come by, particularly in the early days, so relying on your own resources is a good fallback.

But some entrepreneurs and business owners also choose to reject external funding, preferring the independence that comes with going it alone.

So in this tutorial we’ll look at how to fund a business yourself, the pros and cons of the approach, and some ways of doing it successfully. We’ll also look at a few real examples of companies that have relied on their owners’ funds, from small start-ups to giants like Apple Inc., and see what lessons we can learn from them.

After reading this tutorial, you’ll have a clear idea of the advantages and disadvantages of self-funding a business, and will be equipped with some strategies to use if you do follow this route. If you decide it’s not for you, then don’t worry: we’ll explore plenty more options in the weeks to come in this multi-part Funding a Business series.

1. Different Options for Self-funding

Funding a business from your own pocket can take several different forms. The approach you take will likely be determined by your own financial situation.

Savings

If you have a healthy balance in your savings account, this is the most obvious source to draw on. Thousands of business owners have also tapped their retirement funds  as long as you meet certain criteria, you can roll over money from your IRA or 401(k) into a business start-up. For more details on how it works, see this Wall Street Journal guide.

The advantage of using your own savings is that there’s no cost apart from the lost opportunity to earn interest, but of course you need to consider the risk if things go wrong (more on that later). And unless you’re very rich, relying only on your savings may not be enough to fund a business, especially as it grows larger.

Personal Debt

With business loans often hard to secure, many entrepreneurs rely on personal debt instead. This could be anything from making business purchases on credit cards to refinancing your mortgage or taking out a home equity line of credit.

This method is often an easy way of freeing up funds, assuming you have a good credit history. But clearly it needs to be used with caution, by paying particular attention to interest rates on the credit cards you use, and making sure not to borrow more than you can afford.

Friends and Family

If your own personal resources aren’t enough, you could go into partnership with a friend or family member, pooling your funds to put into the business. Or you could simply borrow from them. Going into business with someone you know so well can be a great way to fund a company, but it can also put a strain on your relationship if things don’t work out as planned.

Business Cash Flows

Once the business is up and running, it should start generating profits and cash that can be plowed back into the business. If the company’s doing well, this money can be enough to fund any investments you need to make for the future. “Organic” growth of this kind can be very effective, and is a low-risk, low-cost strategy. But unless the company is very profitable, relying only on business cash flows can result in slower growth. 

2. Advantages of Self-Funding

Bootstrapping a business can be a smart way to fund your venture, particularly in the early stages, when other types of funding can be hard to find. Here’s a look at some of the main advantages of this approach:

Certainty

A big advantage of funding a business yourself is that you know exactly how much money you have available. You don’t have to spend time putting together business plans and glossy presentations, trying to convince other people to part with their money and perhaps ending up with nothing to show for it. You can forget about ifs and buts, and move forward quickly with what matters most: running your business.

100% Ownership

Many of the other approaches we’ll look at in this series involve giving up a stake in your business to other people in return for cash up front. That, of course, means that those people receive a share of any future profits, diluting your own stake. If you raise money through debt, the repayments and interest will eat into your earnings too.

Funding the business yourself means that you retain full ownership of the business, and receive 100% of future profits. Since you’re the one putting in the work, it makes sense that you should get the rewards.

Full Control

Accepting money from outsiders is never free: there are always strings attached. Venture capital or private equity funds will often demand a substantial say in the running of the business, which can mean going in directions you’re not happy with. Even lenders will want to see a detailed business plan, and will expect you to stick to it.

If you rely on your own funds, however, you don’t have to answer to anyone else. You can take the business in any direction you want, and change course whenever you think it’s necessary.

More Discipline

A popular mantra for success in personal finance is “Live within your means.” It applies in business, too. If you fund a business yourself, you’re forced to live within your means, only investing in things like new equipment and expensive advertising when you’re sure you can afford them.

Companies that have received a few million in venture capital funding, on the other hand, can sometimes start behaving like someone who’s just won the lottery. In the dot-com bubble of 1999, for example, fashion company Boo.com burned through $188 million in just six months, spending money on luxury offices, first-class plane travel and five-star hotels, and then filing for bankruptcy in May 2000.

While the dot-com boom was an exception, external funding can lead to inflated spending at any time, leaving the business vulnerable if funding dries up later on. Self-funding makes it easier to keep your business operating at a sustainable level, avoiding excessive spending and relying on its own resources rather than the support of outsiders.

3. Disadvantages of Self-Funding

There’s a flip side to all that independence, though. Here are the main disadvantages of going it alone:

Slow Growth

The number one reason why small businesses seek funding is to fund growth and expansion. Most business owners are not short of ideas  it’s lack of money that holds them back. Imagine what a sudden infusion of thousands or even a few million dollars could do for your business.

If you don’t get outside funding, those growth opportunities are limited by the size of your own funds and what your business produces in cash flow. Slow, steady organic growth may be fine for some businesses, but for others, particularly in fast-moving areas like technology, it can mean ceding the advantage to your competitors.

Personal Risk

When you fund a business yourself, it can be wonderful if things work out, but disastrous if they don’t. One couple in the UK recently lost not only their business, but also their home of 31 years and their savings. They’d plowed so much of their funds into the failing Balloon Workshop store that when it failed, they were left with nothing.

“The business has effectively robbed us of 31 years and it’s time to call it a day,” said the owner Michael Savell, 64, in a recent article. “We’ve lost our house, our savings, everything.”

The Savells’ situation is not exceptional. People often over-commit to their businesses, to the detriment of their personal financial health. In a 2012 Wall Street Journal survey, 38% of small business owners said they’d be forced to retire later than expected, as their retirement savings were tied up in their business.

No Contacts

Angel investors, venture capitalists and other types of investor often bring much more than money to the table. They can give you access to their network of contacts, as well as to their experience and expertise, opening up new opportunities for your business.

If you go it alone, you miss out on all of that. You can develop your own contacts, of course, but it’s easier with the ready-made structure that investors bring.

Red Flag

When I’m looking for a place to eat, I usually avoid restaurants that are completely empty. I figure there must be something wrong with them. Not fair, perhaps, but for the most part it works.

Investors are just the same. If you haven’t raised any money in the past, the “empty restaurant syndrome” can make it harder if you want to raise funds in the future, and can even reduce the valuation of your company. And we all know from our personal lives that lack of credit history makes it harder to be accepted for new debt.

4. Strategies for Self-Funding a Business Successfully

So now that we’ve looked at the pros and cons, here are some strategies you can use to self-fund successfully, maximizing the benefits and avoiding some of the pitfalls.

Set Clear Parameters

You know how when you’re self‑employed, the line between work and personal time can easily get blurred? Well, the same applies to your finances. You need to draw a clear line between your personal and business accounts from the start.

Set up separate business and personal bank accounts and maintain that distinction, using only your business account for business expenses. Pay yourself a salary  something often neglected by small business owners  so that you can cover your personal expenses each month and keep the lines between yourself and your company clearly drawn.

Similarly, if you’re drawing on funds from friends, family or other business partners, make it very clear who owns what. Create formal agreements setting out the terms, and have everybody sign. It may feel strange doing this with people you know and trust, but it’s important to avoid misunderstandings later on.

Plan Ahead

If you’re going without the cushion of external funding, you’ll need to plan carefully.

Begin by taking an inventory of all your savings, loans and other resources you plan to draw on. Decide how much you can afford to commit to the business, and stick to that no matter what. It’s easy to get drawn into putting in more and more money as time goes by, but you need an overall limit, a point at which you’ll stop funding the business to protect your overall financial future.

Then make a detailed business plan, listing all the investments you’ll need to make in the business. If you’re just starting up, figure out how long it will take you to break even, and make sure you have enough funds to cover both business and personal expenses in the meantime.

In all your planning, consider worst-case scenarios. What if the economy tanks? What if your product takes longer to build than you thought? Make sure you have not just enough funds to cover your expected costs, but also an emergency fund to cover any unexpected problems along the way.

Stretch

Bootstrapping a business often means money is tight, particularly in the early stages. So try to come up with some creative strategies for stretching your resources as far as possible.

For example, computing giant Apple Inc. got started by making innovative use of trade credit. In 1976, Steve Jobs secured a purchase order for 100 computers from a local shop, but couldn’t afford to pay $20,000 for the parts he’d need to manufacture them.

He managed to convince a supplier to sell him the parts on credit, however, using the customer’s $50,000 order as a guarantee that he would be able to pay the bill within a month. He and Steve Wozniak built the computers, sold them for $50,000, and were able to pay their $20,000 bill with the proceeds. Apple Computer was born.

There are plenty of other ways to make your money stretch, of course, such as delaying investments, renegotiating payment terms, and minimizing inventory. We covered quite a few of them in our tutorial on managing a business’s cash flow.

5. What You’ve Learned, and What’s Next

As you can see, there are several ways to fund a business without resorting to external funding, and some of them can be very successful. If you plan carefully, and make creative use of the resources you have available, bootstrapping can be a great way to fund a business.

You need to be aware, though, of the risks, and manage them carefully. For every success story like Apple, there are plenty of failures. Tying up your personal funds in your business can be risky.

And also, of course, many people simply don’t have the resources to fund a business on their own. Even if they can do it at the very beginning, it’s often not enough for larger businesses.

So in the next six weeks we'll continue this multi-part Funding a Business series. We'll look at various external forms of funding, so that you can see what your options are. We'll start next week with a look at taking out a business loan.

Resources

Graphic Credit: Pocket designed by Erin Standley from the Noun Project.

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