Written by Team 365 finance
Bootstrapping is the process of starting and growing a business using a combination of savings and cash flow.
Most of the time, entrepreneurs borrow money or seek equity financing in order to pay for their business’s growth. A bootstrapped business works differently — instead of using outside funding to grow, it’s designed to grow using the revenue it produces from its own sales.
Bootstrapping is most commonly used in the software industry, although it’s also used by small and mid-sized businesses in countless other industries. It offers a range of advantages, as well as a few disadvantages.
Below, we’ve explained what bootstrapping is and how it works. We’ve also looked at some of the unique advantages and disadvantages offered by bootstrapping compared to other options for funding and growing a business.
What is Bootstrapping?
Although there’s no exact definition of bootstrapping, most entrepreneurs agree that it refers to the process of founding and building a company without using external funding.
For example, a bootstrapped business might be funded using the founder’s savings. In some cases, such as with service businesses, the business might be launched with no costs at all, then developed into a larger business using the cash flow it produces on its own.
Sometimes, bootstrapping can refer to a business that’s started without external funding, such as angel or venture capital investment, but with the use of credit card debt, business loans or other debt-based financing options.
How Bootstrapping Works
Bootstrapped businesses usually start by offering a simple product or service that’s inexpensive to produce. This product or service often isn’t related to the products and services the business plans to sell once it’s grown in size.
For example, some software businesses have started by offering development services, then using the revenue these generate to develop their own products.
Most of the time, a bootstrapped business will go through two stages. During the first stage, the founder or founders self-fund the business in order to get it started. The business is funded with personal savings or other small-scale sources of capital.
During the second stage, the business funds itself using the cash flow it generates from sales of goods or services. The larger the cash flow grows, the more cash the founders have to grow the business.
Advantages of Bootstrapping
Bootstrapping offers numerous advantages over other methods of funding a business. These range from the founders being able to retain full control over the business to avoiding stressful, potentially costly debt. The owners of a bootstrapped business can:
- Avoid giving up equity. Most forms of equity investment, such as angel investment and venture capital investment, require the owners of a business to give up some percentage of their equity in order to secure financing. By bootstrapping, the owners of a business can retain full ownership of their business. If the business is successful, this can greatly increase the value of their equity, as well as their control over the business itself.
- Better understand their customers. Bootstrapped businesses need to generate cash flow quickly, making it especially important that they offer value for their customers right from day one.
This pressure can help entrepreneurs who bootstrap their businesses understand their customers, market and competition faster than their funded competitors.
- Reduce financial liabilities. When a business is in its early stages, even small amounts of debt can seem like major liabilities. Bootstrapping a business, especially without debt, can help the owners maintain a strong balance sheet as the business grows.
- Better deal with slow periods. Businesses that rely on external financing, particularly debt, often fail when growth slows down. Interest payments, investor milestones and a range of other funding-related liabilities can, and often do, hurt these businesses.
Because bootstrapped businesses tend to have fewer liabilities and less strict growth targets, they’re often better equipped to handle the fluctuations in cash flow that occur while a business is growing.
Disadvantages of Bootstrapping
There are also several disadvantages of bootstrapping a business, especially compared to other financing options. These disadvantages include:
- Limiting a business’s growth potential. Businesses that are bootstrapped often grow organically, but they rarely grow at the same pace as their better-funded competitors. In some cases, this can affect a business’s market share and overall strength.
- Reducing networking opportunities. Business financing often comes with valuable relationships attached, from bankers to venture capitalists. By turning down external funding, the owners of a bootstrapped business often limit their networking options.
- Increased personal risk. Businesses funded using external financing can often fail at little to no cost to their founders. With a bootstrapped business, however, the founders could face a significant financial loss if the business is not successful.
- Affecting product or service quality. When a business is very strapped for cash, it can often affect the quality of the products and/or services it delivers. This is a major risk for a bootstrapped company, particularly during its early stages.
Bootstrapping isn’t for every business, but it can often be a smart way to launch and develop a business without the downsides of conventional financing.
Although bootstrapping offers a range of advantages, it also has disadvantages when compared to other financing options. If you’re thinking of launching a business, it’s worth considering both the advantages and disadvantages of bootstrapping before you decide how to proceed.