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Bootstrap Your Business: Part I

Posted by SBC Team in Accounting and Budgeting on Jul 22, 2010 2:18:00 PM
In this two-part series, we examine how to start a business without a bank loan or venture capital

Part I: personal funds, home equity, credit cards

By Reed Richardson

Entrepreneurs contemplating a business launch in today’s tight credit markets and scuffling economic climate are often plagued by one overarching problem: How will I finance my business? For a small but growing number of small business owners, who refer to themselves as bootstrappers, the solution lies in fostering a newfound self-sufficiency, one that foregoes traditional sources of business capital like banks and venture capital firms.

“In any business, it is the very first few steps in starting out that are the toughest,” writes successful entrepreneur Greg Gianforte in his book Bootstrapping Your Business. And though hundreds of thousands of people start businesses with little or no outside funding each year, Gianforte notes, “few realize that they are members of a silent, yet enormous economic subcommunity.”

Bijoy Goswami, a 36-year-old serial entrepreneur from Austin, Texas, is another evangelist of the bootstrapping business model. Seven years ago, he started the first of a series of online Bootstrap Networks (http://bootstrapnetwork.com) for other like-minded business owners to share ideas and swap advice. Over time, he says this bootstrapping subculture transformed into something more than just how to start a small business on the cheap.

“Funding is one piece of the puzzle, yes, but I believe bootstrapping is less a tactic and more a philosophy,” Goswami says. “It’s about building a business in a very different way.” To truly bootstrap a business involves first selling the idea of your product or service to customers and then using those sales to finance eventual production. This method, Goswami explains, keeps early-stage costs to a minimum, allowing the entrepreneur to survive using small loans from family and friends, short-term credit-card debt, and personal savings. (To view a brief video of Goswami explaining how different funding sources can correlate to a bootstrapping business’s different growth stages, go here: http://www.youtube.com/watch?v=a3JQJKcN_8g ) “Scraping up this money imposes a certain discipline on a business,” he says. “A bootstrapper’s perception of capital should be that it’s an accelerant for a business.”

But before you can accelerate your business, you have to start, and here are the most common funding sources that bootstrappers tap into when launching their business.

Your piggy bank

The quickest and easiest way to finance a small business involves making use of the money you already have. This tactic is so simple, in fact, that a Babson College survey found that 63% of new businesses with startup costs of under $25,000 relied solely on their personal savings for financing. What’s more, self-funding is also a strong, positive signal to others, including, most notably, potential investors, that you believe firmly enough in your ideas to put some of your own skin in the game. But it’s still important to think about what the different parts of your financial portfolio are doing for you before you plow it all into your startup venture.

Savvy entrepreneurs start off by raiding their most liquid assets first. Checking, savings, and money market accounts are readily accessible, typically don’t earn much interest, and the funds in them have almost always been taxed already, so if you’re looking for an initial tranche of startup capital, they are the best places to start.

Selling off stocks, bonds, and mutual funds would be the next likely step, although such a move could have significant capital gains implications, so it’s important to plan accordingly to prevent being hit with an unexpectedly large tax bill that you can’t pay.

The last, worst resort involves dipping into retirement funds, such as traditional IRAs or 401(k)s. Early withdrawals from these accounts carry prohibitively high penalties, so tapping them for business capital typically represents a poor use of resources. Although there are ways to leverage these retirement accounts for cash without incurring penalties, such as 401(k) loans and the increasingly popular Rollover as Business Start-ups, or ROBS, loans, they are complicated and often draw the attention of the IRS. (For more on the growing popularity of ROBS loans, see this article: http://www.washingtonpost.com/wp-dyn/content/article/2010/06/30/AR2010063005243_pf.html .) If you find yourself contemplating such a move, it might be worth exploring other funding avenues first before risking your retirement.

Your home

In recent years, taking out a home equity loan on your house was a relatively easy and risk-free way for a budding entrepreneur to access tens of thousands of dollars in much needed capital. In fact, a Discover Small Business Watch survey from last year found that three in ten small business owners had turned to home equity loans to help finance their startups. But no more. As home values have dipped in nearly every corner of the country—and in some markets cratered—many homeowners have suddenly found themselves with little, no, or even negative equity invested in their homes. As a result, banks have sharply tightened their lending guidelines and home equity loans or second mortgages have significantly lost their luster as a source of business startup financing.

Nevertheless, because you are essentially borrowing against what is your own money, home equity loans at decent interest rates remain a viable option if you have a strong credit score and are able to satisfy certain other financial criteria. Indeed, for entrepreneurs with a low home-loan-to-value ratio, now may be a good time to leverage your home’s equity for business capital, as there are significantly fewer customers available for banks to lend to. But because real estate markets vary widely from state to state and even town to town, it’s a good idea to shop around and consult a financial advisor before signing up for a home equity loan. (To figure out the amount of equity you have invested in your home, check out this online calculator: http://moneycentral.msn.com/personal-finance/calculators/Home_Equity_Calculator/home.aspx .)

Credit cards

Financing your startup using individual savings and stock gains amounts to a bootstrapper’s version of a venture capital investment, but if you don’t have enough personal equity, you might instead decide to fund your business using a short-term debt solution, like credit cards.

While there are numerous risks—personal bankruptcy, perhaps foremost among them—to funding a small business’s cash flow using credit cards, their ubiquitous presence means that, for most entrepreneurs, access to thousands of dollars is only a swipe away. But if a bootstrapper plans to frequently rely upon credit cards as a key weapon in their business’s cash flow arsenal, it pays to plan ahead, according to serial entrepreneur Thomas Frey.

“Few would-be entrepreneurs can imagine the difficulty of finding credit once they leave their steady income jobs,” Frey explains. Frey, the founder of 18 different businesses and currently the executive director of the DaVinci Institute, a Colorado-based think tank, advises budding entrepreneurs to maximize their financial resources and access to credit long before they quit their day job and hang up their own shingle. “Credit scoring systems have a way of branding you as a terrible risk almost instantly as you enter the startup starting blocks. So plan ahead and line up credit in whatever forms you can find, and lots of it.”

If you are going to be charging thousands of dollars on credit cards to fund your start-up initially, it’s advisable to at least get something back for all that activity. The best way to do that is to use credit cards offering robust (and flexible) rewards or cash back programs. Some of these programs target small businesses and provide even higher rewards if cashed in at business-focused retailers, like office supply stores. Others offer cash rebates of 3% or more once you pass a certain annual spending threshold, which could mean an annual rebate of hundreds of dollars, and for bootstrappers, every extra dollar counts. (To find side-by-side comparisons of small business, reward, and cash-back credit cards, try aggregator websites like http://bankrate.com/ and http://creditcard.com/..)

Be sure to come back next week for Part II in our series, which examines family and friends, peer-to-peer lending, and future customers as potential sources of start-up funding.

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