Funding Your Startup – Bootstrapping Is Best! Startup Success Series #5
By Ed McLaughlin and Wyn Lydecker
When I was starting my business, USI, I couldn’t wait to lift off. I had decided to leave my corporate career and was impatient to get started as an entrepreneur. But first I had to line up funding. My accountant counseled me to use Other People’s Money. “OPM, Eddie, OPM,” he said.
So I set out to source seed funding from friends and family. But I came to a screeching halt when I realized three things: First, I was very concerned about putting my friends’ and family’s hard-earned money at risk. Second, I didn’t want to damage the relationships if the business failed. Third, I didn’t want friends and family telling me how to run the business – especially since they had no experience in the field. (I would be remiss not to note that my mother gave me a small loan without any strings attached – just an interest payment that exceeded the CD rate by 1%.)
My next step was to pursue debt financing from commercial banks and the SBA, only to find myself ensnared in the red tape of institutional decision-making. SBA lending requirements for a startup were different when I lifted off.
Finally I realized that bootstrapping was my best pathway. As the sole funder, I could maintain ownership control and answer only to myself. I would use my savings as startup capital and forego a salary for the first year. Then, I would bootstrap USI’s growth by reinvesting all of the business’s income.
Deciding to bootstrap is a big step. There are real tradeoffs and opportunity costs to consider:
Do you have the personal resources to invest in your business without betting the ranch?
Are you comfortable with putting your own money at risk to fund a brand new enterprise with an unknown outcome?
Can you accept the fact that the money you invest in your business will no longer be available for personal contingencies or to buy a car, fund education, buy a home, or save for retirement?
What if the business fails? Can you withstand such an outcome? When you use your own money, fear of failure becomes your greatest motivator. Beside the business obligations, I had a family with two children under five to support. I had to succeed because failure was not an option. I was going to do everything I could to ensure that my business would prosper.
Entrepreneurs who bootstrap have several paths they can take:
Use personal savings
Get a home equity loan
Secure a personal loan
Use credit cards – but only as a last resort.
Personal savings are the cheapest source of startup funding. Although you lose the opportunity to invest the cash elsewhere, there is no direct cost for using these funds. Beyond liquid savings, including stocks and bonds, your 401(k) or retirement savings are also sources of funds, but they do have restrictions that need to be considered. Utilizing personal savings enables you to maximize control, but at the same time it forces you to shoulder the lion’s share of the risk.
Whole Life Insurance Loan
If you do not have liquid savings, a whole life policy is the next least expensive source of funds. The cash value is liquid, and you can take it out any time for any reason. With a life insurance loan, you borrow against the cash value in your policy, typically up to 90% of the surrender value. The interest rate you pay on the loan will be only slightly above the policy’s internal rate of return.
Home Equity Loan
Using your home as collateral will minimize your borrowing costs. However, you will need to demonstrate home equity value above any mortgage debt. Of course, the best time to borrow is during a low-interest rate environment. When your potential returns are above the cost of capital, using leverage is an intelligent choice.
If you are seeking a personal loan as a source of funds, you should expect to pay a higher interest rate than a mortgage rate. The bank will require the loan to be collateralized by other personal assets, such as your savings. Personal loans can be structured as either a line of credit or as a term loan. A line of credit allows for flexible borrowing at a variable rate, while a term loan is for a specific amount at a fixed rate of interest repaid evenly over a set term.
Credit Cards (Not Recommended)
The most expensive and most risky way to fund your startup is with credit cards. Since a startup can burn through capital at a significant rate, and credit card interest rates are so dangerously high, funding your startup with a credit card can bury you in personal debt that can take years to pay off. Be advised that the issuer may offer a teaser rate to start, but inevitably, the rate will rise dramatically. Read the fine print on your credit card agreement. Credit cards should only be used as a bridge as a last resort.
The Right Decision
My wife and I had been saving up to purchase a house. After months of debating the startup and funding decisions, we finally agreed to make the sacrifice and shift our priorities from buying a house to investing our savings in the business.
Once I made the decision to bootstrap, I never looked back. I did not have to struggle with the monthly cash drain of repaying a loan. I didn’t have to worry about losing my relatives’ or friends’ money. But most importantly, I did not have equity investors looking over my shoulder, second-guessing my business decisions. I had complete control over who I hired and where and how I operated. Having control over business strategy and decision-making increased productivity, streamlined operations, and maximized satisfaction. In the long run, bootstrapping enabled USI to enjoy rapid growth, as we kept plowing the profits back into the business.
Bootstrapping can do the same for you. Even though the media is full of stories about venture capitalists funding startups, most businesses in the United States are bootstrapped.
What has been your experience in finding funding? Share it in the comments.
Ed McLaughlin is the founder of four businesses and is currently running Blue Sunsets LLC, a real estate and angel investment firm based in Darien, CT. Follow him at @purposeisprofit. Wyn Lydecker is the founder of Upstart Business Planning, where she works with entrepreneurs to develop plans that answer the questions investors ask most often. Follow her at @upstartwyn