Hello and Welcome to FYI.
This week, we bring you the second installment of a five part series on business finance. It’s about bootstrapping as an internal source of funding.
So what is bootstrapping?
In the start-up phase, it involves investing personal funds and, in some cases, funds from loans against personal assets into a business as capital. But while bootstrapping is usually referred to as a start-up process, in the latter stages, it may include the re-investment of profits, change of use or outright disposal of existing assets to run a self-sustained business. Businesses that navigate this funding process require excellent financial management, creativity and planning but successful entrepreneurs get to retain complete ownership and control while avoiding interest payments.
So how do you achieve this?
In the start-up phase, businesses that adopt bootstrap financing must keep their expenses low. This means money must only be spent on absolute necessities; including number of employees (with founders undertaking responsibility for multiple roles), deferred payments and mutual exchange of goods and services in place of cash (bartering). Other areas where costs must be minimized include office space, furniture, equipment and utilities. As such, where these are essential to the business, bargains on used furniture and equipment are used to drive down costs. These businesses may sometimes also start as freelancing endeavours to cut staff cost, work out of a home or mobile office to save on office space, or adopt trade terms that allow for goods to be sold before suppliers are paid. Innovations in office solutions also allow flexible use of shared spaces, meeting rooms, and utilities such as electricity and internet connectivity.
Examples of ideal bootstrap-financed start-ups in Nigeria include tailoring and fashion design, IT, Business solutions, and Wholesale-Retail. In tailoring and fashion design, savvy entrepreneurs typically bootstrap with home offices, negotiate trade terms that ensure supply of materials on deferred payment agreements and share cost of utilities by partnering with other freelancers. It is also why you shouldn’t be surprised to find tailors offering to pay for a service by making new clothes. In IT and business solutions, home, mobile and shared offices ensure cost reductions while upfront terms of payment are usually preferred to bridge financing limitations. And in wholesale-retail, distributors make their bootstrap investments in form of minimum deposits that ensure supply of fast moving consumer goods (FMCG) such as cement, brewed products, and household equipment at favourable after-sale terms.
In the latter stages, businesses use bootstrapping to finance growth. In the first instance, sacrifices are made by shareholders to reinvest profit towards completing projects over a specified period of time. This may include office expansions or relocation, acquisition of vehicles and equipment, or even bigger staff strength if it is deemed to be profitable in the long run. In the second instance, unused assets such as office buildings, vehicles and equipment are leased to external businesses in order to raise the funds needed to drive the daily operations of bootstrapped businesses during slow or recessionary periods. And in extreme situations, redundant assets are sold to finance growths in other profitable areas of the business. Cases where businesses completely sell off their business offices are also common in recent years due to stretched finances or technological advances that mean the business does not require that amount of space. For businesses with stretched finances, those offices can then be leased from the buyer under what is termed a “Sale and Lease Back Clause”.
So what are the drawbacks to bootstrapping?
In all of these instances business owners retain total control, but also complete share of the risk. As such, when anything goes wrong, it usually translates to a loss of the business including all personal savings and assets. Moreover, growth can only be achieved by reinvesting profits. So during the period before profits are generated, funding might gradually be exhausted, resulting in liquidation. And in fast growth sectors or industries where economies of scale are crucial, the business may also lose out to competitors because of a failure to grow at the right pace. And finally, some of the strategies used to ensure bootstrapping success are not fail-safe. For example, terms of trade may become unfavourable thanks to new suppliers offering lower prices, superior products or quicker delivery. Still, your primary supplier’s terms may change to exclude you or their business may even get liquidated.
That brings us to the need for leverage. And it’s covered in the next three posts. So just follow our social media page(s) and get notified of the next installments.
Care to share your bootstrapping stories?
Abubakar Abdullahi is Managing Principal at The Front Office NG. He tweets @ab_bakr
Editor’s Note: A version of this article first appeared in The Business Hub on 6th August 2014.