Startups are founded by entrepreneurs having ideas about innovations or identifying market opportunities and, in most of cases, missing financial resources. “When starting a company, generating funding to support the business is perhaps the single most important task at hand.” (Harvard, 2011, p. 7). The first step after the initial stages of design thinking is determining how much capital is needed, by analyzing time to market, general and administrative costs including salaries, technology and marketing expenses, legal assistance, and so on.
As startups lack financial track record, collaterals and traditional warranties requested by banks, sources of funding are restricted to equity or mezzanine investments. In addition, startups take time to generate cash, that unsuits lenders and puts additional pressure in founders, what is somehow undesirable.
According to McKinsey and from my own experience and readings, “most of startups rely initially on the founders’ savings and on money borrowed from relatives and friends as a first source of cash, which is known as ‘bootstrap financing’”. (McKinsey, 2011, p. 41). Freear defines bootstrapping as financing the operations without externals, obtaining cash within the own organization with actions of improving sources of funds, releasing trapped money, using government incentives and relying on partnerships. Bootstrapping is a fair alternative (if not the only one in many cases) to avoid equity dilution (from angel investors or venture capitalists) and debt leverage (which may add risk).
I am the founder of venture builder, involved with various startups, and a consultant for large companies in financial distress. I like to think that they are in opposite sides (in one side a promising start and in the other side one established with declining cash generation) but share the same financial constraints. In both cases, my recommendation is the same: preserve liquidity. One can attack both sources and uses of cash.
Increasing sources of cash: speed up the release of services and products, allowing discounts when possible and reducing payment terms with clients. Getting financial aid. Obtaining finance using founder’s personal credit “asset-based finance, such as asset-based lending, factoring and leasing, whereby a firm obtains cash, based not on its own credit standing, but on the value that a particular asset generates in the course of its business. (OECD, 2015, p. 17). Anticipating cash with factoring operations.
Decreasing uses of cash: being assertive of who to hire and at what cost, managing human resources, trying to exchange labor for equity thus saving money. Increasing payment terms with suppliers, including funding from them. Reducing all expenses possible, for instance avoiding unnecessary office space amongst other. Reducing (possibly to zero) founder’s salaries. Negotiating costs of with outsourced service providers. Reducing marketing expenses whenever possible. Avoid extra costs with technology by making payments based on deliverables for developers (it is common for developers in Brazil to charge companies some down payment and simply disappear some months later within delivering the product).
There are dozens ways of bootstrapping to raise money without investors and banks, the tools are quite common, however their combination vary in each case, depending on the sort of the company, its markets and features, and more important, the risks the founders are willing to take, both personally and financially.
I have experienced cases with founders totally on board of the startup, giving up their jobs and investing their own money in the company, and startups with founders not willing to leave their steady source of income and unwilling to invest a dime of their own pockets in the idea. Although its not a rule, excluding all other factors, the higher skin in the game, the higher are the odds of success.
References:
1. Lee, Neil, Sameen, Hiba and Cowling, Marc (2015) Access to finance for innovative SMEs since the financial crisis. Research Policy, 44 (2). pp. 370-380.
2. OECD (2015) Report. New Approaches to SME and Entrepreneurship Financing: Broadening the Range of Instruments. Report. https://www.oecd.org/cfe/smes/New-Approaches-SME-full-report.pdf
3. McKinsey (2011) Report. The Power of Many Realizing the socioeconomic potential of entrepreneurs in the 21st century. https://www.g20yea.com/images/reports/The_Power_of_Many-_McKinsey_Report.pdf
4. Harvard’s Startup Guide (2011) Report. An entrepreneur’s guide for Harvard University faculty, graduate students, and postdoctoral fellows.
5. Freear, J., Sohl, J, & Wetzel, W. (1995) Who bankrolls software entrepreneurs. [Paper at the Babson College Entrepreneurship Research Conference].
