With the recent announcement by George Osborne of a Small Business Bank, my mind has turned again to a perennial problem for entrepreneurs. Every small business owner with a dream eventually faces the moment when they need to decide how they are going to fund the process of turning that dream into a living, breathing business. There are hundreds of different sources of funds, but for commercial ventures that cannot rely on grants, public funding or corporate patronage, the choice comes down to two different funding strategies and the fledgling business will have to choose which best suits. So the dilemma that will eventually face every small business owner is, do I borrow or bootstrap?
For those of you unfamiliar with bootstrapping, we need a clear idea of what we are talking about. It’s probably easiest to characterise a bootstrapper by what they aren’t rather than what they are. For clarity, they aren’t a money-raiser who specializes in using other people’s money to take risks in growing a business. Instead, bootstrapper is determined to build a business that pays for itself every day. Although some small businesses are necessity bootstrappers, who simply cannot access significant finance, bootstrapping is more a state of mind and a conscious strategy than a list of cheap or low cost tactics. Bootstrappers run multi-million pound companies, non-pro?t organizations and start-ups in their bedrooms with the same fundamental approach. They start their business without external help or capital and fund the development of their company through internal cash flow and are cautious with their expenses.
In the light of the recent financial crisis, in which banks playing fast and loose with other people’s money at gearing ratios of up to 30:1, bootstrapping seems to have come back into fashion. But has the pendulum swung back too far in the other direction? “Gearing” or borrowing other people’s money to accelerate business growth and achieve an extraordinary ROI on your own capital still works just as well as it ever did when done right. Some industries, such as the automobile and other heavy manufacturing industries, are so capital-intensive that bootstrapping in its purest form would be almost impossible. So, the question is then, when looking to grow your small business, should you borrow or should you bootstrap? Lets weigh up the pros and cons relative to the following six considerations:
There are time considerations with both strategies. You don't need to spend a lot of time fundraising or answering to your investors, whether that is your bank manager, family and friends or a professional investor. Fundraising can be a long and emotionally taxing process, especially in recent times, for any small business owner, especially in the early stages of your company. If you can bootstrap, you don't have to go through all of that. However, by bootstrapping you're either limiting your resources (keeping the team very small) or redirecting your resources (by consulting or working on the side). Either way, you're moving slower than you would otherwise. In many industries this can create a problem because the markets move so fast that you might get overtaken by a well funded competitor whilst you insist on bootstrapping. Although being the first mover in a market isn’t the be all and end all, arriving when the party is over is probably not a good idea for your business.
Outside investment invariably comes with conditions and forces compromise. If you bootstrap, you keep full control. For example, an angel investor, venture capitalist and in some cases friends and family are going to pressure you to grow fast and exit big. That is the way that they will profit from investing in you. But not all businesses and business owners are cut out for what comes along with the "go big or go home" strategy. By bootstrapping, you get to decide when and how fast you grow. Banks and other investors will want to see proper governance. This could be a good or a bad thing depending on how it is done. For the most part, this means you have to spend time updating and managing a board of directors. Experienced board members can add real value to your business but it does take time.
By bootstrapping you're retaining more value AND taking on more risk. If you borrow, you can share both of these. Again, with riskier businesses or ventures prefaced by long periods of Research and development , this is really important for the business owner. For example, you might take no salary for a year while bootstrapping your start up business. What if you fail? That's a year of personal expenses and no income. Could you even survive that? How about your family? As enthusiastic as they no doubt are about your venture, your kids probably won’t thank you if they need to exist for a year on a steady diet of rice and beans to get it off the ground. With investors you share the risk and in this example you'd pay yourself at least a living wage. The pressure of not being able to pay the bills at home will definitely be detrimental to your performance at the office, so there’s an argument that you are more able to think clearly and tackle the risks inherent in the business more successfully.
Life as a bootstrapping entrepreneur is lonely. You don’t always know which way to turn and as your team is simply the bare minimum required to get by, you may find that bootstrapping your business creates a skill gap. When you have borrowed money, not only can you afford proper help and expertise, but your interests are aligned with those of your investors. So they want you to succeed and good investors will move heaven and earth to help you. Big private investors tend to be well connected, experienced, and smart, but even Banks offer support services to small business customers. So, with borrowing often comes a team of people to go to for help and advice when you need it. This is never truer than when you need more money.
Whilst there is no doubt that insisting to build a business that pays for itself will eventually bear fruit in terms of enhancing of your reputation as a business, this respect is normally only evident when bootstrapping is no longer a financial imperative. Having successfully attained finance signals to customers, potential employees, suppliers, and other investors that your company is solid enough to be investable. This can be really important in the early days of a business. Try convincing a top notch potential employee to quit his stable job to join your tiny outfit. At the best of times, even fully funded, it's hard. Now try it with no financing, an offer of a bootstrappers salary, and no obvious way to prove that you have the resources to be in business in six months time. It’s literally impossible.
We cannot address the question of borrowing or bootstrapping without examining this idea of financial leverage or gearing as we call it more often than not in the UK. Leverage is a double edged sword that can help or hinder a business depending on the extent to which your small business extends itself and the prevailing winds. Leverage, or gearing, is a fair weather friend; it's great during the good times but can turn round and destroy you and your business when the storm clouds start to gather. We were all taught a lesson in the power of leverage in the buy to let boom afew years ago. Fortunes where made as asset prices climbed and climbed and leveraging seemed to be working like a dream. Sadly for those who over leveraged themselves, when the bubble burst it led to repossession, negative equity and huge losses. Leverage can be used by borrowers and bootstrappers alike as evidence of the merits of their preference.
Ultimately, whether you choose to borrow or bootstrap is a matter of personal preference which will depend on a number of factors such as risk appetitie, breadth and depth of connections and the fundamental strength or weakness of you business idea. My personal opinion is that we should bootstrap before we borrow, but in the interests of full disclosure, I've started and grown businesses both ways over the years. Whichever side you come down on in this debate, it's important to realise that there are other ways to start a business other than going cap in hand to some person or institution for the money you need. If you look at it hard enough, you'll often find many ways to start the business you are planning with little or no money at all. If the Entrepreneurial Revolution that seems to be in the wind in the UK is to really ever materialise, that will need to be understood as this understanding democratises entrepreneurship. Perhaps, Mr Osborne, we don't need your Small Business Bank after all?