Starting a business or non-profit can be a very rewarding experience. The rewards can be financial, altruistic, personal, or societal. All start-ups, both for-profit and non-profit, have a common need – funding. Money is needed to begin operations, hire staff, perform product development, initiate marketing, fund working capital, and sustain the business. Most entrepreneurs struggle with sourcing the needed funding/capital to make their businesses self-sustaining. This article will focus on funding for seed/start-up stage ventures.
- No revenue and few tangible assets
- The dominant form of financing is equity from founder, friends, and family
- Bootstrapping is common
- High-potential ventures may have access to outside capital
Most new ventures start at ground zero in terms of revenue and assets. An entrepreneur or an entrepreneurial group has an idea for a business or non-profit and a belief in the viability of the new venture. From ground zero the first step is planning for operations.
A fundamental, critical part of the new venture plans is the financial plan. The financial plan provides an outlook/projection of the monthly funding needs for the first two or three years of operations. Usually, the first months (or even years) for the new venture do not generate positive cash flow for the business. Therefore, funding must be secured to pay the expenses of the organization. The financial plan provides the answers to the following questions:
- How much money is needed?
- When is this money needed?
When the entrepreneur has the answers to these questions, the sourcing of funds can begin.
A common term used to describe funding for a start-up is bootstrapping. The origin of the term bootstrapping is unclear. The term may refer to a saying from the 1800s, “Pulling oneself up by one’s bootstraps.” It generally means doing something on your own without outside help. Today, bootstrapping describes starting a business with little or no outside cash or support.
- Financing does not depend on an investor’s assessment of the merits of the opportunity or on the value of the assets of the venture.
- May be from the entrepreneur’s own resources or from friends and family.
- Personal savings (90%)
- Credit card/personal loans (28%)
- Loans from family and friends (7%)
- Equity investments from family and friends (5%)
With bootstrap financing, the entrepreneur does not need to spend precious time courting potential investors and negotiating investment terms. The business does not need to be assessed for valuation purposes. And, without outside investors, the entrepreneur maintains control of the business. Studies show that the majority of start-up operations (80%) are funded with bootstrap financing.
Often, the first funding for a new venture comes from the company founder(s). This money may be sourced from personal savings or investments. Personal credit cards can be used to pay for expenses. Sometimes the entrepreneur or founders make personal loans to the company with the expectation of loan repayment. Using personal funds to finance a new venture creates risk for the entrepreneur. Start-ups have a very high failure rate, so the financial plan is a critical tool in the decision-making process.
Friends and family members are other common sources of start-up funding. These funds can be invested in the company (ownership) or loaned to the company. Either pathway for these funds should be documented using a formal agreement. These agreements are particularly important for family members to prevent issues within the family.
Decision making regarding funding sources for a new venture can be guided by using the following flow chart:
Source: Entrepreneurial Finance; Smith, J.K.
The timing of the need for the funds impacts the available sources for funding. Immediate needs for funds have limited sources including friends and family, bootstrap sources, and existing shareholders (if any). When more time is available to source funds, more sources can be available. Raising money from outside sources is a time-consuming process and can take up a year to close a deal. Therefore, outside money sources such as angel investors and venture capitalists are used for follow-on financings after start-up. Some start-ups do not require follow-on financings to become self-sustaining.
Loans to start a new venture are difficult to obtain. Loans require repayment and the typical start-up does not have sufficient revenue and income to make loan payments. In some cases, the entrepreneur may need to personally guarantee a loan and provide collateral. This adds to the new venture risk for the entrepreneur. After the business starts generating positive cash flow, loans can be used to grow the company.
Other, less common, sources of start-up funding exist. Grants are an excellent source of funds because grants do not dilute ownership and do not require repayment. However, grants are not available for most start-ups. Finding grant opportunities is a time-consuming process, the grant application process can be burdensome, and the grant approval process is highly competitive. Some government grants are available for research companies if the research meets the grant parameters. Crowdfunding can be used for funding on a limited basis. Most crowdfunding sources have a charitable purpose. When new ventures use crowdfunding, the purpose is to sell a new product such as a prototype. Using crowdfunding to raise funds via the sale of equity is complicated and may not provide the best capital structure for the company.
Bootstrapping a new venture has advantages and disadvantages for the entrepreneur. Advantages include:
- Low cost to start the business. Entrepreneurs who use their own money create efficient businesses. Management is deeply involved, and “lean” business models are developed.
- Control. Without outside investors, the entrepreneur or founders make decisions about operating and growing the company.
- Focus. The entrepreneur can focus on managing the company and not spend time and resources raising outside capital.
- Future financings. Entrepreneurs who build successful start-ups are attractive investment opportunities for outside investors.
Of course, bootstrapping entails some disadvantages:
- Cash flow issues. Lack of cash can make a start-up difficult to grow.
- Equity issues. Imbalances in equity among founders can create problems. If the entrepreneur owns 100% of the company, this is not an issue.
- Commingled funds. Sometimes the company funds and personal funds are not clearly separated.
- Risk of failure. The risk of failure is high for new ventures. This adds to the stress for the entrepreneur or founders.
There are many well-known examples of successful bootstrapped companies. Some entrepreneurs include Bill Gates, Steve Jobs, Michael Dell, and Richard Branson. Successful bootstrapped companies include Microsoft, Dell Computers, Facebook, eBay Inc., and Hewlett-Packard.
Spanx is a company devoted to providing slimming undergarments. Sara Blakely founded the company with $5,000 of her own money in 2000. The first headquarters for the company was her apartment in Atlanta. Sara even wrote and filed her own patent application to save on legal fees. In March of 2012, Sara was named the world's youngest, self-made female billionaire by Forbes.
These successful bootstrapped companies are inspiring. Bootstrap financing is a proven method for funding a new venture. Both for-profit and non-profit ventures can benefit from this approach to funding.
With over 30 years of experience in all phases of life science technology business formation and management, Mr. Kazmer currently serves as part-time business faculty at the University of North Georgia and Advisor to the North Georgia Entrepreneurship and Innovation Center. He has been President of six biotech/biomed companies. He served as COO for a medical research foundation and has mentored over 100 inventors. As a GM, his background includes extensive experience in operations, finance, business development, sales and marketing, and human resources. During his tenure at B.F. Goodrich, he held seven different CFO positions, including a specialty chemicals division. He is a veteran and served in the United States Navy as a Submarine Officer and Nuclear Engineer.