If entrepreneurship is about creating value, then bootstrapping is entrepreneurship in its purest form. Promising and unique as a VC backed startup may be, only a small fraction of startups are funded every year. Instead of aiming for the 99th percentile of startups that receive VC funding, entrepreneurs are better off focusing on what they can control today to build tomorrow’s fundable value.
Bootstrapping is a highly creative process that involves the combination of existing and acquired resources to build business value without relying on external funding sources. This is what key academic findings show about bootstrapping.
Examining bootstrapping and capital constraints
Because of the challenges associated with obtaining capital through debt or equity, young startups bootstrap. In one of finance’s seminal papers, Stewart Myers introduced the pecking order model which states that internal methods of financing must be prioritized over debt and equity. This is because the most expensive form of financing is equity followed by debt while the cheapest is by using company’s internal resources such as retained earnings or other solutions like cutting salaries.
Bootstrapping is startup founders’ response to capital constraints. Small businesses are capital constrained by outside sources mainly because of information asymmetry or the tendency of parties in an investment or lending deal to have private information.
Robert Carpenter and Bruce Petersen show that information asymmetries are higher in small firms due to the limited information that the lender has about the firm which makes it a risky investment that mandates a premium for lending. Consequently, research findings by Robert Watson and Nick Wilson show that the pecking order of finance is most prevalent in firms where information asymmetries is more apparent. In fact, even earlier than their study, Edgar Norton shows that small, high-growth firms generally followed the pecking order of finance to meet their financial needs.
In sum, in terms of fund raising, your main responsibility as an entrepreneur is to reduce information asymmetry by prioritizing and maximizing the return on investment of internal resources to build business value.
Examining the motives for bootstrapping
To examine founders’ motive to bootstrap their businesses, Joakim Winborg distributed a survey to 120 new business founders in Swedish business incubators. His analysis shows that nine out of 10 founders bootstrapped their businesses at some point in the life of the venture. Surprisingly, though, most founders in the sample claimed to have deliberately chosen to bootstrap their businesses indicating that the use of bootstrapping is not necessarily a question of last resort.
Overall, the main motives behind founders’ bootstrapping decisions were lower costs where entrepreneurs are mainly concerned about securing the use of resources at a relatively low cost, followed by lack of capital, those are capital constrained entrepreneurs, and finally, risk minimization, entrepreneurs feel safer investing their own resources for validation before referring to investors or lenders’ money.
An interesting finding in this study is that founders’ entrepreneurial experience significantly influences their bootstrapping motives. More experienced founders tend to be motivated by risk minimization: the resource acquisition behavior changes from reducing costs to reducing risk in the business. Less experienced founders surprisingly have fewer motives than the other two groups of entrepreneurs.
In line with the findings about the influence of founders’ experience on their bootstrapping motives, this indicates that less experienced entrepreneurs do not fully understand the importance and advantages of financial bootstrapping. As they gain experience, they tend to gravitate towards self-funding (bootstrapping) either to lower costs, overcome lack of capital and/or minimize risk in the business.
In sum, it’s important for every entrepreneur to understand the importance and need for bootstrapping as much as they do about funding. No matter what motivates your bootstrapping decision, the investment pool is becoming very competitive that funding ideas is turning into history. Therefore, every entrepreneur should be prepared to bootstrap her ventures at least during the initial stages of the business.
Examining founders’ resource acquisition behavior
Through qualitative analysis, Joakim Winborg and Hans Landstrom identified and tested 32 commonly used bootstrapping techniques in a sample of 262 firms. These techniques were grouped into six bootstrapping methods that differed in nature and approach:
1) Owned and self-generated resources: investing existing funds and money generated from other assignments such as a part-time job, consulting, property rent, etc.
2) Accounts receivable management: such as receiving cash upfront or pre-selling products and services.
3) Sharing and borrowing resources: from suppliers, partners, family, friends or personal relations.
4) Delaying payments: such as negotiating flexible terms with suppliers, manufacturers and/or contractors.
5) Minimizing capital invested in stock: instead of stocking inventory or hiring in expectation of demand, invest in response to demand.
6) Using government subsidies: mostly for businesses with a potential for increased employment, the use of government grants has shown to significantly impact their resource needs.
The research further shows that the bootstrapping methods used depend on the phase of the business. Some methods are seen more at the startup stage (e.g., owned and self-generated resources, accounts receivables, delaying payments and others) whereas others become interesting options during the growth stages (grants and agreements with key stakeholders).
A recent Google search on the terms “startup bootstrapping” returned 663,000 results as compared to 2,2720,000 for the terms “startup funding”. Despite the relatively limited attention given to bootstrapping as an effective business building strategy, it is imperative for every entrepreneur to get equipped with the needed bootstrapping knowledge regardless of their funding intentions and motives.
Today, with our network of entrepreneurs we shared how to start building a customer base for your bootstrapped startup as soon as you know your space/industry and before you even have an idea. Join us below.