Financing for startups: bootstrapping

What do you do when you have an idea for a company, but nobody is waving with money to support you? “Bootstrapping” is the magic word, at least if you want to try your idea in the real world. But what does that actually mean?

A chic term — for a precarious situation

“Bootstrapping” is the term for a company founded entirely without third-party capital (meaning without investors or investor capital) by trying to reach as much as possible for its business with as little money as possible. So it’s about keeping the costs as small as possible, doing as much as you can yourself and earning (small) revenue and ultimately profits as quickly as possible.

There are different theories on where the term comes from. Sometimes a derivation from the American term “bootstrap” — shoelaces — is referenced. Just as the laces should be tightened for the efficient and foot-friendly use of a shoe, so too should the company’s initial start-up and growth strategy be closely align with the scarce financial resources available to the founders.

Sometimes the Baron-Munchhausen story is also used. The latter is said to have pulled himself out of a swamp by his hair (“he lifted himself out of quicksand by pulling his bootstraps”) — referring to this, “bootstrapping” describes a process in which founders build a business independently, only with their own money and efforts, without outside funding.

No matter where the term comes from, for bootstrapping it is ultimately crucial that the founders use the resources they already have and that they use them effectively. In short, bootstrapping is about achieving financing on its own.

Advantages of bootstrapping

Bootstrapping has several advantages.

For example, due to financial constraints founders learn very quickly to be economical and effective right from the start.

Because external investors are lacking founders are not under pressure from the outside and can pursue their own goals and visions more freely — experimenting with ideas is so much easier.

They are gaining experience and knowledge in all areas of the business and are unlikely to grow faster than they can manage. Bootstrapping is therefore a good alternative especially for first-time founders, because it means that they grow their own business and themselves at the same speed.

Finally, it can impress investors (if their money is need at a later stage) when the company has managed to finance and grow on its own.

Disadvantages of bootstrapping

As you would expect, bootstrapping as a form of financing not only has advantages.

One disadvantage, for example, is that the founders not only have to make do without external financial resources, but also without the network and the support of investors.

Bootstrapping also increases the general business risk for the founders because they have to be very much in control of their spending and their activities. And if a business is started only with its founders’ own resources, generating revenue is essential to keeping the business afloat. As a result, this can lead to business strategies that were not part of the original plan, simply because you need the revenue (which of course can create opportunities for the business).

In addition, the company may not be able to grow as fast as desired. For the expansion of the team and for an appropriate marketing certain funds are needed that are not available to a company that is bootstrapping (this situation can of course also be very productive and inventive — the lack of money is offset by ideas, if one has such). In general, though, if a company is in a market that is going to be saturated quickly and speed is a massive strategic advantage, then bootstrapping may turn out to be a bad idea.

Another drawback that founders should consider when bootstrapping: lack of credibility. Not having external investors could compromise the credibility of a business from the beginning because it does not seem like anyone is interested in the business (even if that’s not the case — it just depends on the impression).

Finally, founders should take into account that bootstrapping can lead to high mental strain on the founders. As they take care of everything themselves to save on spending, they are busy with a variety of organizational tasks (keyword: “burnout by micromanagement”). And the lack of financial resources can ultimately lead to existential concerns, if one has the feeling one does not know how to pay the next bills or survive the next month — especially if the hoped-for revenue surprisingly fails.

Principles of bootstrapping

At first glance, more aspects seem to hoghlight the negative side of bootstrapping. However, for many founders, bootstrapping is actually a necessity, simply because they have no external investor — for a variety of reasons. There are even studies that say that 80% or more start-ups are founded without external investors. And because many of these startups are successful, there is hope for success when using the method of bootstrapping.

What principles should founders follow if they want (or need) to use bootstrapping? I recommend the following:

• Founders should start as soon as possible to sell a product or service to generate revenue. Eventually, the product or service can be improved over time and the improvements made available to customers or users. But it should be started at least as fast as possible. Associated with this, founders should focus on achieving breakeven points and positive cash flows early on, and their focus should be on “cash” in the early stages of the development of the company.

• Additionally, it is important to focus on the sales process. Since revenue must be generated quickly, the product or service must be sold. So if the founders do not enjoy selling, then it will be hard for them and their company.

• As part of the growth strategy, founders should operate in a very controlled manner with regards to spending, according to their limited resources, and think carefully about the benefits of each expense. In particular, they should align the expenses with the company goals. It is always necessary to ask which tasks can be taken over by the founders instead of, for example, commissioning service providers. But beware: often bootstrapping is confused with “excessive money saving”. The goal, however, is not that the founders basically do everything themselves and save every penny or cent. Rather, it’s about consciously and efficiently using existing money and time, and critically examining spending.

• Founders should not work with high paid team members who do not under the startup culture of the young company. Rather, it is important that the team members believe in the company’s vision and have some intrinsic motivation to work in this company. Team members who only care about money will quickly find themselves in trouble in a bootstrapped company.

• Although they are not needed or wanted at present, banks or potential investors might play a critical role for the startup in the future. Therefore, the relationships with them should be cared about and they should be kept up to date on the development of the company.

Is bootstrapping the method of choice for startups?

It is not easy to say whether one should rather “bootstrap” a company or start working on external financing right away. Ultimately, every method of financing has advantages and disadvantages. In any case, one can say that often the only option is to start by bootstrapping the company — and there is nothing wrong with that. But founders should know what they are dealing with and what they should look for. A few of today’s unicorns were founded by bootstrapping — so do not throw in the towel!

Final remark

Finally, a note: one can wonderfully argue about whether bootstrapping is even a form of financing for startups. It may not be on the same level as traditional financing methods such as loans or venture capital. However, focusing on the question of how a startup dispenses its necessary expenditures and thus assures its own existence, in my view bootstrapping must clearly be seen as a form of financing.