Last week I started a conversation about why entrepreneurs bootstrap. The most common Reason? Because they have to.
Various studies on start-up funding report that 70-85% of all start-up capital comes from the entrepreneur, family members, and close friends. The reality is that traditional sources of external money — loans from banks and investments by equity investors — are just not an option for most start-up ventures. Venture capitalists actually fund very few businesses.
One recent study found that only 38 out 100,000 new businesses reported receiving venture capital funding. Another way of looking at that is that of all estimated 650,000 new businesses that will start this year, only 247 will have had funding from venture capital. Equity investors such as venture capitalists and angel investors place their money in high growth, high potential ventures that can result in very large returns over a relatively short period of time. Most entrepreneurial ventures, particularly small businesses, just do not fit the criteria that such equity investors are seeking.
Generally banks also do not loan to start-up businesses. As one commercial banker stated in one of our Entrepreneurship classes, “Bankers do not lend money to start-up ventures. Period.” To understand why, it is important to understand how bankers make lending decisions. Much of the money they keep on deposit is in demand deposits, such as checking accounts, which need to be available when people need or want their funds. When you write a check to pay your rent, you want to know that the money is in the bank available for your landlord to put into his account in his bank. Therefore bankers tend to be conservative when lending out money. They need to know that loans will be paid back, because they money for those loans comes from their customers who trust that their bankers will keep it safe and secure.
Bankers tend to only loan to established businesses that have a proven ability to repay the loan due to strong and consistent cash flow. They also like to see that the owners can pay the loan back personally if the business fails. They will ask for personal guarantees from the owners on any business loans. This means that even if the business fails, the entrepreneurs who owned that business will be held personally liable to pay back any and all business loans from the bank. Banks also like to see that a business has collateral that can be used to back the loans. This can take the form of equipment, buildings and land, inventory, and accounts receivable. New businesses generally do not have cash flow and have very few have assets to serve as collateral.
But, even without ready access to equity investment or traditional loans, entrepreneurs find a way to get it done. That is the power of bootstrapping.
Dr Jeff Cornwall
Co-founder of The Entrepreneurial Mind, serial entrepreneur and professor of entrepreneurship.
Since opening a Start-Up Venture Capital Firm in Memphis a little over a month ago, we have been swamped with new companies, existing companies and potential companies all submitting their deals for investment consideration. When first meeting with the promising ones, I hear the same stories. They hit their savings first, then Friends and Family, then the banks, then finally went looking for outside investors. Jeff has mentioned this before, but to secure professional money, you really have to be almost perfect. I have a minimum checklist of 10 items that I want to see in companies for investing, and Management tops that list. There are some great ideas out there, but to gain money it takes a lot more than an idea. It takes a comprehensive plan and all the key points. Bootstrapping can be a great way to survive until you have it all together but many times I see it as a reluctance to take investment money so they can retain full control of their company. Clearly there is a balance that must be considered very early on in the process between control and outside investments.