Many entrepreneurs do not want the added complexity of having to manage the expectations of outside investors and the demands placed on a business by banks. In this case it is not that the entrepreneur cannot raise outside funding — as discussed in my previous post on bootstrapping. There are many cases of businesses that could have fairly easily raised external funding, but the entrepreneurs made a conscious decision to use bootstrapping techniques to avoid any need for such funding. These entrepreneurs just do not want outsiders — be they investors or bankers — significantly involved in their ventures.
There are several reasons behind this concern:
– External equity funding creates dilution of the entrepreneur’s ownership in the business. Equity financing reduces the ownership percentage of the founding entrepreneurs, thus reducing their share of any profits and any wealth created through the venture. The business must get that much larger for them to reach the financial goals that they had originally established for their business.
– Equity investors can sometimes turn out to be less than scrupulous individuals — commonly known as sharks. Sensing the entrepreneur’s vulnerability, these investors will demand much more of an ownership stake than the deal actually requires, based on their investment. They can also intend from the very beginning to force the founding entrepreneur out of the business once they have taken financial control.
– Adding equity investors complicates the interpersonal dynamics in the company. Many entrepreneurs report that partnership relationships can be even more complex than a marriage. The commitment with equity investors is long-term and in reality, indefinite.
– Significant debt financing can make a business much more susceptible to downturns in the economy. If a downturn occurs and profits decline, large payments on loans can become difficult or impossible to meet. A similar business with less debt will have more excess cash flow, without the large debt payments, to cushion the blow of declining revenues and profits.
– When a business is sold, the entrepreneur is required to pay off all debts before any money can be distributed to the owners. Since taxes owed on the proceeds of the sale are typically calculated without consideration of any debt that must be paid off, entrepreneurs who have relied heavily on debt have been known to have little or no money left after the sale of their businesses.
– Bankers impose many restrictions on a company as part of the terms of large business loans. These restrictions may limit the entrepreneur’s freedom to make some decisions on major issues affecting the business, such as expansion, payment of dividends to shareholders, or compensation of management.
– Most debt issued to entrepreneurial ventures requires personal guarantees by the entrepreneurs. These guarantees mean that if the business defaults on its debt, the entrepreneurs will be personally liable for those loans. The bank has the right to come after personal assets to pay off the loan. Avoiding personal guarantees of business loans has proven to be a compelling reason for many entrepreneurs to use bootstrapping to avoid the need for bank financing.
Dr Jeff Cornwall
Co-founder of The Entrepreneurial Mind, serial entrepreneur and professor of entrepreneurship.
This is a great site – just found it yesterday.
Those are the reasons I’ve chosen to bootstrap my company. The only sort of outside funding I would be interested in as a new entrepreneur is seed or angel financing.
Interestingly enough, I’m coming into contact with quite a few VCs / Equity folks who actually recommend bootstrapping or taking angel capital at the most to fund the business all the way to growth stage. There is, in my limited experience, a correlation between this mindset among certain VCs and their willingness to let the business evolve naturally (eg. without attempting to control it at every step).