Should you rely on personal finances to start your new company, or should you look for outside investors such as family and friends?
- The success of every business venture depends on its ability to continually make profits.
- The source, cost of capital, and capital formation affect the productivity of every business and its ability to make profits in the long run.
- Every business should weigh which method of funding best suits it as an enterprise and will be more advantageous to the company.
Starting a business isn't cheap, and figuring out funding is a critical first step. Entrepreneurs have to make a lot of financial decisions when starting a business, and one of the first is whether they want to fund their own business or secure equity funding.
When an entrepreneur bootstraps, they start and expand a business with their personal finances and revenue from the company. Other business owners use traditional equity funding, such as funding from friends and family, angel investors, early-stage investment firms, and venture capital firms. Here are the advantages and disadvantages of each approach.
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Limited companies raise capital through the sale of shares, collecting funds from the public in exchange for part ownership of the company. Equity funds may come from family and friends or by issuing an IPO. The process of equity financing must be in line with government regulations.
Pros of equity funding
Jen Young, co-founder and CMO of Outdoorsy, explained that equity financing means trading your equity in the company for cash from investors. These are some advantages of equity funding.
Faster business growth
Equity funding allows you to grow your business faster, being less strapped for cash and having investors who can help you improve the business.
"An infusion of working capital from an investor or a small business loan can make growing a startup much easier," said Nishank Khanna, CMO at Clarify Capital. "Apart from the capital, an investor also helps connect a founder to people in their network."
No interest payments
The business does not pay interest for money received through equity funding. This is essential for startups that may not be in a position to bear the burden of debt.
If the business is unsuccessful, the cost of liability lies with all shareholders, not one individual.
Cons of equity funding
Changes in company ownership
"The equity comes from the original founders, and this trade dilutes the founder's ownership in their company," said Young. If business owners give away enough equity, the investors may ask for rights such as board seats and preemptive rights. Individuals who buy shares from a company may demand to be involved in the the company's decisions, such as how the money is spent or where it is invested.
Bootstrapping is the process of an entrepreneur using existing resources such as their personal computing equipment, garage space or personal savings to grow their business. The company stretches the resources it has to their maximum utilization, reducing costs.
Instead of getting investors or taking out a loan, bootstrapping entrepreneurs use personal credit cards or dip into their savings accounts to help fund the business, said Deborah Sweeney, CEO of MyCorporation. Once the business is off the ground, they use revenue to fund the organization.
"You are completely self-funding your business when you decide to bootstrap," said Sweeney. "This means you are not taking out loans or crowdfunding or getting investors involved."
One bootstrapping technique is refraining from investment in any dedicated working space until necessary. Keep minimal space for employees or use cheaper space until your team outgrows it.
You might also only buy supplies from companies that are offering discounts, engage in an exchange program with companies that buy products from you, or negotiate a longer repayment period (which would be an interest-free debt for the company).
Pros of bootstrapping
"The main advantage of bootstrapping is that you get to keep 100% equity ownership of your business and don't take on any debt," Khanna said.
Sweeney said the greatest advantage of bootstrapping is that it allows you to discover what you're truly capable of. "You can step back and marvel at what you've done once you're on the other side."
Good spending habits
Your company will form better spending habits in the long run if you rely on the business's own minimal resources.
Cons of bootstrapping
"Bootstrapping is not for the faint of heart," Sweeney said. "It requires a great deal of budgeting and discipline to do. There's also no guarantee that your hard work will pay off, which is the risk every entrepreneur faces when they decide to start a business."
Limited resources hamper business growth. When demand exceeds your production capacity, your clients might seek alternative companies that can meet the demand.
If you bootstrap, you'll bear the liability of the business if it does not succeed or faces economic challenges. Natural disasters or calamities may result in significant losses, which are your obligation.
The bottom line
Every business is unique and follows a different path. While bootstrapping may work for one company, it may be impossible for another.
Before you take on the task of funding your own business, Sweeney recommends speaking with a financial professional. "I can't say bootstrapping is the best option for every entrepreneur, and a financial professional can assist you in determining whether or not you can and will be able to bootstrap on your own terms."
If you decide to go the equity funding route, Young recommends picking your investor wisely.
"They will be with you for the entire journey, and you could be with them for a long time," she said. "Make sure there is a good fit in terms of vision, strategy and direction."