Bootstrapping

Article byRutan Bhattacharyya
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Bootstrapping Meaning

Bootstrapping is a process that involves establishing and building a business with personal savings, earnings from initial sales, and borrowed or invested money from family and friends. This is a way to build a small business without giving up equity or taking out substantial bank loans.

Bootstrapping

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Self-funded businesses adopt an approach opposite to traditional financing methods, such as attracting investors to raise additional funds. As a result, entrepreneurs can maintain control over all business-related decisions if they use their finances to start and grow a business. Nevertheless, individuals choosing this method may not have adequate funds to expand a business’s operations at a reasonable rate.

Key Takeaways

  • The bootstrapping definition describes a self-starting and self-funding process wherein individuals launch their startup without external funding. As a result, they can start running a business with total control.
  • There are many advantages of bootstrapping. For example, entrepreneurs do not have a debt burden and can focus on every key business-related aspect without worrying about investors.
  • When entrepreneurs opt for the bootstrapping process, their business goes through three stages — beginner, customer-funded, and credit.
  • One important disadvantage of this practice is that entrepreneurs might not have sufficient funds to grow the business quickly.

Bootstrapping Explained

The bootstrapping definition refers to starting and building a business utilizing personal finances or the organization’s operating revenue. The high dependence on personal savings and other internal sources of financing is the main feature of this concept.

By bootstrapping a startup, entrepreneurs can refrain from raising funds via venture capitalists or angel investors. As a result, they can grow their business without giving up equity in the company.

Entrepreneurs depend on sweat equity, personal savings, quick inventory turnover, a cash runway, and lean operations to become successful. For instance, bootstrapped companies may take preorders for their products. This enables them to utilize the funds generated from the orders to develop and deliver the items.

That said, this practice may put significant financial risk on entrepreneurs. Moreover, it might not give them sufficient capital to grow the business quickly.

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Stages

Typically, a bootstrapped company goes through the following three stages.

  1. Beginner Stage: This stage begins when individuals start a business with savings or funds borrowed from family and friends.
  2. Customer-Funded Stage: In this stage, the entrepreneurs utilize the amount received from clients or customers to keep running the business and fund its expansion.
  3. Credit Stage: During this stage, the business’s income is inadequate. Hence, the entrepreneur seeks external funding to execute another strategy or expand the operations. The external source can be a bank loan, an initial public offering, etc.

Examples

Let us look at a few bootstrapping examples to understand the concept better.

Example #1

GitHub founders PJ Hyett, Tom Preston-Werner, Chris Wanstrath, and Scott Chacon bootstrapped the company for the first four years before deciding to opt for external funding. When they started the company, they did not quit their day jobs. Instead, they worked on GitHub remotely and paid themselves a small (but increasing) amount to ensure that there were enough funds for the project.

Developers worldwide use GitHub to store code written in any programming language. The company received a valuation of $7.5 billion in 2018 from Microsoft, its new owner. The takeover fit Microsoft’s ambition of offering a go-to platform for all developer requirements.

Example #2

Let us say that Tom started an apparel and clothing business using his savings and money he borrowed from his brother. He did not take any money from an investor and utilized the income generated from sales to grow the business. After bootstrapping the company for ten years, Tom realized that external funding was necessary to expand the operations to other countries and fulfill his dream of building a multinational company. Hence, he raised $200 million from a venture capitalist.

Advantages And Disadvantages

Let us look at the advantages and disadvantages of bootstrapping.

Advantages

The benefits are as follows:

  • If a business fails, the entrepreneur will not have any legal obligation to pay off the outstanding borrowings. On the other hand, if the project succeeds, it can attract investors and accelerate the organization’s growth.
  • Entrepreneurs can make all decisions independently. Hence, they have the scope to develop a unique product and fulfill their dream.
  • Attracting investors can be a time-consuming task. However, by utilizing the existing resources, entrepreneurs can focus on the business’s crucial aspects, such as product development, sales, etc.

Lastly, entrepreneurs can create a strong financial foundation for their businesses by opting for this method. This can help attract future investments, which can help the business grow at a faster rate.

Disadvantages

The disadvantages of this concept are as follows:

  • Bootstrapped organizations often cannot grow exponentially owing to the limited availability of capital. For instance, an entrepreneur might not have sufficient funds to run an advertisement campaign on social media and other marketing channels to spread brand awareness and acquire new customers. Moreover, the consumer demand may be more than the organization’s ability to provide goods and services or procure raw materials.
  • The entrepreneurs who start the company take on all the financial risks by putting their money directly into the business. In other words, when the business takes a hit owing to unforeseen expenses or a lack of sales, the entrepreneurs have to bear the losses.
  • If a business does not have the backing of established businesses, the founders might find it difficult to find the connections required to build a prototype, brand, etc. Hence, entrepreneurs must build a customer base and find collaborators independently.
  • Individuals running self-funded organizations must ensure that their books are in order so that no issue arises later.

Bootstrapping vs Funding

There are multiple financing options available for businesses. Among them, bootstrapping and funding are two popular choices of entrepreneurs. However, these two approaches are completely different. Hence, individuals must understand their key differences before deciding which method of raising funds is the best for their organization. The table below highlights the distinct characteristics of funding and bootstrapping in business.

Basis Of ComparisonBootstrappingFunding
Decision Making Entrepreneurs can make decisions independently. For example, they can decide what salary to pay, whom to hire, and what products to manufacture or sell.The founders might not be able to make all decisions independently. However, since the investors put their money into the business, they expect to have control. Hence, they influence the entrepreneurs’ decisions.
FocusThis practice allows entrepreneurs to focus on any aspect of the business. Moreover, they can manage their time effectively, per their requirements.In this case, entrepreneurs have to meet the investors and make an effort to build a strong relationship with them. However, at the same time, they have to focus on crucial business-related aspects. As a result, they might not be able to manage time effectively.  
Availability Of FundsIndividuals building a business from scratch with their savings might have little money to invest at the start. Hence, they will have to compromise on profit levels. Moreover, limited funds can restrict their competitive edge.Entrepreneurs can opt for funding to raise substantial capital for a business. The funds can help them exponentially grow their business.
Building ConnectionsPeople running a bootstrapped startup might not have the necessary connections to help the business succeed.Funding comes with various benefits, such as expert help, instant networks, and connections. The investors can help founders build networks of their own. Moreover, the former can connect the latter with the right people in the industry.
Financial RiskIn a bootstrapped startup, the entrepreneur bears all the financial risk as they do not opt for an external source of financing. Hence, if the business fails, they lose all the money.It offers entrepreneurs more financial freedom to fail. That said, the agreement and investment influence how that failure will impact their bottom line.

Both practices have helped entrepreneurs succeed. However, to decide the best option, individuals must consider the type of business they want to build and their expectations.

Frequently Asked Questions (FAQs)

1. When to use bootstrapping?

Typically, individuals choose the bootstrapping process for the following reasons:
– They do not want to give up equity.
– Entrepreneurs do not know how to raise additional funds.
– They do not want to spend time looking for investors.
– Entrepreneurs can increase their leverage for future fundraising.

2. What are bootstrapping strategies?

Let us look at some proven methods that can help entrepreneurs during the initial stages of a bootstrapped startup:
– Develop an effective business plan.
– The product or service offered must solve a problem.
– Reinvest as much net profit as possible.
– Attract an experienced person who has worked in the industry for some advice.
– Build connections and try to get help from people in a developed personal network.

3. What is bootstrapping in statistics?

This process involves resampling a dataset to create various simulated samples. This comes under the topic of resampling. It allows the computation of standard errors, confidence intervals, and hypothesis testing.

This article has been a guide to Bootstrapping and its meaning. We explain its stages, examples, advantages & disadvantages, and comparison with funding. You can also go through our recommended articles on corporate finance –

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