When business owners have cash on hand, they typically look to their own bank account as a first source of financing.
Lump-sum financing is when you have a fixed amount of money from the sale of a business or investment, an inheritance, personal savings, 401(k) cash-out (rarely a good idea) or other amount of cash that can be used to finance a business venture. The amount you have available is relatively fixed, and the investment is simple to calculate and track.
Bootstrapping is constantly used by many small businesses, usually without conscious knowledge. Bootstrapping is where you pay for the new or expanding business through cash flow coming in from another source.The other source may be your day job, your spouse or partner’s job or business, a profitable business or product line, or passive investments (real estate, mutual funds, and bonds). Bootstrapping is where it can get messy.
(Using your own credit cards, your home equity line of credit, or loaning your money to your business is not really self-financing–it’s debt financing.)
What are the benefits of self financing?
- You don’t have to create a long formal business plan.
- You don’t have to get permission (except from your spouse or partner).
- It’s fast and simple.
- You are not bringing on additional costs (i.e., interest).
- You are not giving away future profits in the business (i.e., by bringing on investors).
- You show future investors or lenders that you are serious about the business and believe in the business, because you have invested your own money.
What are the dangers of self financing?
- You don’t have to create a formal business plan, so you don’t do a business plan at all. Any business, however small, must have a business plan, even if it is just one or two pages.
- You don’t have accountability. With no one overlooking the financials, business plan, and marketing of the business, you may neglect necessary parts of your business or pursue unprofitable business ideas.
- You are taking on all the risk. If the business goes under you lose your investment. You may not get back your entire investment if you sell your business. You may not get a good return on your investment for years, if ever.
- You may run out of money right before the business takes off. It can take 2-3 years before a business is profitable, and you may not be able to self-finance until it turns around.
- You are locking your funds into this business when they could be used for something else. By using your cash here, you are temporarily giving up returns you could get on other investments and/or goals you could achieve (traveling, buying real estate, etc.).
- You may be funding a loosing proposition without knowing it. The big danger of bootstrapping is that one part of a company may be funding a perennially unprofitable product line, and no one may realize this fact if the overall business is still profitable.
Do You Have an Unprofitable Venture Hiding Inside Your Business?
A colleague of mine was running three different ventures, all under the same business umbrella. She was making six figures and felt successful. But once she analyzed these ventures separately, she realized that one of them was unprofitable … and was never going to turn a profit. Even though she had been running that venture for four years, she knew that she needed to shut it down to spend more time and money on her profitable businesses.
Self-financing only works when you have a lump sum on hand or a profitable business that can absorb a new venture.
But don’t forget to track your investment & make sure it’s worthy of your cash.
Do you want more financial insight as well as legal advice? Let’s chat!