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It is not uncommon for a new client to tell me they have an idea for a business and that all they need is an investor. As a coach, I welcome these kinds of comments, because they provide a perfect opening to provide some useful insight into what it means to be an entrepreneur, and the role that outside investment has in a business startup.
To start with, it's important to realize that businesses that exist only as an idea won’t generate much interest from outside investors. As a result, most businesses need to get up and running first. The number one source entrepreneurs tap for startup financing is ... themselves.
Studies from researchers at Clemson University consistently show that the source of most business seed capital is the founders' personal savings, personal credit, equity in their primary residence and the like. Only a minority start out with bank loans. Even fewer have outside investors.
The number of startups that receive venture capitalist backing is truly tiny. For all of 2016, according to the MoneyTree Report, venture capitalists funded 1,513 companies. That's a minuscule 0.005 percent of the 28 million small businesses counted by the Small Business Administration.
So odds are good that you will fund your own business startup out of your own pocket, perhaps with some help from friends and family. After startup, you will most likely use profits generated by the business -- not investments from outsiders -- to fund future expansion.
Growing a business without external funding in this fashion is called bootstrapping, notes the SBA. Bootstrapping is popular, in part, because it offers significant advantages over taking money from someone else.
Independence is the first bootstrapping benefit that I point out to my coaching clients. It is an inescapable fact that when you take some money, you lose some control. If independence is a key reason for starting your business, you may not be happy taking on financial partners.
Having investors is not always in your business's best interest, or yours. Investors may want the business to grow too fast. They may desire to cash out by selling to the first suitor who comes along. They have been known to force founders out if they don't get their way.
While bootstrapping does offer benefits, it must be done right. Here are three dos and three don'ts for successful bootstrapping:
Do be just as careful with financial projections as if you were seeking venture capital. If you've drained your savings and taken out a second mortgage on your house, you owe it to yourself to invest the proceeds wisely. Do all you can to see that the money you invest in your startup will be enough to see it to profitability.
Do consider adding partners who can bring financial assets as well as operational expertise. One plus of having a startup team rather than going solo is that, in addition to expanding in-house knowledge and experience, you may also be able to tap team members' personal net worth to fund the business. Having management with skin in the game is an asset, and other team members are more likely to focus on the long-term health of the business than outside investors.
Do consider starting your business part-time while continuing to work. If you maintain regular employment and work on the startup as a side venture, profits can go to expand the business rather than the founders' living expenses.
Don't overpay yourself. It's called sweat equity for a reason. The less money you take out of the business to compensate yourself for your efforts in the early days, the greater the value of your ownership stake. At worst, paying yourself too much can hamstring the startup's ability to survive and expand.
Don't grow too fast. Bootstrapping a business usually means taking a slower approach to growth. If you try to add new products, new markets, and new employees as rapidly as a startup with deep-pocketed backers, you may run out of funds before the business become self-sustaining. Organic, moderate growth is the best approach for many bootstrapped firms.
Don't take on risks you can't afford to lose. No ethical entrepreneur would be careless with funds supplied by outside investors. But no sensible entrepreneur would heedlessly invest more of their own wealth than they are prepared to lose. Obligations to children or a spouse, for instance, may mean a founder can't responsibly mortgage the family home to the hilt and empty savings accounts to fund a risky startup. That doesn't mean the business can't be started, but it may mean a more moderate pace of growth in the early days.
Among all forms of startup financing, none has a longer and better-traveled track than bootstrapping. If you think you must have outside investors before you can make your business dream a reality, think again. If you carefully craft a plan that makes efficient use of resources, and are ready to take reasonable personal risks, you can start and grow a business successful enough that someday outside investors will be clamoring to join.