Bootstrapping Financing is a popular way of internal funding with SMEs. It is the practice of using a company’s resources to fund itself in its initial years.
Bootstrapping financing relies on a company’s ability to utilise its resources to
- Grow a new business
- Meet operational needs
- Expand a business
The fact that bootstrapping is an inexpensive way of raising capital makes it very popular with SMEs.
Why should SMEs consider Bootstrap financing?
- It increases the worth of a company financially for the simple reason that there is no money borrowed. This makes it possible for a company to be free of equity positions that need to be relinquished.
- It removes the necessity of paying high rate of interests that comes with borrowed money.
- A company that has built itself on its own earns the confidence of external lenders and investors in the long run.
There are several sources of bootstrap financing. Here is a list of the most popular resources that SMEs can seriously think to implement to finance their businesses.
- Trade Credit:
Trade Credit is one source of bootstrapping financing. In trade credit a supplier extends credit to a business for a span of 30, 60 or 90 days free of interest.
For example – Supplier A ships products to business B and the bill for the received product is due in 30 days. Business B can however choose to pay after 60 days of receiving the goods because it has trade credits from supplier A.
A supplier allows a company trade credit only when it has earned the company’s trust that it can pay its bills on time. There is a negotiation process in the early stages of business between the company and the business. A great way to sail smoothly through these negotiations is to have a prepared financial plan. It is advisable that a business approaches the CFO or the owner only with the financial plan and proceed with theTrade Credit negotiations.
How to make Trade Credit work?
The main aim of a business looking to get a profit out of trade credit should be to get the goods shipped and sell it before the payment is due. One can borrow the money that is required to pay for the inventory but would anyway have to pay the interest that comes on that money. This reduces the amount of working capital that a business needs to start. More so if a company deals in retail operations.
What to Watch Out For?
Trade Credit is quite alluring for SMEs given that it is so convenient. However, it is important that a business resort to trade credit only for the short term needs of a business. This will help a business to stay away from being heavily committed to suppliers who accept extended credit terms. This may result in a new company losing access to other suppliers who offer lower prices, better quality products and reliable deliveries.
Factoring is a way of selling the accounts receivable of a business to a buyer to raise capital. The buyer in this case can be something like a commercial finance company etc. A ‘factor’ in terms of bootstrapping financing buys the accounts receivable of a company at a discounted rate. This rate ranges between 1 to 15%. Overtime the factor becomes the creditor of the business and takes the responsibility of collecting receivables as well as doing the paperwork chores.
Factoring is a very good source of bootstrapping because it helps to minimise costs of a company.
- It reduces internal costs
- It frees up money that is otherwise tied to receivables.
- It helps to keep cash flowing
Leasing is another great source of bootstrap financing. Leasing instead of purchasing is great way to save money. There is a huge financial difference between leasing an automobile van for a business and investing a large sum of money on procuring a van when a company is just starting up.
The benefits that come with leasing are:
- Businesses can make smaller payments on required facilities.
- A company has the freedom to walk away at the end of term
- A company has access to built-in maintenance provided by the owner.
Another great source for bootstrapping financing are customers. A business can ask customers to write a letter of credit and use it for bootstrapping.
Here’s how it works?
Business A is a company that sells commercial bags. Company B has associated with business A to ensure a steady supply of bags. Supplier C provides the material to business A. Business A can obtain a letter of credit from the customer placing the order. This letter of credit can then be used to purchase all the material from supplier C. This makes it possible for business A to buy materials from the supplier without having to spend any money.
- Equipment Suppliers:
Purchasing equipments can drain a company’s finances. One way of bootstrapping with equipment suppliers is by purchasing the needed equipments on loan from the manufacturers. This allows a business to pay the amount in small sums over a period of time.
There are two types of contracts that are used for equipment purchases:
- Conditional Sales Contract:
In this contract the purchaser do not own the equipment until the payment is made.
- Chattel Mortgage Contract:
In this contract the purchaser acquires the ownership of the property on delivery. The seller on the other hand holds a mortgage claim against the property unless the payment is made.
Things to Watch Out for While Bootstrapping:
- Check that a business is not in an overly expensive office/location/situation unless it is going to pay off. This would result in a business unnecessarily going top dollar when it could have been avoided.
- Keep a close watch on the operating expenses.
The profit of bootstrapping rests on a company’s ability to manage its finances in a way that it generates funds. Boost your financial management and give your SME the benefits of bootstrapping financing.