Funding bootstrapped startup through internal sources

Funding Bootstrapped Startup 

As an entrepreneur seeking funds to transform an idea into a company, one may choose to secure capital from two broad sources –internal or external sources. Most entrepreneurs with bootstrapped start-ups choose internal funding as an option due to the absence of a requirement of external analysts or investors to independently appraise the worthiness of the entrepreneur’s business idea before releasing funds – as this is a time-consuming option. Managers or owners of large, mature firms, in contrast, have access to profits from operations as well as funds from external sources.

External investors and lenders also don’t share the entrepreneur’s vision, so they may view the potential risk/return trade-off in a different vein and demand a relatively certain return on their investment in the firm has an established financial track record. Soon after, entrepreneurs begin tapping their personal fund sources; they may also solicit funds from relatives, friends, and banks. Entrepreneurs would generally prefer to use other people's money (OPM) rather than their own because, if their personal investment turns sour, they still have an income source to feed themselves and their families. The need to protect an income source may be particularly acute if the entrepreneur leaves a viable job to pursue an entrepreneurial dream on a full-time basis.

The costs to the entrepreneur in this case include -

The opportunity cost of income from the prior job;

The forgone interest on the initial investment;

The potential difficulty of being rehired by a former employer (or others) if the idea does not succeed.

Add to this the embarrassment of having to constantly beseech former colleagues for a new job while paying off old debts and the prospective entrepreneur quickly realizes that the total cost of engaging in a new venture is very high. Family and friends may volunteer to fund the entrepreneur’s project in the early stages and often will do so without a formal repayment schedule or specified interest cost.

It is clear, given the aforementioned reasons, why an entrepreneur will prefer to secure funds via internal sources as opposed to appealing to formal external sources as a means of funding a bootstrapped start-up. However, it is important to realize that internal sources provide funds in a manner that is far from being ’free’.

In this case, it becomes important to recognize the existence of total costs—including non-financial indirect costs, such as family pressure, internal monitoring, and strained relations—which are certainly extremely high. Added to that, family and friends make poor financial intermediaries, since they have limited financial resources, different repayment expectations, and narrow loan diversification. That is to say, these internal sources may indeed have binding financial limitations and may, in the end, be unable to provide enough funding for the entrepreneur to be able to continue business operations, or may demand to be repaid in case of some unforeseen personal emergency. This may well contribute to the entrepreneur’s desire to get outside funding from a traditional source as soon as possible.