1. Personal Funds The vast majority of founders contribute personal funds along with sweat equity to their ventures. In fact, the results of a Kauffman Foundation survey of nearly 5,000 new business owners indicate that just 10 percent of those surveyed used external sources of funds their first year of operation. The numbers change some but not as much as you might think as firms get older. Results from a number of studies that have examined firms that have been in business for just a few years up to a total of eight years show that close to 50 percent of the firms received no external funding—the money came strictly from the personal funds of the founders and the profits of the firms. Sweat equity represents the value of the time and effort that a founder puts into a new venture. Because many founders do not have a substantial amount of cash to put into their ventures, it is often the sweat equity that makes the most difference.
2. Friends and Family Friends and family are the second source of funds for many new ventures. This type of contribution often comes in the form of loans or investments, but can also involve outright gifts, foregone or delayed compensation (if a friend or family member works for the new venture), or reduced or free rent. For example, Cisco Systems, the giant producer of Internet routers and switches, started in the house of one of its cofounder’s parents.
There are three rules of thumb that entrepreneurs should follow when asking friends and family members for money. First, the request should be presented in a businesslike manner, just like one would deal with a banker or investor. The potential of the business along with the risks involved should be carefully and fully described. Second, if the help the entrepreneur receives is in the form of a loan, a promissory note should be prepared, with a repayment schedule, and the note should be signed by both parties. Stipulating the terms of the loan in writing reduces the potential of a misunderstanding and protects both the entrepreneur and the friend or family member providing the funding. Third, financial help should be requested only from those who are in a legitimate position to offer assistance. It’s not a good idea to ask certain friends or family members, regardless of how much they may have expressed a willingness to help, for assistance if losing the money would cripple them financially. Entrepreneurs who are unable to repay a loan to a friend or family member risk not only damaging their business relationship with them, but their personal relationship as well.
LendingKarma (www.lendingkarma.com) helps people involved with friends and family develop loan documents and then track the loans. Following a simple set of online commands, a user can select a loan amount, designate if he or she is the borrower or lender, and set various options such as interest rate, payment frequency, and length of loan. A promissory note, in PDF format, can then be created along with an amortization schedule. LendingKarma will track the loan repayment. E-mail reminders can even be sent to the borrower, reminding the borrower of the amount and due date of an upcoming payment. LendingKarma has three different levels to their loan documenting service, starting at $14.95 for the basics and working up to $59.95 for the premium service. Accountants, attorneys, and bankers can also help people structure loan agreements.
3. Bootstrapping Bootstrapping is a third source of seed money for new ventures. Bootstrapping is finding ways to avoid the need for external financing or funding through creativity, ingenuity, thriftiness, cost-cutting, or any means necessary. (The term comes from the adage “pull yourself up by your bootstraps.”) It is the term attached to the general philosophy of minimizing start-up expenses by aggressively pursuing cost-cutting techniques and money-saving tactics. There are many well-known examples of entrepreneurs who bootstrapped to get their companies started. Legend has it that Steve Jobs and partner Steve Wozniak sold a Volkswagen van and a Hewlett-Packard programmable calculator to raise $1,350, which was the initial seed capital for Apple Computer.
There are many ways entrepreneurs bootstrap to raise money or cut costs. Some of the more common examples of bootstrapping are provided below. A simple example of bootstrapping is that fax machines are no longer an absolute necessity, in most cases. There are several Web-based services that allow anyone to fax a document for free, as long as they have a scanner and are able to scan the document into a word processing program. The document can then be sent to the recipient’s fax machine and it will print out as a normal fax. Examples of companies that offer variations of this service are FaxZero, Got Free Fax, and MyFax. The overarching point is that a little ingenuity (learning how to fax for free) can save an entrepreneur the cost of purchasing a fax machine.
While bootstrapping and using personal funds are highly recommended actions in almost all start-up situations, there are subtle downsides. Cost-cutting and saving money are admirable practices, but pushing these practices too far can hold a business back from reaching its full potential. For example, renting space in a community incubator or building where other start-ups are located, rather than working from home, may be worth it if it provides entrepreneurs access to a network of people who can be relied on to provide social support and business advice.
Examples of bootstrapping methods
• Buy used instead of new equipment
• Coordinate purchases with other businesses
• Lease equipment instead of buying
• Obtain payments in advance from customers
• Minimize personal expenses
• Avoid unnecessary expenses, such as lavish office space or furniture
• Buy items cheaply, but prudently, through discount outlets or online auctions such as eBay, rather than at full-price stores
• Share office space or employees with other businesses
• Hire interns
Reference: Entrepreneurship (Book)