Are you considering bootstrapping your small business? Around 77% of small business founders rely on their personal savings to get their businesses off the ground, so you certainly wouldn’t be alone if you decide to bootstrap. But let’s take a step back and dig into what exactly bootstrapping could mean for you:
What is Bootstrapping?
Bootstrapping is one of three extremely common ways to fund your business, alongside debt and equity financing. The term broadly refers to the idea that business founders “pull themselves up by their bootstraps”, or use their own, limited funding to get a business into motion. 82% of small businesses are self-funded, and there are a number of reasons for that. First, it leaves the owner (or owners) of the business entirely in control of the direction of the company, limiting the number of stakeholders like investors or bankers that would require oversight on major decisions. Second, bootstrapping is commonly praised because it requires quick learning and even quicker innovation – there’s no extra money to make egregious mistakes with.
How Can You Bootstrap your Business?
If you’re ready to make the leap with bootstrapping your business, there are four key areas that you can tap into to get started.
Using personal savings to get your business up and running is ideal, but often impossible. If you are able to use savings, they will be the cheapest source of funding. There are typically no limits or restrictions on using this money since withdrawing this money is less likely to have tax implications or fees for early withdrawal. Depleting your personal savings is also less of a risk than digging into your 401(k), retirement money, or other funds designated for your future.
Don’t overlook the importance of your personal savings in supporting your own living expenses, particularly if you plan to leave your previous employment. You should map a path to generating a salary from your new endeavor, and ensure you have the resources it takes to last that long either before committing to using your personal savings or before leaving your job.
Every entrepreneur is supported by a friends or family that want to help. Gifts are money that you receive, usually from this group of people, without any obligation to repay. (They could also be called “donations.”) Documenting each gift is important: you’ll need to document gifts in a letter to the IRS explaining that the money is a gift. Be sure that you and your generous giver keep a copy of the letter in case the IRS asks for proof.
Documenting each gift is also a healthy way to protect yourself and your business. Imagine that when your business becomes successful, some of your givers request a return or ownership of the company. It’s important to know that repaying fits can be seen as an interest-free loan by the IRS.
As a note, if a gift is given to you personally (rather than your company), there are limits on the amount you can receive before you incur income tax liabilities.
Find out more about using gifts for your business in the StartBlox app.
Most entrepreneurs already know that credit cards could be a beacon of opportunity, but also a huge risk for every cardholder (or in this case, your business!). If you decide that you are ready to manage the responsibility of having more money to spend than cash in your bank account, you’ll need to decide between a personal credit card and a card tailored to small business.
Using a personal credit card offers you more governmental protections, but leaves you with a lower spending limit. Without a high limit, your ultimate goal of having money to spend may not actually be met. A business credit card typically offers a higher limit alongside a few other benefits, including special offers and discounts and a cleaner accounting practice. (Separating business and personal expenses is important to manage the cashflows of your company, and it will help you during tax season.)
The problem with using a credit card to fund your business is their expensive interest rate. If you receive a bill you’re unable to pay, you’ll hurt your credit score and leave a lasting impact on your personal finances. On the other hand, if you expect to pay your credit card bill on time, you’ll only help yourself and your business with a healthier credit score.
Retirement Loans & Withdrawals
Using your retirement plan to fund your business is a risky choice that you should think carefully about – this money represents your future.
It’s possible to borrow or withdraw (distribute) money from your retirement plan to fund your business. However, not all retirement plans allow for this, you’ll usually need to pay a penalty if you’re choosing to withdraw the funds before a certain age. Borrowing and withdrawals are different; if you choose to borrow from your retirement plan, you’ll be required to pay the amount back to avoid tax implications. Withdrawal before the designated age in your plan, on the other hand, faces a 10% penalty from the IRS and other income tax implications.
Using your retirement funds to build your business is discouraged. If you choose to do so, make sure you know what that will mean for your future.
Before you take the leap, remember that you’ll need to bootstrap responsibly. Your approach to bootstrapping should be no different than your approach to business, be aware of what’s happening. Your success and your ability to mitigate the risks to your personal finances is dependent on your care and attention to your expenses, your revenues, and your resources.
With every business, it’s advisable to aim for a minimum viable product first, and later develop your company into the vision that you have for the future. This is even more important when dealing directly with your personal funds. When making your next investment, be sure to ask yourself: is this crucial to the next phase of my business’s success, or can it wait?