When companies plan and make goals for growth, the question of where to obtain capital to fund such growth needs to be addressed. Two common options are borrowing the required funds (a.k.a. going into debt) or reinvesting the profits of the business to grow much more slowly (a.k.a. bootstrapping or running on ‘survival mode’).
As your business expands, you need a source of funds that will meet your appetite for growth. Businesses just starting out are advised to run in survival mode as they test the viability of their business model, consumer demand, and get themselves established in the marketplace. But as a business proves itself and is successful, it may need external finance to allow growth at a greater rate than before. At what point should a business use external lenders to fund capital growth?
Many large and profitable businesses started off using very little resources and ‘sweat equity’ from the owner in their garage, using their own computer and their personal savings. It is hard work and encourages businesses to be creative and find ways to raise profits without external sources of finance. Such businesses will often see low revenue numbers at the beginning, and profit may not be sufficient to meet all costs.
When to take the plunge
When demand exceeds your production capacity, and you don’t have the resource to adequately fund growth, your limitations may cause your clients might seek alternative companies that can meet their requirements. This is where debt becomes a good decision. Investing in key machinery or having breathing space with working capital may make all the difference.
Benefits of bootstrapping
An advantage of bootstrapping is that your business may be worth more due to less money being borrowed. Also, when you do decide to raise money through external lenders you are a larger and more attractive client and will have better negotiating ability as to the terms.
Disadvantages of bootstrapping
Bootstrapping is a slow process and requires a significant amount of work on the part of the founder. Growth is capped at the amount of profits being funnelled back into the business.
Interest rates are currently at record lows, which makes loans much more attractive that they have been in the past. Be mindful that interest rates are not permanent and ensure your business can withstand changes. To manage debt closely and effectively, plan out exactly what the capital will be used for and when. It is important that debt is only used to provide working capital or capital expenditure and not to fund overheads.
Debt is generally the fastest way to provide business growth, and by accommodating the disciplines of hard work and budgeting associated with successful bootstrapping, sound resilience can be formed to control and steer your business through all stages of its cycle.