Low Cost Start Up Business: Bootstrapping

Bootstrapping is one method to keep the cost of a start up business low. In common business lingo, bootstrapping means using your personal funds in order to finance the business. You may start the company with your own savings; as the business grows, you will spend only the company's profits to continue expanding operations. This is in stark contrast to methods of financing that involve investors or loans. Bootstrapping has several advantages over these methods.

Bankruptcy & Credit Protection

Even a struggling business will have a very high interest coverage ratio without debts. Interest coverage is a measure of how easily a business could, if need be, pay the remaining interest on all owed monies. It is determined by a mathematical computation where earnings before income and taxes (EBIT) is divided by debt interest. When you are not taking any loans, you are never at risk of default on your debts. Your interest coverage will always show you are in good financial condition. If your business ever suffers from a loss of earnings, you can pack up and walk away without declaring bankruptcy or otherwise facing debtors.

Retention of Ownership

Seeking investors is a great alternative to taking on a large amount of debt. However, for each investor you add, you will give away a piece of equity in your business. Even though there are various levels of investor involvement, most investors do not provide funding without wanting a degree of say over how the business will operate. To some entrepreneurs, this is a destruction of the initial desire to own a business and run it their own way. If you would prefer to be the sole captain of your own enterprise, bootstrapping is preferable to giving away ownership in exchange for financing.

Tax Advantages

If you purchase every expense with a piece of your business income, you will see a very low taxable income at the end of each year. This is particularly true if you are personally taking a small salary while the business is in its start up phase. Many business owners who adopt a bootstrapping model have nearly zero taxable income. Every penny of earnings is poured back into the business as an operating expense. Since all expenses, even capital expenses, are deductible in the first year, you will see low tax liability in year one of operation.

Lean Operating Model

Ultimately, bootstrapping leads to discipline. Consider a comparable model where a frugal person lives without taking on any debt. This individual does not have a credit card; he/she will only buy a car once he/she has saved personal money to do so. This individual would not spend lavishly and would only purchase items which he/she had budgeted for and could afford. As a business, this same discipline is required in order to successfully use a bootstrapping model. Many business owners find they will continue to have a lean operating model even after they have abandoned the bootstrapping technique and begun using loans to finance expansion. The mentality is in place, and the business is capable of operating at a low expense for years to come.

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