Bootstrapping: The financing option startups shouldn’t ignore
Bootstrapping, the term used to describe self-funding a startup with little or no resources, is not a new concept. It gained popularity among startups who were unable to secure funding from formal lenders.
Well-known ways of bootstrapping a business include using personal income and savings, sweat equity, as well as having a fast inventory turnaround, and a cash-only approach to selling as well as keeping their operating costs low.
Most people are familiar with the above forms of bootstrapping, but what they are less familiar with is the concept of trade credit.
How it works
According to Richard Angus, CEO of an outsource financial firm The Finance Team, a simple way to understand trade credit is to think of it as a loan provided by a supplier to its customer.
In the case of startups, trade credit is one way of generating cash flow. Instead of taking out a loan from a financial institution to buy the inventory, the business sells inventory they obtained on credit.
Trade credit works on the premise that the business will be able to sell the goods before the payment is due.
“You’re using internal capabilities to run your business without using external help,” explains Angus.
Typically, vendors extend credit of 30, 60 and 90 days to their established customers, without charging interest.
New customers, which startups often are, however have to pay on delivery until they establish a trust relationship with the vendor. Because they don’t have a transaction history, business owners will therefore have to negotiate with the vendor to extend them trade credit for 30 – 90 day terms, without charging interest.
Pros versus cons
One advantage of trade credit is that there is no interest charged, which would be the case with a loan. But the biggest benefit for startups is that trade credit allows them to generate cash flow without using any of the companies cash.
The biggest obstacle for entrepreneurs, says Angus, is the constraints to the business’ growth. With this arrangement, a business can’t grow faster than their credit allows. Whereas if you have your business funded by external sources, there’s no limit to how much you can grow.
A business also faces a much shorter repayment period (between 30, 60 and 90 days, depending on the terms of agreement). This is compared to banks who usually are willing to give you years to settle your credit.
Angus says businesses should carefully examine if trade credit would work for their business before taking the leap.
“My advice to entrepreneurs is to plan a growth strategy carefully, and not to exceed it. Don’t grow faster than you can afford”.