When you're thinking about how to raise money, one of the first things you should consider is bootstrap financing--using your own money to get your business off the ground. This is one of the most popular forms of internal funding because it relies on your ability to utilize all your company's resources to free additional capital to launch a venture, meet operational needs or expand your business.
Bootstrap financing is probably one of the best and most inexpensive routes an entrepreneur can explore when raising capital. It utilizes unused opportunities that can be found within your own company by simply managing your finances better. Bootstrap financing is a way to pull yourself up without the help of others. You are the one financing your growth by your current earnings and assets.
There are a number of advantages to using the various methods of bootstrap financing:
- Your business will be worth more because less money has been borrowed, and therefore, no equity positions had to be relinquished.
- You won't have to pay the high interest on borrowed money.
- Coming from a stronger position (with less debt on hand), you look more desirable to external lenders and investors when the time does come to raise money through these routes.
- You can be creative in finding ways to raise profits, without having to look to external sources. It will give you the added confidence of business savvy.
The first source of business money we'll discuss is trade credit. Normally, a supplier will extend you credit after you're a regular customer for 30, 60 or 90 days, without charging interest. For example, suppose that a supplier ships something to you, and that bill is due in 30 days but you have trade credit or terms. Your terms might be net 60 days from the receipt of goods, in which case you would have 30 extra days to pay for the items.
However, when you're first starting your business, suppliers aren't going to give you trade credit. They're going to want to make every order c.o.d (cash or check on delivery) or paid by credit card in advance until you've established that you can pay your bills on time. While this is a fairly normal practice, to raise money during the startup period you're going to have to try and negotiate trade credit with suppliers. One of the things that will help you in these negotiations is a properly prepared financial plan.
When you visit your supplier to set up your order during your startup period, ask to speak directly to the owner of the business if it's a small company. If it's a larger business, ask to speak to the chief financial officer or any other person who approves credit. Introduce yourself. Show the officer the financial plan that you have prepared. Tell the owner or financial officer about your business, and explain that you need to get your first orders on credit in order to launch your venture.
The owner or financial officer may give you half the order on credit, with the balance due upon delivery. Of course, the trick here is to get your goods shipped to you, and sell them before you have to pay for them yourself. You could borrow the money to pay for your inventory, but you would have to pay interest on that money. So trade credit is one of the most important ways to reduce the amount of working capital you need. This is especially true in retail operations.
Despite the urge to use trade credit on a continual and consistent basis, you should consider it as a source of capital to meet relatively small, short-term needs. Do not look at it as a long-term solution. By doing so, you may find your business heavily committed to those suppliers who accept extended credit terms. As a result, the business may no longer have ready access to other, more competitive suppliers who might offer lower prices, a superior product or more reliable deliveries.
The Cost of Trade Credit
Depending on the terms available from your suppliers, the cost of trade credit can be quite high. For example, assume you make a purchase from a supplier who decides to extend credit to you. The terms the supplier offers you are two-percent cash discount with 10 days and a net date of 30 days. Essentially, the suppliers is saying that if you pay within 10 days, the purchase price will be discounted by two percent. On the other hand, by forfeiting the two-percent discount, you are able to use your money for 20 more days. On an annualized basis, this is actually costing you 36 percent of the total cost of the items you are purchasing from this supplier! (360 ( 20 days = 18 times per year without discount; 18 ( 2 percent discount = 36 percent discount missed.)
Cash discounts aren't the only factor you have to consider in the equation. There are also late-payment or delinquency penalties should you extend payment beyond the agreed-upon terms. These can usually run between one to two percent on a monthly basis. If you miss your net payment date for an entire year, that can cost you as much as 12 to 24 percent in penalty interest.
Effective use of trade credit requires intelligent planning to avoid unnecessary costs through forfeiture of cash discounts or the incurring of delinquency penalties. But every business should take full advantage of trade that is available without additional cost in order to reduce its need for capital from other sources.