How To BootStrap Your Business With Funding From Your Shareholders

How To BootStrap Your Business With Funding From Your Shareholders

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In the early stages of a business there is often little or no revenue – so where does cash come from to keep the lights on? In our previous article, we discussed raising funds by bringing on new shareholders.

Now we are discussing the opposite scenario – where you support the business with your personal funds rather than bringing on new shareholders. Ultimately, this is what start ups mean by bootstrapping: You, as the shareholder, get your business through a tough patch or an early stage growth phase with your own funds.

Three reasons to consider bootstrapping

Bootstrapping is a very powerful way to grow one’s business for a number of reasons. The first reason is that by having fewer shareholders, you will have fewer partners to share the profits or future value with.

But there are other more complex reasons to bootstrap. You keep control over your business, taking strategic decisions independently without consulting a large board of directors or shareholders.

Often, in the early stages of a business, this kind of nimbleness is essential for maximising the impact of the founder’s creative ideas. You can rapidly deploy ideas, learn from them, improve them and deploy again – ultimately, that is the beauty of a lean start up as opposed to an established company.

Related: Arbor Capital Tell You Which Funding Is Smart – And Which Is Not

Understand the risks

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So why doesn’t everyone do it? Well, aside from the obvious point that not everyone has the cash to invest, there is another more subtle point: Risk.

With a limited liability company, you only lose what you put in (see our previous article describing this here). So, if you have personal savings, a bond, etc. you won’t put those on the line unless you decisively invest those funds into the company.

Raising funds from other people spreads the risk around – if you put all your cash into the company, you take all the risk.

So, what to do if you fund the company with a shareholder loan? The critical thing is to record it! If you don’t’ record it, your accountant can’t track it, and there is a good chance that the cash will remain untraced and never repaid.

A simple one page document recording how much was loaned, and a simple liability entry into your financial statements, can mean the difference between getting that money back (with interest) or not.

Treat the funds as loan capital

Then, what about the terms on which the cash is loaned? Many founders regard this as an equity investment, in terms of which the money is “invested” into the business, hopefully repaid, but not with interest. That is wrong.

No matter the scenario, you need to ensure that the funds are treated as loan capital, with a clear understanding that a market-related interest rate applies to it.

Related: Funding And Resources For Young SA Entrepreneurs

Why? Well, aside from complex tax implications otherwise, the question is actually whether or not you are a prudent investor? The reality is that these are your funds and prudent commercial practice means that you should weigh up your options.

For example: do you pay back your debt (saving you interest payments), do you invest it in your pension (earning you returns), or do you invest it in your business. Surely if you invest it in your business, you would only do that the investment has a comparable return – otherwise it is nonsensical.

An interest free loan earns you nothing, in fact, it simply depreciates your investment by the amount of inflation on a daily basis.

Having said that, although interest will accrue on a shareholder loan, it will typically not be repayable until the company actually has the funds to pay. This also applies to the principal amount (i.e. the upfront cash amount loaned to the company).

For that reason, although shareholder loans are regarded as debt, they are treated as “junior” debt – i.e. they are repaid last, only repaid after normal (arms length) creditors have received back their cash.

Related: The Tenacious Matsi Modise Has Her Game Face On When It Comes To Funding

This is where your shareholders agreement is so useful (once again!) – one of the things which a shareholders agreement does is to lay out the general terms on which shareholders give loans, including interest rates and repayment terms.

Then, as and when loans are made in the future, you don’t need additional or lengthy loan agreements, you just need to confirm receipt, and record the loans in your financials.

Good luck bootstrapping!

Adrian Dommisse
Having established Dommisse Attorneys in 2008, Adrian’s firm offers corporate finance and commercial law, with a strong focus on providing start-ups with the legal support they need. As the founder, Adrian thrives on guiding clients in the start-up space, by understanding their products and helping them take their businesses to the next level. With over a decade of experience in law, he is eager to use innovative ways to help his client’s gain value.