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Bootstrap or Business Loan: How to Decide
Being able to self-fund or bootstrap your business is an amazing feat, but not every expense is worth risking your personal assets and safety net. That is where a small business loan comes in. But small business loans for younger businesses normally require collateral, personal guarantees, or high interest rates as newer companies tend to be higher risks for lenders.
The good news is that it is generally easy to know when you should bootstrap and when taking a small business loan is the better choice.
Below, you’ll find examples of when both could be good options, like restocking inventory for a busy season, fixing a machine that breaks unexpectedly when an order is due, or taking advantage of a growth opportunity. You’ll also find the pros and cons with each option to help you feel confident that you are making the right decision based on your situation.
The Benefits of Bootstrapping Compared to Business Loans
Being able to bootstrap your business has a few advantages over a small business loan including:
- There are zero interest payments, decreasing the debt owed.
- You can access the money immediately without approval.
- There is no need to put assets up as collateral.
- Your business credit score does not drop.
- It is easier to keep spending under control and operations running lean.
- Sustainability becomes equally as important as growth.
One of the reasons business owners prefer to bootstrap over taking a business loan is there is no debt that needs to be paid back and no interest fees that reduce cash flow. Because no hard inquiry happens when you pay out of your cash flow, there is no impact on your business credit score. Small business loans from alternative lenders can approve financing, sometimes on the same day, but when you bootstrap, you have the funds available immediately.
When you take a business loan, chances are it will need to be secured. That means you have to put assets up as collateral. If you take an equipment financing loan, you’ll likely need to put the new equipment on a UCC lien as a protection for the lender. When you self-finance, you don’t have to, because it is your money.
When you use your own money, chances are you’re going to pay more attention to how it is spent, including on growth strategies, maintenance, and operations. If the growth won’t lead to sustainability, you may say no to certain projects as you want consistent revenue. The same goes with finding places in your operations where money is being wasted. Nevertheless, that doesn’t mean a business loan doesn’t have benefits over bootstrapping.
When Business Loans Are Better Than Bootstrapping
Business loans have advantages over bootstrapping, including:
- Keeping a business’s cash flow intact.
- Low financial risk to the company.
- More funds are available to invest in your business.
- Access to resources from the lender including advisors and strategists.
- More growth opportunities.
- Easier to upgrade systems and machinery, as well as hire staff.
When you take a business loan, you do not deplete your cash flow like you do when you bootstrap your business. This means you have money to invest in new personnel or take advantage of a new opportunity, and you’ll still have money in the bank in case there is an emergency.
If there is more money at your disposal, chances are you’ll be more open to growth opportunities, as there will be less risk if they fail. The same goes with marketing and advertising. If you bootstrap and the first few tests do not work out, you may cut the channel. With a business loan, there is more incentive to try a few more times and find a way to make it work. This is why business loans help companies grow faster than bootstrapping.
When it comes to accounting and tax time, if your business is being funded from your personal account, it is harder to sort personal vs. business expenses. By having a business loan, it is easier for your accountant or bookkeeper to separate the two, making for a more seamless tax season. Plus, most lenders will require a business bank account to provide you with a business loan, so there’s extra incentive to separate your finances if you’ve been putting it off.
Situations to Choose Either Bootstrapping or Business Loans
Being familiar with the advantages and disadvantages of business loans and bootstrapping is only the first step. Here’s when to choose one over the other, and in some cases, when both could work.
Machinery Breaks or Vehicles Need Repairs
When machinery breaks down or vehicles need to be repaired, both business loans and bootstrapping can make sense. This is where the specific situation will determine the better option between the two.
- When you’re on a production deadline and output is needed fast, you can pay for the repairs or replacement by bootstrapping if you have the funds available. This way, you don’t miss the quota and lose a customer. Then, the customer will pay you back once you deliver the production, so your cash reserves will only be reduced temporarily.
- When the repair is affordable, but you plan on upgrading in the near future as a newer model is coming out, you can bootstrap the repair to keep operations running and take a small business loan for the new purchase. This way, your business credit score remains intact, making you more appealing to lend to when you are ready to upgrade.
- If there are a couple of days to spare and the expense is large, a business loan will be the better choice, as the approval time is normally just a few days, and you won’t have to deplete your cash reserves. This is especially important when you need cash reserves and your client may be delayed in paying you, or if there is a large gap of time between now and the next busy season.
Expansion and Growth Opportunities
In most situations, you’ll want to take a business loan instead of self-funding an expansion or growth opportunity. By using a business loan, you’ll have money in the bank that you can use to address day-to-day expenses as well as plan for the future.
Note: If you depleted your cash flow by self-funding an opportunity, you may look like a high-risk borrower and get declined if you later apply for financing. This leaves you in a worse place than taking the loan from the start and using cash reserves for any expenses.
Increased Production or Replenish Inventory
If you’re in a time crunch where business is on the line, bootstrapping is likely better than a business loan as you can take action immediately. This applies when:
- The money is coming right back, like replenishing inventory during a busy season as sales are actively happening.
- A new contract has been signed, and it is dependent on you increasing production in a short amount of time.
- Purchasing raw materials or expanding equipment capabilities is time-sensitive, and waiting for a loan could cost you the deal.
- Hiring and training staff to meet an influx of demand or for busy seasons, as the revenue will be coming in much faster than when hiring year-round employees.
Meanwhile, business loans make more sense than bootstrapping when:
- The profits and revenue will be coming in the future, as you don’t want to deplete your funds.
- An example would be buying farming equipment or fermentation tanks for a winery, as the profits are a few years away. The equipment does help you increase production, but the profit is long term.
- Replenishing stock after a busy season to make sure customer needs are met during the slow season.
- You’ll have cash flow to maintain your business until the next busy season and the business loan will allow you to pre-order next year’s products.
Bootstrapping and business loans are two options at your disposal when it comes to financing your business operations. It comes down to how fast you need the money, the risk level of what you’re spending on, and when the revenue generated from the spending will come back. If the money comes back quickly and the investment is low-risk, bootstrapping makes sense. If it is a long-term investment or high-risk, business loans are a better choice. If you need a quick cheat sheet to remember this, here’s a table you can print out for reference.
| Bootstrapping | Small Business Loans | |
| Access to funds | Immediate | 1 business day or longer |
| Additional costs | No | Yes, such as interest fees |
| Reduces cash flow | Yes | No |
| Allows for flexible usage | Yes | Yes |
| Financial risk | High | Low |
| Encourages growth | No, you may not have the money to cover growth opportunities, or you may take less risks because it is your money. | Yes, you have more funds available to invest. |
| Lowers business credit score | No | This can impact your score. |
