Bootstrapping Preparedness

Many funding options are available for an entrepreneur, but which you choose depends on your lifestyle, your aspirations, your experience, and your desire for control, among other things. We chose Bootstrapping for many reasons. We like to have complete control over our business, and we had been both already been working as engineers for over a dozen years, so we had savings and had established ourselves. Our goals are modest—we merely want to create an income to support our family, be able to spend more time with them, and enjoy the flexibility of working for yourself. Bootstrapping may not for everyone, but if you're considering it as an option, this post will cover some ways to prepare and some pitfalls to avoid.

We started Creative Algorithms in 2003, but before we went full time, we set up a few plans for financing ourselves in interim. Cash flow is critical when your income is variable, so even if your income is sufficient, you may need another source to cover the low sales months and still pay your bills. In addition, the time it takes to be successful can vary greatly, so if you want to ensure the longest amount of time to get things working, you need to have as much cash as possible at your disposal.

A Plan

Before quitting your full-time job, you should understand your monthly income and cash flow. Cash flow is timing of when cash comes in (income) and when cash to go out (bills and expenses). If you are only paid monthly, on the fifth of the month, but your mortgage is due on the first, you will need to ensure you have money in the bank to pay the mortgage from last month's royalty check. In addition, not all bills are due monthly, such as as insurance and property taxes. Money must either be set aside to pay these as they come due, or you must have an alternative where you can draw temporary funds. Intimately knowing your expenses can help you trim them down to stretch out your cash reserves as long as possible.

Cash

Before you quit your day job, it's important to have enough cash in the bank to handle monthly fluctuations of your cashflow variances. If you have not established any business income yet, you will also want to have a cash reserve established to use until your first royalty check comes in. Don't forget that you will be paid for sales usually two months after they actually occur. Estimate the time it will take to release your app, add in a few months to cover the delay in payment. If you do not prepare for this in advance, you will set yourself up for certain failure. If you can, place your cash into a short term, liquid investment, such as a money market, so you do get some interest on your cash. If you can tolerate more risk, buying stock is also possible, but it depends on when you will need the money. You do not want to be stuck selling your stock just after a big dip, for example, just to pay your tax bill.

Credit alternatives

Some bootstrap “financing” you will need to set up when you are still employed full-time. One of the best places to find credit that is your own money is in the equity of your house. Set up a Home Equity Line of Credit (HELOC) before you quit, because if you wait until after you quit, most likely you will not qualify for the credit line. A line of credit is better than a Home Equity Loan because you only use the money as you need it and only pay interest on the money you use. We are living in our second house and so had a nice amount of equity in our house to use for a line of credit.

Credit cards are another alternative, but not recommended unless you are very desperate, as the lending rates are much higher than a HELOC, and the minimum payments can be much higher. You do want to avoid getting yourself into a large amount of debt because if your business does fail, you will still have to dig out of that debt. At least with a HELOC, if you move, you will erase that debt immediately as it is paid from the proceeds of the house. Before you quit your day job, it is a good idea to have a couple of credit cards established. Do not go crazy, however, as too much open credit can damage your credit rating. Pay off any balances you already have on cards so your monthly expenses are lower while you are establishing your business. Carrying a balance at the beginning of your venture is also a way to potentially set yourself up for failure. Credit cards are also useful for cashflow management. You can charge expenses as they come up and pay off the card monthly.

Pay off loans

If you have car payments, credit card balances (as mentioned above), student loans, etc. it is best to pay these off before relying on your business income. You can use your HELOC to pay off some of these, as the interest is usually lower, but don't use up too much of your line of credit. Paying off these loans buys you time because the cash you have saved will last longer if you do not have these expenses in your monthly plan. The HELOC has a lower and more flexible monthly payment, so you can manage how much you pay each month.

Protect yourself from liability

The best way for a micro independent software vendor (micro-ISP) to protect yourself from personal liability is to incorporate your business as a Limited Liability Company, or LLC. It's the simplest way of “incorporation”. You choose to pass-thru your annual income as a partnership or sole proprietor for tax purposes, but your liability is limited to the assets of your company. It is inexpensive and quick to establish a LLC and you can do so via many online resources. We did ours through BizFilings, back in 2003.

Some other things to consider

Once you establish yourself as a LLC, you'll want to apply for a Tax ID number (a company social security number, in the USA), or other tax identification, depending on what country you live in. An ID will help you established a business bank account outside your personal account (also important for liability issues). We also have a personal umbrella insurance policy, which is very inexpensive (about $150/year) and another layer of liability protection, should we need it.

Health insurance

The best way to bankrupt yourself is to not have health insurance, and then have someone in the family have an accident, or discover an unknown illness, at any age. Doctors and hospital bills can quickly overwhelm any savings or credit you may have established. You cannot plan for them. Healthcare is a necessary evil, and one of the most important protections you can establish. In the past year, for example, one of our kids broke her collarbone, and my husband wiped out on his bike and fractured his jaw. One trip to the ER or Urgent Care is costly enough with copays, let alone the out-of-pocket if you do not have insurance.

If you have full-time employment with healthcare, you can elect for COBRA coverage after you quit. This coverage lasts for 18 months minimum. Some states have extended coverage and many companies offer “conversion” policies for individual policies. The advantage of COBRA is that pre-existing conditions are not denied. Conversion policies can also beneficial because, although they are "individual" policies, they sometimes cover pre-existing conditions because you have had coverage without any lapse. It's important to prevent ANY lapse of coverage because, until the new healthcare laws take effect, you will often be denied coverage for simple, sometimes illogical, conditions such as acne, or pregnancy, if you have to get an individual policy. If you can establish a “Group” policy for your company (usually need 2 or more employees, one of which can sometimes be a spouse), the rules are different, and covered under the HIPAA laws, whcih are more flexible. However, continuous coverage is still crucial for getting a policy, no matter on what you decide.

Summary

To sum up, when preparing to bootstrap, understand your expenses, get your finances in order, set up lines of credit while you qualify for them, maintain your health insurance coverage without any lapse, and protect yourself with a LLC and umbrella insurance. By no means is this an exhaustive list, but one that will point you in the right direction for success as an indie developer.