Dave Elkington self-funded his billion-dollar sales technology company, InsideSales.com, for eight years — even cleaning medical offices overnight to make the company's payroll — until it finally received a round of venture capital in 2012.
What Elkington wouldn't do was accept loans or outside money. He wanted to make decisions independently, without "worrying about debt collectors or outside influences." He was also in a stronger position to negotiate favorable terms with investors when the right time came, because the company had proved its ability to control costs.
InsideSales.com, founded in 2004, has raised $264 million in venture capital since its first investment round in 2011 and is currently valued at $1.65 billion, according to PitchBook.
While building Pluralsight, an online learning company that has been valued at more than $1 billion, Aaron Skonnard and his co-founders also avoided outside financing in order to maintain control of the overall business direction. Skonnard says staying in the black on a shoestring budget ultimately helped to make Pluralsight, also founded in 2004, more attractive to venture capitalists that have invested more than $200 million in the company since 2013, according to PitchBook.
The decision to self-fund — bootstrap a business, as it's known — or take money from lenders isn't an easy one and depends on many factors. Before taking a loan or credit to start a business venture, entrepreneurs should review the following.
Debt can be a good way to leverage growth, especially for those not wanting to give up an equity position, but it's really a tool for businesses already making money.
"We look at the company's ability to pay us back through cash flows as our primary underwriting tool," said Jay DesMarteau, who heads up the small-business banking division at TD Bank. "As a start-up, you don't have those things, which can make it more difficult to get a loan," he said. "Debt is not constructed to start a business. It keeps an existing business going."
Businesses that need capital but are unproven are a better fit for equity funding. Customers and revenue should come before debt financing.
A personal guarantee means the entrepreneur agrees to pay the loan or credit back with their own money or assets if the business folds. That's a risky proposition for the owner of a firm that isn't yet established.
"The benefit of bootstrapping and funding growth from cash flow is that an entrepreneur doesn't have to give up equity or personally guarantee a bank loan," said Skot Carruth, who co-founded his digital innovation consulting business, Philosophie, while still employed in a full-time job. It has since worked with firms such as Nintendo, PWC and Royal Caribbean.
Andrew Filev bootstrapped his workflow technology, Wrike, for five years using personal funds. It was founded in 2007. Several years and two rounds of investment later (its first VC came in 2012), the company now has 3,000 customers and has raised $26 million in venture capital at a valuation of $125 million, according to PitchBook.
"Loans can be good tools for businesses with assets," Filev said. "In our case, the business had very little physical property." This would have made it difficult to get a bank loan anyway, but Filev also wanted to first establish a track record that wasn't reliant on outside financing.
"Are you willing to mortgage your house for a business that isn't proven?" Filev said. If not, don't guarantee it to a bank, either.
The biggest downside of self-funding a company is that it can be slower to grow and acquire market share.
"You can only grow as fast as you can sell," Elkington said. "But instead of going to investors for funding, you have to go to your customers for funding."
InsideSales' growth — it was founded in 2004 and took its first VC in 2011 — was partly fueled by selling custom products existing clients requested, but that could also be sold to others, Elkington said. The cost of research and development was then paid by customers rather than investors.
"The upside is, you have a very customer-adapted product. The downside is that if you are not careful, it can take you down paths you don't necessarily want," Elkington said.
Having predictable cash flow also helped InsideSales scale with annual and monthly subscriptions.
"Think about it like inventory," Elkington said.
Violette de Ayala, founder and CEO of FemCity, an online women's professional network, took out her first small-business loan last year after launching in 2011. Her company grew 250 percent by year's end by using the money to fund marketing efforts. The turning point for outside funding came when the company was growing steadily and positively, but it needed a boost to break through to the next level.
"We now have about 80 locations, an app, a podcast and have had the opportunity to expand our revenue streams, all due to the loan," De Ayala said.
She'd tried to take out loans before, but because the company was new, it was difficult.
When the company was new, it didn't have collateral to attract a lender. By last year "it had to happen … and I had already invested so much of my own money. It was easy, but we were also ready," De Ayala said.
Being tied to loan terms means you may not have the freedom to make critical adjustments or changes to the company as necessary, or may not be able to afford them.
"When you need it, it is tempting to take money from any source, but it can have a big impact down the line," Philosophie's Carruth said.
Instead, entrepreneurs who need bridge funding or temporary cash may find a revenue-based credit line a good compromise while trying to bootstrap. Elkington took a $150,000 Small Business Administration line of credit early on, which he said helped InsideSales.com sail through "revenue peaks and troughs." Before that, Elkington used personal credit cards and an equity investment from his in-laws to kick-start his company.
If taking a loan or credit is something you may need now or down the line, start a relationship with a banker as early as possible, DesMarteau said.
"I would start talking to a bank the day you want to open a deposit account, but to be creditworthy could take [a while]," DesMarteau said. "If the business model takes off within two years, we might still lend to them."
It took years for Elkington to build a relationship with a Silicon Valley bank, which eventually offered InsideSales a commercial line of credit, he said.
It never hurts to ask a banker to help you decide when you're loan worthy.
"It's free advice," DesMarteau said.
— By Kayleigh Kulp, special to CNBC.com