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Raising Money In Tough Times: An Entrepreneur's Guide to Bootstrapping

Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP

As many entrepreneurs and leaders of emerging growth companies know, the capital markets have been weak for nearly three years, making it very difficult to raise the resources needed for continued growth. Although there have been a few hints of recovery and the Federal Reserve has adjusted rates to 40-year lows, the economy remains weak, the fight against terrorism rages on, the threat of war with Iraq looms, and consumer confidence has hit a 10-year bottom.

The few companies that have been fortunate enough to raise money during these tough times have demonstrated all the following characteristics, and even they haven't all been able to close new rounds. Nonetheless, the traits include the following:

  • Strong team
  • Concise game plan
  • Clearly defined market
  • Achievable milestones
  • Intellectual property for protection and leverage
  • Engaged and experienced advisory board
  • Customers willing and capable of payment
  • Durable and reliable revenue streams
  • Timing, luck, great smile, passion

For everyone else, there's bootstrapping. Entrepreneurs who haven't been able to meet the above standards (and even some who have) have been forced to survive via this tried and true technique.

Bootstrapping: The Art

Bootstrapping is the art of learning to do more with less. It's not about writing 200-page business plans, power lunching with venture capitalists or triple-mortgaging your home to pay legal and accounting fees. A company that is started and built around a culture of bootstrap management understands that all resources are scarce and that cash must be cherished. "Cash is king" becomes the mantra.

Entrepreneurs across America have repeatedly started successful businesses on a wing and a prayer and one special ingredient: an understanding of the art of bootstrapping. Imagine building one of the most recognized brands in the winemaking industry with a few hundred dollars. That's exactly how Ernest and Julio Gallo started in 1933 in a rented warehouse in Modesto, California. They were turned down for a loan by several banks, so they convinced local farmers to provide them with grapes and defer payment until the wine was actually sold. They also convinced manufacturers to sell them crushing and fermenting equipment on 90-day terms. Instead of hiring expensive consultants, they learned to make wine by studying resources in the local library. Today, the company started by these two bootstrappers enjoys annual worldwide sales of more than $600 million.

The Gallos aren't alone. Household names such as Domino's Pizza, Hallmark Cards, Black & Decker, Ross Perot's EDS and many of todays most successful businesses were started by bootstrapping entrepreneurs with fewer than $1,000! These companies all learned how to get going a shoestring budget and still survive - by being creative, aggressive and careful about monitoring cash flow. Thousands of companies each year start with just hundreds of dollars and manage to survive. Conversely, many die because they try to grow too big, too fast, or, worse, raise significant capital and then squander it.

Let's assume your company is like most early-stage businesses and could really use an immediate cash infusion for growth and expansion (and in some cases, for survival). Instead of focusing on how and where this money can be raised, the bootstrapper will ask, "What were we actually going to do with the money, and are there other ways to obtain these resources?"

Bootstrapping: The Science

With that question in mind, let's turn to bootstrapping as a science and consider proven bootstrapping techniques and strategies. Among them are the following:

  • Focus on Cash Flow
    The experienced bootstrapper knows that there is always a way to find the necessary resources and that the only real limits are an entrepreneur's resourcefulness, creativity and tenacity. The bootstrapper also keeps his or her staff focused on activities that produce income or expand market share and tries to limit all expenditures to these areas as well. The bootstrapper leads by example, not only by living a Spartan personal lifestyle, but also by continually asking the staff whether a given project is helping to create cash flow and whether a specific expense can be postponed. A positive cash flow - an indicator of entrepreneurial happiness (indeed, "Happiness is a Positive Cash Flow" is the entrepreneurial credo) -- is only possible if everyone is dedicated to getting beneficial terms from suppliers and receiving timely payments from customers, within reasonable moral and financial boundaries. The bootstrapper understands that raising capital is secondary to producing profitable and durable income streams - that raising money is not a substitute for making money and that managing expenses doesn't mean trimming the expense account to $3,000 from $5,000 a month! The smart bootstrapper knows that too much capital can actually destroy an otherwise viable company - that when the belly is too full there is no room left for the fire! A fancy office, excessive staff, big houses, fancy cars, hefty expense accounts and name investors don't create an atmosphere of prudence and conservation. Remember that a dollar in revenue may only produce 20 cents in profit but a dollar in cost savings goes 100 percent to the bottom line.
  • Be Frugal But Not Cheap
    There's a big difference between frugal and cheap. The bootstrapper must distinguish between costs that can be avoided, like lavish office space, and those that are necessary to build a foundation for growth, such as the proper computer systems. Being cheap with your employees and vendors is shortsighted and will have long-term negative implications. Being frugal means being creative as to how and when employees will be motivated and rewarded. For example, a bowling party and home barbeque can be more fun and far less expensive than a staff retreat to a fancy resort. And the same goes for entertaining customers and clients. Lavish meals will be forgotten long before the memories of a Sunday afternoon at a baseball game with a client's family.
  • Leverage Your Assets
    The bootstrapper understands the importance of growth strategies like franchising, licensing, joint ventures and other strategic and interdependent relationships that tend to facilitate business growth yet conserve cash. In many ways, franchising and licensing are the ultimate bootstrapping strategies because they allow you to leverage intangible assets and conserve scarce resources. You get to spend the money on what you were otherwise going to buy, and you still share in the financial rewards. For example, assume that you have spent most of your available cash and time developing a certain technology but lack the capital for advertising and promotion. Rather than trying to raise the capital, you might find a willing licensee that would gain access to the use and further development of the technology in exchange for an initial license fee and ongoing royalty payments. You could use these up-front license payments for other cash flow needs. An Internet client of mine recently launched his business and received exposure to millions of potential customers by structuring a series of strategic marketing alliances with affinity groups whose members were his exact target customers - at a fraction of the cost of traditional advertising to send a message to that many potential customers in such a short period of time.
  • Trade Equity for Services
    The effective bootstrapper also understands the concept of "equity for services." Subject to the securities laws, a company can conserve cash by "paying" with its stock for services rendered by lawyers, accountants, architects, designers, advertising agencies, consultants, investment bankers and other suppliers. When service providers are part owners, they may have a greater sense of loyalty and higher level of commitment to the project. You may want to create multiple classes of stock or build in certain redemption features to allow for the eventual repurchase of shares by the company at a re-determined price or formula. It's also possible to use options or warrants that are exercisable only in specific circumstances, such as an initial public offering or sale of the company. If you offer shares to your lawyers or accountants, however, be aware of potential conflicts of interest and respect their views if they feel that, for ethical reasons, payment in the form of company stock is not appropriate.
  • Be a Junkyard Dog
    The bootstrapper understands the meaning of the phrase "one man's junk is another man's treasure." More than one entrepreneur has built a business by searching through junkyards, trash containers and rummage sales (or online via eBay and other auction sites) to find the equipment and supplies they need to start and grow the company. If sifting through trash on a Saturday night isn't your cup of tea, then at the very least be on the lookout for another's underutilized resources. For example, let's say you need access to specialized computer equipment or a licensed commercial kitchen for research and development. Instead of building your own from scratch at a significant initial cost, approach others who may allow you to use these resources during off-peak hours (even if it's the middle of the night) for low or no rental rates or in exchange for equity.
  • Make The Best Of What You've Got
    A true bootstrapper knows how to make the most of existing resources. Many have referred to it as the art of "stretching a dollar," but there's more to it now. For example, one early-stage client of mine lacked the capital at the end of one year to pay bonuses. Fearful of losing key employees and de-motivating a hardworking staff, he "negotiated" six weekends to be set aside at his parent's cabin in the mountains and then bartered some computer services with a local upscale restaurant. Instead of being empty-handed at holiday time, he was able to deliver a series of getaway weekends and complimentary dinners to his loyal team, and everyone agreed to hang on until next year - when cash bonuses would be paid.
  • Be Prepared to Sacrifice
    Bootstrappers understand that they must be creative and aggressive in their cash-management techniques and in their quest for necessary resources. Yet sometimes the solutions are right in your own backyard, hidden within your existing working relationships with customers, suppliers, advisors and consultants, local government agencies, universities and business networking groups. You must be prepared to demonstrate that you have assumed risk and made personal sacrifices. We live in a country that lauds entrepreneurs and loves underdogs. Everyone wants to help people who are trying to help themselves. Your request of a customer to pay early, or of an important vendor to pay late, will get a more favorable response when you pull up to their offices in a $12,000 car and a $150 suit rather than a $40,000 car and a $500 suit. Building a business in tough times hasn't ever been easy, but savvy bootstrappers have understood that the art and science of bootstrapping is what enables the job to get done. They're constantly looking for new ways to do more with less, without shortchanging the quality for which they're striving. In that spirit, what follows is a list of 10 additional bootstrapping tactics that could help you build your company.

TEN MORE TRIED AND TESTED BOOTSTRAPPING TECHNIQUES

  • Wear multiple hats in managing your business to save personnel costs.
  • Buy or lease used furniture and equipment, and don't overpay for unnecessary service warranties.
  • Share office space with (or sublease from) a large company that will offer you access to conference rooms, office equipment, reception or typing services.
  • Apply for several credit cards at once, and use the available portions as your operating line of credit.
  • Hire student interns who are willing to forego a salary in exchange for work experience. Better yet, hire a retired executive or family member who may be willing to help out just to stay busy or serve as a mentor. A wonderful resource for this is the Small Business Administration's SCORE (Service Core of Retired Executives) program.
  • Work hard to maintain excellent customer relationships to encourage and require early payment.
  • Commit only to short-term leases and other obligations to maintain maximum flexibility and cost controls.
  • Ask major clients to purchase the key equipment that you'll need to service their account and then lease it back from them.
  • Offer shares in your company to vendors, landlords and key employees in lieu of cash, subject to federal and state securities law and acceptable dilution ratios. (Sam Walton used this tactic when starting Wal*Mart -- and his former secretaries and office workers are now multi-millionaires!)
  • Join a commercial barter exchange, and use it to acquire key products and services. In some cities, even alternative currencies have emerged as a type of barter exchange and bootstrapping technique. These local currencies have stimulated economic development in small towns and rural areas that haven't yet been affected by the regional gluts of venture capital or where commercial lending dollars aren't flowing freely. Many local currency programs have been sponsored or financed by the E.F. Schumacher Society, whose local success stories include Ithaca Hours (Ithaca, New York), the Sand Dollars (Bolinas, California), Barter Bucks (Indianapolis, Indiana), Great Lakes Hours (Detroit, Michigan), and Gainesville Hours (Gainesville, Florida.)

* * * * * * * ABOUT THE AUTHOR

ANDREW J. SHERMAN is a Capital Partner in the Washington, D.C. office of McDermott, Will & Emery, an international law firm with nearly one thousand (1,000) attorneys worldwide. Mr. Sherman is a recognized international authority on the legal and strategic issues affecting small and growing companies and serves as one of the practice group leaders of the Emerging Business and Technology Practice Group in the firm's Washington, D.C. office. Mr. Sherman is an Adjunct Professor in the Masters of Business Administration (MBA) program at the University of Maryland and Georgetown University where he teaches courses on business growth, capital formation and entrepreneurship. Mr. Sherman has been General Counsel to YEO since 1987. Mr. Sherman is the author of eleven (11) books on the legal and strategic aspects of business growth and capital formation. His most recently published books include The Complete Guide to Running and Growing A Business, published by Random House in November of 1997 and Mergers and Acquisitions: A Strategic and Financial Guide for Buyers and Sellers published by AMACOM in March of 1998 and Parting Company published by Kiplinger's in May of 1999, as well as Raising Capital published by Kiplinger's in Spring of 2000. His newest book, Fast Track Business Growth, was published by Kiplinger's in January of 2002. Mr. Sherman can be reached at (202) 756-8610 or e-mail ajsherman@mwe.com.

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