Bootstrapping is the term used to describe the process of starting a business with no outside funding. Many famous entrepreneurs bootstrapped their now well known businesses when they were first launched including Bill Gates (Microsoft), Michael Dell (Dell Computers), Pierre Omidyar (eBay), Paul Simon (YDE) and Richard Branson (Virgin) to name just a few. These entrepreneurs used a combination of different tactics to get their businesses off the ground without outside capital.
These tactics are summarised into seven broad strategies for bootstrapping a business. Your personal bootstrapping plan should use a combination of these tactics. Focusing on just one tactic will probably not be adequate; you will need to attack the challenges from a number of different angles using a combination of different tactics to leverage every opportunity for success.
Break the Golden Handcuffs
Many talented individuals who have a desire to start a business are scared of not meeting the car repayments on the BMW, not paying into the pension fund and not meeting the repayments on the holiday house. The reality is that launching a business takes sacrifice.
Unless you are willing to make a sacrifice, entrepreneurship is not for you. If you do want to launch a business in the future, set a deadline for when you wish to start and begin cutting back now. Learn to live on less and put money aside so that you have some of your own funds when you do break away.
The greatest believer in your business idea is you. If you are not willing to put a large chunk of your own money into the business and make the necessary financial sacrifices to get the business off the ground then no one else will be willing to back you.
Once you have put your own resources into the business, your most likely source of support is the people closest to you. They know you, trust you and want to see you succeed. Paul Simon, in launching the first YDE store in a back alley shop in the centre of Cape Town, borrowed R10 000 from his mother’s retirement policy to get the concept off the ground. He never borrowed money again nor did he take on any outside investors until he sold the store 10 years later to Truworths for an undisclosed sum in excess of R200 million.
True entrepreneurs become jacks-of-all-trades in the start-up phase of their businesses. I have known accountants who became designers, engineers copywriters, marketers accountants and programmers salespeople. There is no such thing as sticking to your specialty and only doing what you are trained for if you are launching your own venture.
The more you do, the less you need to pay someone else to do so teach yourself to engage with new activities and tasks so that you can get your business off the ground. When you are making millions, then you can hire an accountant, outsource the design, engage a PR firm and get a freelance copywriter in but until then you and your management team will need to train yourselves to fill many of these roles.
Related: DIY Funding
Work in Parallel
Selling your time or delivering a service usually costs very little and translates into quick cash. Therefore, it is sensible in the early stages of a business to do some sort of consulting work while you are building the business and its products.
Selling time means that you can have income in month one and you can use that income to acquire what is required to get the rest of the business off the ground. Nkhensani Manganyi dreamed of launching her own retail outlet in which she could sell clothing under a brand she had created and developed. However, to dive straight into developing a shop in A-grade retail malls would have required huge amounts of capital that she did not have so she started designing, manufacturing and selling clothing through direct channels.
This cost very little and generated cash flow while also forming the foundation for the Stoned Cherrie brand. After a period of designing and selling clothing, Nkhensani had some capital and a good reputation. She used her reputation to raise further capital to open her first retail store at The Zone in Rosebank.
Guy Kawasaki, in his book The Art of the Start, uses the following example to illustrate this concept:
- Some programmers get together to provide services to a niche market. They operate as consultants, getting down and dirty with the client. Billing is on an hourly basis and payable within 30 days.
- In the course of providing this service, they develop a software tool for the client. As they add clients, they continue to enhance the tool. Soon they realise that there are many customers who can use this tool.
- They use the consulting fees from clients to fund further development of the tool. At this point, the consulting practice has grown and provides a steady base of profits.
- They complete development of the tool and try to sell it independent of consulting services. Sales take off. The company stops doing consulting because “there is no leverage in consulting.”
- The company goes public or Microsoft acquires it. The founders buy Porsches, yachts and live happily ever after.
Keep the End in Mind
Consulting is a good way generate cash flow in the start-up phase of a business. The risk is that the entrepreneurs become too dependant on consulting or too greedy. They sell more consulting time without ever developing the product that can be sold independently of the consulting work.
They then get caught in the cycle of just doing more and more consulting work and the business becomes totally dependant on them selling time. Selling time means hard work for the entrepreneur and fewer opportunities to sell the business in the long-term. If you do opt to consult to generate cash flow, always try to work towards productising your offering so that you don’t need to be present to deliver your offering. This means that you can be on holiday and still earning money or your business will be far more attractive to a buyer because they get a viable product that they can take over and sell.
Related: Money Isn’t Everything
Too many entrepreneurs want to raise hundreds of thousands of rands before they have done anything. While your business is still a concept that only exists on paper it is unlikely that anyone will take notice. The reason that Facebook was able to raise $25 million in venture capital was that Mark Zuckerberg had already built his first version of the Facebook platform and had already attracted users. It worked the same way for Sergy Brin and Larry Page of Google.
They put up a test site on Stanford University computers and asked their friends to try it out before they had any investor interest in their multibillion dollar search algorithm. If you want to get people interested in what you are doing, start doing it, build something tangible that they can see, try and experience in order to get them to buy in.
Be careful of analysis paralysis. Many people spend so much time planning that they never actually get into business. MBAs and CAs (I fall into both categories) are notorious for over-analysing an opportunity. Often they build so many models, do so many excel spreadsheets and engage in so much discussion that they never actually get to the market. This leads to nothing. There comes a time in the process of building a business when one needs to draw a line in the sand, decide it is worth doing and just start building the product or delivering the service.
Ship then Test
Many people want their product or service to be absolutely perfect before they ship. Microsoft has never done this. They ship their software before it is perfect and adjust and update along the way. Certain products or services don’t need to be perfect before you ship. Quality assurance processes are critical for other products. If MSN messenger does not work absolutely perfectly, it can quickly and easily be fixed and no one will die. If Boeing ship a product before it has been perfectly refined and tested, the ramifications may be far more serious.
Ask yourself: “Would I let my mother or father use the product or service in its current state?” If the answer is yes, ship it.
04 Sell (upfront)
If the product or offering that you are creating in your new business is appealing enough, you may be able to make some sales before the product is produced. The money that comes from these sales can be used as a form of capital in the development of the product.
Recently I launched a new product called Business-in-a-box, a toolkit for creating new businesses in South Africa consisting of two books, an audio CD, a CD of business document templates and a CD of book summaries and insights from top authors and entrepreneurs.
We did not have enough capital to develop the first 1 000 boxes when we started so we went out and sold advertising space in one of the books to all our trusted service providers who would find value in marketing their products and services to the people who buy the box. We collected the cash from these sales and used it to create the first 1 000 boxes. Anyone with a compelling enough product and some innovative selling skills can sell their product or service – even before it is developed – and use that cash to develop the product or service.
Dell computers allow users to create their own PC via their website; they then get customers to pay for their PC before they even start building it. After receiving the payment they begin building the computer and ship it to the customers 10 days later. This gives the company massive cash flow advantages and enables them to hold minimum or no finished goods inventory.
How could you sell your goods or services and collect the cash before you have even begun to build the product or deliver the service?
Related: How Entrepreneur Waste their Money
In launching a new business, you will almost always make use of suppliers. Your suppliers are the people giving you a product or a service. If you are retailing coffee, your suppliers are the people giving you coffee beans and mugs. If you are starting a website, they may be providing you with server space. It is very useful to try to negotiate payment terms with suppliers who allow you to pay them 30 or 60 days after they have delivered the product or service to you. This is not always easy but you may be able to convince them by being a tough negotiator or by offering them something in return for favourable payment terms.
As you grow as a business and your negotiating power with suppliers increases, this becomes a more realistic option. Pick n Pay is brilliant at it. They get suppliers to supply stock, they then sell that stock to customers four to six days later (on average), customers pay in cash as they buy the goods and Pick n Pay pays the supplier 90 to 100 days later. This means that they have the suppliers’ money for 90 days before paying it over.
As a smaller business you may need to incentivise suppliers to give you extended credit terms. Such incentivisation can come in many forms: One online marketing company gave their client a free monthly campaign in return for favourable credit terms while other companies sometimes select their suppliers on the basis of their credit policy.
06 Swop & Share
Swapping and sharing are two of the most logical yet overlooked tactics for bootstrapping. Consider this scenario: I live in a complex, like many South Africans. The gardens in my complex are fairly small, each takes a maximum of 90 minutes to mow properly yet almost every home in that complex has a lawnmower. Would it not make more sense for every 14 homes to buy one lawnmower and for each home to get the use of that mower for half a day once a week? The same principle can be applied to start-up businesses.
It makes no sense for a start-up business to buy its own printer or delivery vehicle or rent its own boardroom or manufacturing facility. Clever bootstrappers will link up with other small businesses and share resources, thereby minimising the outlay and maintenance cost for those resources.
Bartering is the oldest way of doing business. People have bartered for years, swapping their wares and services for the wares and services of others. This is one of the most powerful tools for anyone looking to launch a business on a really small budget. Offering your product or service to another business in exchange for something that you need creates a real win-win relationship for both parties.
You land up getting what you need to start your business at a lower “cost” than normal and more importantly for a zero cash outlay and the other party gets something they need for much lower than the market price. One of the lecturers I worked with set up his entire home office by running management development sessions for a local office equipment retailer. It cost him a few days of his time but nothing flowed out of his bank account.
Craft a verbal proposal for suppliers, offering them something of value in exchange for something they have that you require to manage or launch your business.
The most critical thing that you can do in bootstrapping your business is to manage for cash flow and not for profits. Over 70% of the start-up businesses that fail are profitable. They don’t fail because they are not making profits; they fail because they run out of cash. They don’t have anything left in the bank account to pay suppliers, employees or other creditors and therefore need to file for bankruptcy.
One of my old mentors used to say “profits are vanity, cash flow is reality”. Cash is the short-term economic driver of a business, so do everything you can to keep your cash balance in the black.
Starting your business with mounds of capital can make your business fat, lazy and unresponsive. Starting your business with minimal capital will make you lean, responsive and focused on meeting the needs of customers. I would like to adjust that to suggest that if you want to unleash your true creativity in starting a business, launch the business without outside capital. This will force you to put the foundations in place for a business that can last long into the future.
How To BootStrap Your Business With Funding From Your Shareholders
Fund your business: Bootstrapping with loans from shareholders.
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.
Understand the risks
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.
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.
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!
Ever Heard Of The SAFE Funding Agreement?
A new way to raise capital? It provides an interesting new way to raise capital for your business.
Everything in Silicon Valley moves to keep pace with the speed at which business and entrepreneurship evolves and adapts. As a result, the legal and transactions infrastructure is forced to match this development by using increasingly innovative transaction documents.
An example of this is the SAFE agreement. Pioneered and made popular by the famous Y Combinator, the SAFE Agreement — an acronym for Simple Agreement for Future Equity — represents the evolution of the much-favoured convertible note.
The South African entrepreneurial ecosystem, whilst a bit behind the pace of San Francisco, has a habit of adopting these trends and applying them, right here in Mzansi. The SAFE agreement is no exception.
However, a word of caution — simply adopting a US template and applying it to your company can create some undesirable consequences.
To keep pace with innovative financing mechanisms, it’s important to be familiar with the salient features of a SAFE agreement.
Briefly, these are:
- Unlike a convertible note, the SAFE is not a debt instrument and so, it wouldn’t traditionally attract interest
- It seeks to mitigate the risk of insolvency for the Investee and does not have a maturity date
- It’s intended to be a simple, standardised document to cut down on transaction costs, negotiation time and provide an easier way for businesses and investors to agree on a neutral document to regulate the advancement of funds.
Typically, an investor would advance funding, in exchange for a future, contingent right to acquire equity in the business, upon the happening of pre-agreed ‘trigger events’, such as:
- Equity Financing: For example, where the Investee company raises capital in exchange for equity
- Liquidity Event: May occur upon a change of control or an IPO
- Dissolution Event: When the company voluntarily ceases to trade and/or is liquidated. One would have to regulate whether business rescue proceedings constitute a dissolution event in SA.
When one of these trigger events occurred, the investor would acquire the right to purchase shares in the company at a pre-agreed ‘valuation cap’ or a discounted valuation to the actual value of the company.
The valuation cap attributes a pre-agreed, but notional, value to the company that will be used in the calculation of how many shares the investor will purchase. For example:
Investor A invests R1 million into Investee Company B at a valuation cap of R10 million. At the Trigger event, the actual valuation is calculated to be R20 million. Accordingly, Investor A will purchase shares equivalent to a R1 million equity purchase in a R10 million company, despite the value of the company actually being R20 million.
This translates into relatively more shares in Company B, than if purchased at the actual valuation — a win for the investor and just reward for taking a bet on a speculative business.
An alternative is the ‘discounted valuation’ method, which arises where the investor agrees with the investee company to discount the real value of the company at the trigger event, by a pre-agreed percentage.
In the example above, where Investor A agrees with Investee Company B to invest R1 million at ‘valuation less 20%’, he would get more preference shares than if he had invested R1 million at the actual valuation.
A further alternative is a hybrid of both the discounted valuation and the valuation cap, where the investor is able to choose either scenario, depending on which would yield the greater number of shares.
It is worth remembering this about SAFE agreements:
- The business is free to issue as many SAFE agreements as it pleases, unless this is specifically regulated
- There is no uniformity on the treatment of the SAFE as a non-debt instrument and has not, to the best of my knowledge, been tested by International Financial Reporting Standards
- The SAFE provides for the subscription of shares on a substantially similar basis to that of other shareholders, but the investor has no way of knowing those terms, unless specifically regulated in the document
- There is no maturity date, so the investor could wait indefinitely for the trigger event to occur.
6 Tips For Bootstrapping
Not all start-ups have the luxury or know-how to gain financial investment at the outset. Most often, newbie entrepreneurs will need to fund the business from their own pockets and resources — this is called bootstrapping.
Bootstrapping a business is a lesson in hard work and flexibility, but ultimately it can help accelerate a company’s success.
Here are my survival tips for entrepreneurs
1. Pick your business partners carefully
When you are bootstrapping, most of the work will have to be done internally; you need to have a partner who shares your vision and is able to bring a skill-set that you don’t necessarily possess.
If you are good at different things, chances are that you can get more done and keep expenses and outsourcing to a minimum.
2. Generate cash flow fast
The most successful bootstrapped companies today share this common trait: They generate cash flow almost straight from the word go.
Without cash flow you will burn any initial investment you have made in the company and you will definitely not be able to show investors any traction.
3. Get good at accounting
If you’re not a numbers person, get one. Track what is coming into the business and what is going out. If more money is leaving than coming in, we have a problem. Look at free budget tracking apps online, such as GoodBudget and You Need A Budget.
4. Don’t be lazy
Don’t outsource work that you can do yourself. Yes, there may be people out there who can do certain tasks better than you can, but in a bootstrapped environment, you will have to learn to wear many different hats.
5. Don’t try to be fancy in the beginning
Posh offices, embossed business cards and fancy tech are all unnecessary items for the bootstrapped entrepreneur.
Use freeware, print your own business cards and use social media instead of expensive websites to promote your business.
6. Don’t take no for an answer
Perseverance is everything. Network, build relationships, be seen, use social media to your advantage. Bootstrapping is ultimately an investment in yourself that will yield results in the long run.
Read next: Essential Tips for Bootstrapping