With thanks to the O2 Ideas Room for blog posts…
Economic downturns tend to be self fulfilling. We all help to drive market conditions, so if we all decide to ‘batten down the hatches’, and become more risk averse we all contribute to prolonging a downturn. However though it may sound counter intuitive, an economic downturn is as good a time as any to start a new business. This short article discusses how entrepreneurs can bootstrap their way to success, by describing what it means in practice and suggesting some benefits to bootstrapping.
While certain businesses will struggle to get off the ground in a recession (in particular ones that require significant investment), for others, the time is as good as any to take the plunge. For a start, there tends to be a wider pool of qualified candidates available to work as unemployment rates increase. Similarly some companies may reign in marketing spend so there is a greater opportunity to market at more competitive rates. Finally, there are also stronger disciplining forces at play when conditions are tougher as people keep a much closer eye on outgoings. In short, it is a perfect time to bootstrap a start-up.
What is bootstrapping?
The phenomenon of bootstrapping is simply starting a business without external funding such as venture capital (VC) funding. The aim is to maintain a strict discipline on cash flow by managing costs very closely and trying to get the company up and running as cheaply as possible. By ensuring as low a cash burn rate (rate at which a company uses up cash) as is feasible, you increase the chances of your business succeeding. Similarly, without any debt repayments or obligations to shareholders you can afford to be more flexible with your idea. Other commentators, such as Seth Godin, believe bootstrapping is as much a state of mind as anything 1.
Of course, bootstrapping is not possible for all start-ups as it will depend on a number of factors ranging from the nature of the product or service, whether the business is capital intensive or not, and whether low-cost guerrilla-marketing techniques are suitable in the industry context, etc.
What does it mean in practise?
For me, bootstrapping means behaving very smartly at every cost point, given there is no external investment in the business. It means entrepreneurs consume business essentials only and are constantly looking for innovative means to substitute costs out of operations. It means resourcefulness, and plays to the fact that larger companies are less nimble than start-ups.
The phenomenon of bootstrapping can be viewed in stark contrast to the excesses of the ‘Dot-com’ boom. During this period, companies secured significant funds from financiers and some of these investments were squandered or invested in non-revenue-generating assets such as perks. This profligacy typified a classic case of the ‘Principal Agent problem’ 2, which occurs when the incentives of management and investors are not aligned and management (agents) spends money on items (perks) which are not aligned to generating a return for investors. These included water features in receptions, chill-out rooms replete with table football, offices in prime locations and generous expense accounts. With bootstrapping there is no scope for excess. The sole focus is getting the company running without incurring any non-essential costs.
What are the benefits of bootstrapping?
One immediate benefit of bootstrapping is that you are not reliant on outsiders for funding. As a result there is greater flexibility afforded you, the entrepreneur, as you put your ideas into practise.
Similarly, if the business fails to take off it is less painful to exit as the cash burn rate will have been low, so there are no significant losers. However, if the business takes off the rewards are not dispersed to third parties. Once there is proof of concept and evidence of demand, it is a lot easier to secure financing at more favourable rates.
Finally, with bootstrapping, incentives tend to be aligned so those that invest their time are rewarded accordingly, which typically leads to greater focus and reduced agency costs (see Principal Agent problem above).
Bootstrapping ideas
Bootstrapping includes outsourcing certain activities, so you pay on a usage basis rather than bearing the full cost. It also means negotiating hard with every supplier you deal with and eschewing capital expenditure in favour of renting or leasing. The following represents a list of some typical bootstrapping behaviour:
o Purchasing office equipment on eBay
o Using a virtual office assistant system rather than a full-time secretary
o Choosing efax solutions rather than buying a physical fax machine
o Using Open Office or Google Docs for word processing instead of Microsoft Office
o Promoting your offering through blogs, commenting on blogs and other relevant forums
o Hiring staff that are generalists and are happy undertaking a range of varied tasks
o Remunerating staff with stock options rather than high salaries
Additional examples can be found in Jason Calacanis’ excellent article called ‘How to Save Money running a Start-up‘ and the article by Guy Kawasaki entitled ‘The Art of Bootstrapping‘.
The Starbucks office
A major cost for any new business is rent. However, increasingly it is becoming more popular for people to start from their home or a small, flexible rental arrangement. As a result of these trends and the increased ubiquity of wireless, more and more companies are bootstrapping by using Starbucks as their meeting rooms.
Dangers of bootstrapping
While certain aspects of bootstrapping are clearly useful, it is important not to overstep the line. There needs to be some reasonable amount of cash available. Excessive thrift can be counterproductive and can send out the wrong signals to staff, customers and prospects alike. The objective is not to become compulsive in managing the costs or to expect a company to successfully develop on nothing. As always it is a question of balance. You do not want to lose credibility by being noticeably focused on bootstrapping, but you do want to manage your cash position to move the company forward.
Summary
Bootstrapping is an increasingly popular way to start a business, regardless of the economic conditions. Naturally it is more conducive to certain businesses, such as Internet based businesses, where initial costs can be managed until there is clear evidence of demand. Once the idea you are bootstrapping gains traction and revenue begins to increase, you may then need to switch out of bootstrapping mode. At this point it may be appropriate to seek external funding from the likes of VCs. However once you have proven the concept, the risk for investors reduces a little and hence you should capture more of the upside as you need to give away less equity. In short, the aim of bootstrapping is to keep a low cost base to ensure you can gain a foothold in some market and to generate a sufficient return so you can then assess how best to proceed.
Alan Gleeson
Managing Director
www.paloalto.co.uk
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