Bootstrapping gets startups going
Ilana DeBare, Chronicle Staff Writer
Tuesday, November 29, 2005
Since I started writing the weekly Mind Your Business column for The Chronicle in the spring, I've gotten a lot of questions from readers about how to obtain resources to create a startup.
Often they ask, "How can I get venture capital funding?" But VC funding is hard to get -- one estimate is that for every 1,000 startups that apply for VC funding, two actually get funded -- and such financing is not appropriate for many kinds of businesses.
So how can you start a company with little cash? Some common solutions are borrowing from your friends and family, or taking out a home equity loan. But when I heard Bruce Maxwell talk about how to "bootstrap your startup" at a recent small-business conference, I knew this was something I needed to share with Chronicle readers.
Maxwell is a Los Gatos serial entrepreneur with an MBA from Stanford. He started his first company in 1992, a company called Positive Communications that sold pagers to the U.S. consumer market. Since 1998, he has worked as a consultant for more than 40 companies, often serving as an interim chief executive officer or chief financial officer during the startup process.
Not every small business will find Maxwell's suggestions feasible. But many businesses should be able to make use of at least one or two of his ideas.
Q: What does bootstrapping mean?
A: It comes from the tradition of immigrants coming to America and pulling themselves up by their bootstraps. We don't wear bootstraps anymore, but within the context of a startup, bootstrapping is about attracting resources to your enterprise without cash. It is kick-starting your company without a large quantity of capital from family or angel investors.
Q: You were involved with one tech company that went from conception to its first major customer while spending only $6,000. How did it do that?
A: The CEO was very canny. He was looking for all the traditional resources -- such as people, work space, software and hardware. On the people side, he was able to attract six people willing to work for no cash at all -- we were all working for equity.
We needed work space, so he went to a company that was downsizing and had lots of extra space, and he offered to barter. He said, "I'll run your e-mail system for you if you give me some space."
We needed about $500,000 worth of software. But when you really think about it, the actual marginal cost of selling software is the cost of the salespeople and of producing a CD, which is about $2. So he went to the software vendors and said, "Sell it to me for nothing, and I promise to pay you in the future on a per-subscriber basis."
Then he needed hardware to run it. This was the one place he was not able to finagle a barter deal, so he ended up buying a bunch of equipment that was nominally used but had come from a dot-com that had dot-bombed, and the boxes hadn't even been broken open. He bought three servers that way.
In the first six months, while he was constituting his business, he spent just slightly over $6,000, about 90 percent of that on those three servers. That is a classic example of bootstrapping.
Q: How does one go about bootstrapping?
A: Bootstrapping is founded on two simple techniques. The first is time-shifting your payables into the future. You don't have the cash today, so you say to people, "If you give me this resource today, I will pay you in the future."
If you can do this on some kind of per-customer or per-transaction basis that you can document, people feel relatively confident -- so (they know that) in every future transaction you do, they will get a piece of that transaction.
The second technique is barter. If you are in a business, you've got something that other people want. You don't have cash, but you have a service, or software or a product.
Q: Let's start with staff. How do you get people to work for you if you can't pay them?
A: There are two concepts here. One is to ask people to defer some or all of their salary into the future, so they are accruing it, but you are not paying it in cash yet. Of course, that is risky for the individual. But in theory, they are working at your side to make this happen, creating the success that is going to pay them.
The second concept is sweat equity: "I'm going to give you a stake in the business in exchange for you working for no cash."
They key thing about either of these techniques is putting it all on paper so there is no misunderstanding of what each party is agreeing to up front, and to avoid lawsuits.
You also need to plan for high turnover. If you are asking people to work for sweat equity or deferred salary, there is a high probability someone may offer to take them on for cash. Plan for that. You should always be in recruiting mode.
Q: How about getting an office?
A: One of the beauties of the modern American business environment is that work space is less necessary than it used to be. With the Internet and modern telecommunications, you can pretty cheaply work from home.
Another way of doing business is to incubate at another company in exchange for bartering services, or even for free if you have a friend. A lot of the time, companies rent far more space than they need because they think they're going to grow.
It's not hard to work out deals where you say, "I'll come in on a month-to-month basis and take this space you're not using, and in return, one of my people will act as the receptionist." But if they need the space, you're out of there.
You can also go to one of the formal incubators, like the Enterprise Network in Santa Clara (or the Renaissance Entrepreneurship Center in San Francisco). They offer formal incubation services where you get a little cubicle and access to all of their services.
But they also have associate memberships that allow you to just come in and access their meeting rooms. I got space for one startup for $40 a month, where we all mainly worked from home, but when we needed to get together, we'd take advantage of this well-equipped conference room.
Q: What about getting software and hardware?
A: The technique here is to attempt to match your expenses to your future revenues -- to time-shift forward and tell the people you're buying from, "I'll pay you in the future (based on sales or other transactions)." That is possible with software because the cost is almost zero for an additional copy of the software.
Hardware is a little harder because there is a real cost associated with it. But even there you can say, "I'll pay the cost of the hardware, but your profit margin is something I will pay you in the future."
Then of course there's always the option of getting financing (from the vendor). You're a little business, and your credit rating is probably nonexistent, but they're a big hardware vendor, and their credit rating is excellent. If they co-sign the note, you can get the financing you need. So ask for that, and you just might get it.
Q: What about sales and marketing expertise? How can you handle those needs if you don't have the money to hire sales and marketing people?
A: One way cash-starved businesses handle sales is through paying pure commission: "I'll give you a very generous cut on sales, but that's all you get." Salespeople will inevitably try to take a better offer if they can find one, but during the past few years, there have been plenty of salespeople out on the street who were quite willing to work on a pure commission basis.
There are other alternatives. You could take on manufacturers' reps, which are organizations of professional salespeople. They typically cover a state or region. A manufacturer's rep is paid on pure commission. They are generally experts in certain fields, and they only get paid when they make a sale.
The other big component of sales is travel. Booking on the Internet and setting standards like "Travel must be booked two weeks in advance" is a good way to keep your costs down.
One of the best means of getting some marketing help is telling a marketing firm that you will pay them a percentage of your revenues. This is an interesting proposition, because you are asking the vendor to put their money where their mouth is. You tell them: "I'm coming to you because I'm going to increase sales if I buy your services, right? So if you believe that, then you ought to be willing to get paid on a percentage of my sales."
Q: Can you also get services from professionals like lawyers and accountants?
A: What you want to do is find lawyers and accountants who are hungry enough to either defer their billing for a year or give you a steep discount in order to get you. There's a quid pro quo for that -- they're expecting that you will stick with them. A lot of lawyers and accountants want to get clients when they're small, because they can grow with them.
In some cases, professionals will actually take payment in equity -- not for everything, but may say, "I'll give you a 50 percent discount for your first year, but I want some shares in your company."
Q: What if you have a business that needs inventory?
A: One technique is consignment: "I'll take your inventory, but I'm not going to pay you until I sell it." Another is to work out long payment terms. The vendor may only offer "net 30," but explain that you will probably hold the inventory for 30 days, and then it will be 60 days before your customers pays for it, so your sales cash cycle is 90 days, and you need 90-day terms.
Tell them, "I can't buy your stuff unless you give me 90-day terms. Are you willing to stake me to it?" Not everybody will, but some will.
It's very important for a small business trying to bootstrap to understand what its actual sales cycle is -- how long is it between the time they take possession of inventory and when a customer actually pays cash for those items? Don't be optimistic, be conservative. If you're careful, and you know what your cycle really is and you can get your vendors to fund you on that cycle, then effectively, they're your bank.
Then, of course, you can look for secondary market deals when you need inventory. Sometimes you can get a really good deal by finding out about customers who have bought too much of that inventory from the same vendor.
I used to run a paging company, and I could buy my pagers directly from Motorola. But I got in pretty tight with the Motorola salespeople, and I asked them, "Do you have customers who are trying to give pagers back to you because they bought too much?"
As a matter of fact, they almost always had customers who had misestimated demand. Motorola didn't want to take those pagers back and un-book them as sales, so it was in the salesperson's interest to say, "Yeah, Bruce, I know about this company, and they're sitting on a bunch of pagers."
I would then call up the CFO of that company and say, "Motorola tells me you're trying to return a bunch of pagers. I'll take them off your hands at 70 cents on the dollar." From his perspective, that was a pretty good deal, and it was a great deal from my perspective.
Q: You also talk about the technique of "scrounging."
A: That's one of the essential bootstrapping techniques. Some people have a real knack for scrounging. The technique of scrounging is to buy nothing new -- try to buy everything used. Go to bankruptcy auctions, and network like crazy to find downsizing firms.
You're getting yesterday's equipment, but often that's just fine, and you're getting it for just pennies on the dollar. Use the Internet -- there's eBay, Craigslist, dozens of specialty brokerage sites, and then there are news articles about downsizing and bankruptcies.
Q: Then there's barter.
A: That's the other essential technique. Barter is a forgotten art, but if you have no cash, an absolutely necessary art. You can barter your product or your service. You can also barter the labor of your specialists. Maybe the guy who is your CFO can provide some CFO services or help prepare some financial projections.
I took some space for a startup from a big company moving to a new location. In their move to the new location, they were going to buy a whole new set of furniture.
They offered to sell us about $70,000 worth of dividers and desks and other furniture, and the price was $5,000. We had to move it -- to physically get it out of the facility. So I and the other four people in the startup rented a huge U-Haul truck and some very cheap warehouse space, and we worked for three solid days getting all of that.
Essentially, we bartered our labor for all this furniture. ... There were four or five of us at the time, but that furniture held us until we hit 70 people.
Bootstrapping really comes down to chutzpah and creativity. You don't get what you don't ask for, so it's really important that you ask.
A good part of bootstrapping is being unafraid to tell people you have no cash, and you're not going to be able to pay them, so how can we creatively work out a method for me to give you some value for this resource that you're going to give me?
Q: Underlying all the strategies you've mentioned is the necessity of a good idea. People need to feel confident that you're going to have a viable business and you are going to make money off it.
A: Yes. They have to believe in the business concept, that there's really going to be cash there in the future. They also have to believe in you. I can't emphasize that too much.
Karma is involved here. You are asking people to trust you -- if they give you this resource now, you are going to pay them in the future. And trust is not easily won in business.
So generally, if you adopt this technique, people really need to believe in you. And you need to be worthy of that trust.
Q: So you can't do this and burn people? Can you get a lawyer to give you free services for a year, and then move on to a different law firm for another year of free services?
A: You can burn people once, but bad news travels fast. The valley is surprisingly small, and if you treat people badly, it will come back to haunt you. You've got to go in not just with a good idea but with good karma.