The current economic crash may force “Bootstrapping” to be the primary funding strategy for many startup companies, for the next few years.
Where would startup companies be without Angel Investors? In 2007 alone, 258,200 angel investors pumped $26 billion into 57,120 companies.
In 2008, The Angel Capital Association (the official industry alliance of over 100 of the largest angel investor groups in the United States), conducted an Angel investments survey. In that survey, half the respondents noted that they were confident they would receive more investment requests in 2009 than they did in 2008. 60% of them, however, also noted that the number of investments that would be made and the number of dollars available for investments would decrease in 2009. And that certainly did happen!
If the reduction in dollar amounts available is in keeping with the runoff in the equity markets, there is likely to be 40% to 50% less Angel money available. Angel liquidity, like yours and mine, has been devastated by the current unprecedented economic downturn.
Sweat Equity
The downturn is forcing Angels to invest more carefully! Deals will still be made, but they will be fewer in number, and happen less frequently, and likely will be for less investment dollars. Despite the expected dearth in Angel (and VC) dollars, the entrepreneurial minds in our population are still clicking away. They will continue to come up with great ideas and the desire to start new businesses.
The situation requires startup companies to exist on founders and others’ funds, and “Bootstrap” their way to generating revenues; possibly all the way to breaking-even! Bootstrapping is a way for entrepreneurs to utilize other peoples’ money in order to grow their company.
OK, it may not be actual money every time, but it is peoples’ time and their expertise, and time is money. It is very common for engineering teams to be made up from Bootstrappers, working for sweat equity in the startup company.
Bootstrap Financing
Bootstrapped financing, in effect, is a means of financing a startup company by innovatively acquiring funds, or other assets, without raising equity through traditional sources such as banks.
The traditional direct approach for many entrepreneurs is to get money from their family members, or friends, or from the sale or mortgage of their own assets, or even credit cards.
There are positive and negative aspects to Bootstrapping. On the positive side, waiting as long as possible to consider equity financing gives the entrepreneur a better chance of retaining increased ownership in his/her company.
Angel or VC Money
Waiting for funding may actually raise the probability of obtaining Angel or even VC funds. Limited funding hinders the performance and success a startup can achieve, and/or determines its solvency. Angel money (and VC money) is often invested later in a startup’s growth cycle.
Waiting until a company is further developed, gives an entrepreneur greater control in running the company. There will be fewer questions and less monitoring pressure from investors.
In effect the new company can be more flexible and agile and be better positioned to deal with the ambiguities that all startups face. Investor involvement and monitoring often forces a strategic rigidity.
Types of Startups
Success or failure in Bootstrapping as the predominant funding strategy is dependent on a variety of factors (such as the economic environment or business ambiguities), some of which may not be within the sphere of control of the entrepreneur. And being unaware of how the type of company (being started) affects the success (or failure) of a new company is often a “doesn’t know” for entrepreneurs.
In my book Business Genesis – A Strategic Approach to Starting a Business, I describe five types of startup businesses:
- Life-Style Businesses
- Evolutionary Businesses (Corporate Spinouts, etc)
- Venture Funded Startup Businesses
- Revolutionary Startup Businesses
- Corporate Revolutionary Businesses
Each type of business requires a different funding strategy. Life-Style businesses for example are almost always Bootstrapped (about 95% of all startups in the US). And the other types, and variations of those other types, present differing funding and Bootstrapping challenges.
Startup Growth Phases
Startup companies have three phases of growth: 1) internal, 2) external (market), and 3) ‘GAP’ growth; i.e. the GAP is the potential growth opportunity space/time between internal growth, and growth in the market. Bootstrapping efforts ‘in the GAP’ may provide some market growth opportunities for a new company.
When the business’ activities cross-over into the market space, Bootstrapping opportunities decrease greatly. Generally, businesses that have, or are developing, an end-product (not a service), usually have specific Bootstrap issues on which they must focus.
Most Bootstrapped businesses use sweat-equity labor to design, engineer and/or manufacture their products. The concept of sweat-equity may work fine in some cases, for engineers and internal marketing and sales, or even finance, but many other types of labor don’t have the personal luxury of being able to work for free. And external marketing people and companies all want to get paid!
Time to completion is also a very important factor in the successful use of Bootstrapping. Sweat-equity labor usually has an undeclared tolerance for how long it can wait until a startup is at the stage where it can pay wages. This time will vary as a function of the individual but success in less than two years would not be an unusual expectation.
That Special Case
Businesses developing services or applications for the Internet, that are using Bootstrap self-funding techniques, can grow in both phase 1) and phase 2) simultaneously. Internet service/application/software companies can actually grow in all phases at the same time!
There may not be a GAP for businesses developing Internet Services or Applications. They develop their App or Service while operating in the target medium using its technology.
These companies would fall into the Type 2 category (above), similar to a spinout; they are in effect extending the capabilities provided to an existing market. Bootstrapping is a very effective strategy for Internet/Web based startups.
An important area of consideration for a Bootstrapped Internet company, like others, is the time to success, or to when wages can be paid. Internet companies can actually be category 1, 2 or 3 (above). Many of them are lifestyle companies, providing incomes to the founders, but some of them eventually received VC funds and grew to be giants – Yahoo, eBay, etc.
The Bootstrap GAP
The GAP is a time or activity period in which Bootstrapped labor and techniques can still be used effectively to generate revenues and operational growth.
The GAP comes between a startup’s first growth phase ‘internal’ and the second growth phase ‘external’. Bootstrapped self-funded companies may actively use the GAP period to Bootstrap revenue (maybe op’s) growth and generate cash.
Some companies will have little or no chance of creating cash for themselves in the GAP! Consumer-product companies could face this issue. Bootstrapped companies must accept lower performance targets, and develop strategies that will allow them to gain traction in their target markets; strategies like targeting and tailoring an offering to a niche market.
When the GAP is in Play
Knowing when the GAP is in play is very important for all startups.
- Is the target market dollars > 100 times the total capital available?
- Is the business consumer-product based?
- Will the end- product sell for > $1000?
- Is the business developing Web based products or services?
- Are current operational costs > 50% Bootstrapped?
If you answer in the affirmative to questions 2 or 4 the GAP is not in play for you; if you answered in the affirmative to question 2 you need to develop a special strategy of how to get your product to market; Bootstrapping will not work. If you answered in the affirmative to question 4, Bootstrapping will work just fine for you in all stages of your business development.
Answering in the affirmative to questions 1, 3 or 5 means that the GAP is in play for you. You need to develop a strategy that will allow you to Bootstrap your way to making sales. Answering in the affirmative to 3 means that Direct Sales strategy might work for you. All others should think about Niche Marketing or developing a Strategic Alliance.
Using the GAP
A company’s ability to use the GAP will also be a function of its type.
Type 4 companies (from the definition above “Revolutionary”) will have a tough time utilizing the GAP; the requirement to create awareness and to create a market requires cash. These companies must develop strategies that will generate revenues in as short a time as possible.
Companies selling high price capital goods will find it easier to use the GAP in their growth strategies. The very nature of their product will force them to target, and they will have little need for mass marketing, they can use direct sales effectively to generate revenues.
Whether the GAP is in play (or not) startups must manage their dollars to maximize its potential and benefit. The best way to do this is to control finances using Zero Based Budgeting; this forces continuous attention to managing cash usage and to operating on a project basis.
Bootstrapped Businesses Marching Orders
- Determine the type of startup being launched
- Develop a Zero-Based Budgeting process
- Determine if the GAP is in play
- If the GAP is in play, develop a GAP Strategy
- Consumer-product companies should develop a niche strategy
- Revolutionary businesses should develop a strategic alliance
- All businesses should develop Post-GAP revenue objectives
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