Battle lines have been drawn in the entrepreneurial world, with venture capital squaring up to its penny-pinching cousin, bootstrapping.
Before budding entrepreneurs can reach the dizzying highs of business triumph, they must first launch their idea off the ground, and this requires finance. Venture capital (AKA private equity) is hard to obtain, competition is immense and investors can be reluctant to hand over their capital without evidence that the business can work and eventually bring a return. Most start-ups must go through a phase of bootstrapping before they can prove to investors that they are a good bet. The question is – can bootstrapping successfully continue indefinitely?
Bootstrapping means entrepreneurs going it alone, by whatever means possible. This can involve tapping into savings and accumulating private debt, including loans and borrowing on credit cards. It is clear that if bootstrapping goes wrong, it can go terribly wrong for the individuals involved.
However, there are also many positives associated with bootstrapping. Bootstrapping does not mean sacrificing equity, and it allows entrepreneurs to keep control of their business. This can seem undeniably appealing; the dream of starting your own business is, after all, about freedom. Bootstrapping allows business owners to call the shots (and, perhaps, make their own mistakes).
Investing personal finances arguably promotes caution, and a real consideration regarding where money is being spent. When their livelihood and savings are on the line, people tend to think through every business decision with precision. Lastly, when you bootstrap there is only one possible source of income, and that is your customer. Pleasing the customer is an essential element of business that many failed start-ups somehow seem to have missed, and bootstrapping can help prevent this. Yet, for many businesses, a point is reached when the credit cards are ‘maxed’, when customer revenue cannot come in fast enough and at that time growth crawls. Bankruptcy is a real possibility and driving the business forward seems unfeasible.
It is hard to obtain venture capital backing, but it is also hard to grow your business at a sufficient rate without it. Focussing on building the product is not enough, marketing and sales must be grown if the business is to succeed. The fact of the matter is it takes money to be noticed.
Hiring is affected, too. When candidates look for a job with a start-up, they need to know that the business they might join is financially secure, with viable plans for growth. Investors can provide credibility and reassurance. Joining a start-up can feel like a risk to many, and if the business is stagnant and relying on personal investment to stay afloat, it may not seem like a risk worth taking. For business to attract the best, they need to not only be ambitious, but also have the finances to back up their ambition.
It is all about the rate of success. If your business survives bootstrapping financially, it still faces the hurdles of sustained growth and marketing without an influx of investment. When it comes to starting your business, bootstrapping is for the beginning – otherwise it can be the end.
Copyright (c) BlueGlue 2014
I have just read an article claiming that 10% of companies that America’s top ten venture capital firms or VCs [ie private equity firms] invest in actually succeed. This correlates exactly with the yardstick that VCs and seed corn capitalists I know use. 10%!
One chance in ten. We know that only 10% of small businesses actually make it to year five, so it could be reasonable to suggest that anything greater than 1:10 (10%) odds would be better than you get from starting a business. Just 10%.
So, is it worth it for a 10% gamble? Well, to put all this in perspective, here are the chances of winning at the casino:
Slot machines 32%
Horse racing 41%
Here are some conclusions (if you are in any way rational).
Do not gamble at small business unless… Unless what?
Starting your first business can be a daunting task and raising finance can often seem impossible. So what are your main options?
1 Savings and self-finance
Start putting money aside soon as you can. If your long-term aim is to start a business, cut down on your spending and save as much as you can from your current wages. I moved in with my parents, paid a much lower rent and saved hard to ensure I had as much money as possible before starting my first business.
Cash in any ISA’s or savings accounts. If your business is successful, you may get a much greater return on your money than you currently get, with interest rates as low as they are.
If you have no capital, it is difficult to get finance, especially post credit crunch and with no trading history. Banks require a detailed business plan, preferably with three years projected forecasting and profit/loss models.
However, as interest rates are currently low, a business loan can be a reasonably cheap to borrow. The new Enterprise Finance Guarantee (which has replaced the Small Firms Loan Guarantee Scheme) is useful for start-ups with no capital. Under the scheme, the Government guarantees 75 per cent of the loan should the business be unsuccessful. The EFG is available for businesses with a turnover of less than £25m and offers loans up to £1m. If you borrow under this scheme, you will have to pay a set-up fee, plus a quarterly fee for the borrowing.
Shop around for the best deal on any bank loans – interest rates can vary dramatically. With my original business loan, I naively accepted the first one I was offered (at an extortionate rate) as I was convinced I would not be offered another. Six months later I approached a second bank and moved it, saving me 5 per cent interest.
3 Investors – family and friends
It can be worth approaching family and friends to see if they will invest in your new venture. Discuss various levels of involvement; some may expect a share of your profits, while not wanting involvement in the running of the business (a silent partner). Others may be happy to lend long term, receiving only interest payments, as does one of my investors.
Whatever the situation, always make sure both parties take independent legal advice and draw up an agreement outlining the terms. This prevents any potential problems if the future relationship breaks down.
4 Investors – business angels or venture capitalists?
Look for financial involvement from established business people, either in the form of a business angel (ie a local businessperson who lends money to businesses) or a private equity provider (ie usually more suitable for larger businesses with higher turnovers). Both can provide a wealth of information and assistance, especially if they have relevant contacts. In return, they will expect a share of profits and possibly a share of the equity.
Be cautious about giving away too much control over your business. You must also find an investor that is right for you and the business – having a good working relationship is a must. If you feel this is unachievable, don’t take the risk.
Whilst notoriously difficult to gain Government or EU funded grants, it’s worth making enquiries in your local area to see if you are eligible for help. The EU has a wealth of grants available, especially in rural areas, but they are badly advertised and difficult to access.
The Princes Trust is useful to young people starting up a small business, but the loans offered are fairly small and the criteria strict – although they are helpful for people from disadvantaged backgrounds.
If you are restoring an older property as part of your business, see if you are eligible for support from the local council, English Heritage or local conservation trusts.
6 Reducing Costs
It pays to keep your start-up costs as low as possible, of course. You could get equipment on hire purchase or loan or use a ‘rent a desk’ scheme, for example.
Utilise your friends and acquaintances – perhaps you know designers, IT professionals or PR experts? Set up a social networking account (eg Twitter) and find others in your area who are setting up businesses – perhaps you can exchange skills. I’ve done this many times – exchanging free coffee for help with my website.
7 Don’t put all your eggs in one basket
Share the risk when starting up. Spread the borrowing and the repayment terms. This will make everyone – including you – feel less vulnerable.
Sadie Hopkins is founder of York Coffee Emporium
I developed a business idea which I know is a strong, feasible proposition but, with only having normal jobs, no mummy or daddy to hand me large amounts of cash and no major savings in the bank, I knew that I would need external funds to realise the plan.
Back in March I decided to learn how to be “investment ready” so that my business could grow with the support of some external investment from a bank, Business Angel, private investor or venture capitalist. I went to some excellent courses run by Connect Midlands to understand the process of writing a good, solid business plan and understand the business from an investor’s perspective.
It took me a good eight months to write that business plan with a convincing proposition and a solid set of numbers to show investors. It seems like a long time, but I needed to:
I went to the bank. Here are the lessons I learned:
I know everyone is talking about banks not lending but I must admit I was sceptical to believe this, as I fiercely believe that entrepreneurship is vital for the recovery of the economy and it should be supported by the banks.
As a consequence, entrepreneurs have the option of turning to investors/business angels. These investors receive many plans to review. I have now sent my plan to the Growth Investment Network (East Midlands) who have a range of investors in their network. I sent the plan as soon as I felt it was ready and I have to be open to feedback even if it’s hard to take. Fingers crossed.
I have to keep trying, and persevering, believing and visualising that I will be successful in raising the funds I need.
You can find out more about Marcela on the new interactive business website www.inafishbowl.com
Back in the mid-1990s, my company, SellerDeck, was set up using my own money and some I borrowed from family and friends. My business partner and I then raised £165k from an angel investor, and later a further £1.5m from venture capitalists, 3i.
At the height of the dot-com boom in 2000, we went public on the London Stock Exchange, raising £25m. A couple of years later, the company de-listed and became a limited entity again.
When you are seeking funds, you won't feel it, but there is plenty of money around. You just need the right formula to tap into. So it's important to understand the keys to attracting investment – particularly from business angels and venture capitalists.
The challenge is that investors – just like those on Dragon's Den – receive numerous approaches, but make few investments. How can you make yourself stand out, and get the cash you need to grow?
I’m assuming that you have a workable business, and a well-written plan that covers finance and marketing without boring too much with detail. However, even when you have these, you still have a long way to go.
There are three keys:
Incidentally, the way to generate excitement is to provide hard data on the size of market you can address and what margin you can obtain. This must be evidence backed. Simply saying: “we estimate the market at £100m and will take 70% share” without any facts to back it up is a real turn off. But don’t go into too much detail.
Once there is an initial attraction, the key questions will be about the credibility and commitment of the management team and business generally.
The best answer to is to have a great track record. If you don't, get people involved who do and get experienced people onto your board. This will have a cost, probably in shares. You also need to listen to their advice – no one who is good will stick around if they are ignored.
Investors will also want to be certain of your commitment. Don’t mention any alternative business ideas, because this will be a big turn off. If they put their money in, they want you to be fully devoted to making it grow, becoming profitable as soon as possible.
The next question is whether the business itself is credible. This is best demonstrated by having real sales and customers. In fact, if you don't already have these, you need to ask yourself some tough questions.
Investors will sometimes ask you to put your house on the line. Personally, I’ve always refused, arguing that I had already taken a pay cut to start the business, risked my career and was utterly committed anyway. Finally, I pointed out that such a high price runs the risk of the directors behaving desperately if things get tough – which doesn't promote good business practice or the protection of their investment. I’d suggest you sharpen these arguments up, too.
Many people obtain their investment from family and friends. Assuming you know people with sufficient capital, this has the advantage that it’s easier to tap them. The disadvantage is that if the business fails, which is bad enough, you may also face losing key relationships. And I'm afraid to say that if you believe there is no chance of that happening, you probably don't understand risk and should reconsider your career direction.
I myself borrowed money from family and friends to help get the business going. But I deliberately took the loans on personally, so if the business failed I’d still have to pay them back. And I kept the loans at a level that I would just about be able to pay them off over a few years.
Remember, the key lesson is to look firstly at the needs of investors. Only secondly present your need for money and how much sense the business makes to you.
I can’t pretend raising money is simple, and a pre-requisite is having a viable business and plan anyway. We presented to more than 70 investors before getting our first funds. However, if you follow the advice here, your chances will be improved. Good luck.
If you have an idea for a business and want to progress it, you are probably thinking in earnest about your business plan. If you are looking for outside finance, you are no doubt keen that the business plan will be a great marketing tool for your idea to banks or other investors.
Years ago, when private equity was still called venture capital, I was involved in funding start-ups. I would look through countless business plans, trying to sort the ‘possible’ from the ‘dream-on’ varieties, with a view to investing in the best. Some plans were back-of-the-envelope affairs, with enthusiasm but no financial viability analysis; some described in depth inventive products, but showed no realism with regard to cost of production; others assumed world domination in a few months.
But what really put me off was the business plan that plainly had been written by someone other than the people who were going to make the idea happen. However slick the document, with every possible detail carefully analysed in beautiful spreadsheets, if the words do not reflect the essence of the entrepreneur – his enthusiasm, her conviction the idea will succeed, their commitment to the project – then the proposal will lack that essential ingredient that is the reason for making an investment. The basis of our decisions was mimicry of estate agents’ ‘location, location, location’ replacing the key word with ‘management’. Yes, of course we wanted to see that the projections made sense, and that the amount of investment required was adequate and would be wisely spent; that there was indeed a market for the product or service, and that it would be sold appropriately. But the key was always: is this the right person to make the proposed business succeed?
So if you do use professionals to help compile your business plan, make sure that the final result is imbued with your DNA, and that it convinces the reader why you are the one to turn the plan into the success you describe.