[This article first appeared in OBJ, Ottawa Business Journal: http://www.obj.ca/Opinion/Bruce-Firestone-5444.]
“The world is a tough, competitive place,” said Jerry McGuire in the film of the same name. When I was a boy, there were about 3 billion people on this planet. Now there are nearly 7 billion. If you are a young person today entering the workforce or starting a new enterprise, you not only have to compete with more people in your own nation but all those clever, hard-working folks overseas too. I would guess, in an inter-connected, Internet-savvy world, it isn’t twice as hard today; it’s probably more like a factor ten times tougher.
If Ottawa-Gatineau is going to have a seat at the table, it will be because we produce tough, competitive entrepreneurs. To that end, we need to provide far more intensive education for all ages and stages of life. We also need unconventional mentoring for startups as well as much more effective promotion and sales of their products and services. Plus, when warranted, let’s celebrate their achievements.
You’ll note that I didn’t say they need more bank financing or more VC funding. That’s because I think that early-stage companies should focus on and rely on building real cash flow—finding real launch clients and holding onto real customers.
I have been doing work in this area since 1999 and it proves that, if you wear an old suit long enough, it will eventually come back in style. And that has happened here—the world has come to share this view.
Not only is it better for new enterprises to self-capitalize (since the Founder(s) retain ownership and control over their companies instead of losing it to VCs), it is better for VCs (they should be looking for the ‘tall poppies’, i.e., investing in more mature/profitable companies and more mature entrepreneurs who have built real businesses) and it is better for Canada as well since the nation will see more employment from more startups that are more sustainable and it will serve to ration a scarce commodity—capital.
Most people can not really grasp the idea of bootstrapping a new business. I have found through more than a decade of research and nearly three decades of practice that I can give a three hour lecture on the subject and a dozen examples but, the following week, I’ll be asked a question by a student entrepreneur: “Sure, that worked for Eseri.com but I still need $3 million to start my business, don’t I?”
Eseri.com, started by PhD entrepreneur, Bill Stewart, provides lightweight Internet-based (actually cloud-based) desktops that use widely-available and proven freeware. Eseri is based in Ottawa and Montreal and was started with nothing—Bill still gives $1,000 per day seminars on project management software so that he can fund his real passion—building a great business of his own. He also uses stock options to keep his core group of developers on the job. Plus he leverages what money he puts in with GOC (Government of Canada) IRAP grants.
In the Great Depression of the 1930s, King Clancy built the old Maple Leaf Gardens the same way. He paid his workers with script—if the ‘Carleton Street Cash Box’ had failed that script would have been worthless. Fortunately, for their workers and Toronto Maple Leaf fans, it wasn’t and they were able to redeem it for more familiar currency and feed themselves and their families.
In the US, the number one source of finance for SMEEs in 2009 was supplier credit. Sometimes called Trade Credit (TC), it amounted to $2.15 trillion and dwarfed bank lending to SMEEs of just $1.5 trillion. As entrepreneurs well know, Canadian Banks have a habit of lending money only to people or businesses that don’t need it; i.e., they only lend when they have adequate collateral. Loan to value ratios typically are in the 50% range for commercial lending—entirely useless to entrepreneurs who, by definition, start with almost nothing.
Suppliers, on the other hand, want a new enterprise to be successful—that way they will have helped create a new client for themselves. If you are going to start, say, a new fencing and deck company, the way you bootstrap it is: you arrange supplier credit from a friendly lumber store and you get funding from your clients too.
For example, you get an order for a new deck for $8,000. You ask your client for a deposit of 50% when you get the order with the other 50% paid when you finish. You then order $5,000 worth of materials from a supplier who has extended credit to you. Perhaps, for example, they have given you 45 days to pay for what you just purchased.
Now you’ve got $4,000 in cash in the bank and $5,000 worth of supplies on site—so you have enough cash to pay your workers and yourself until the job is complete and then, with the balance in hand, you’ll have enough to pay your supplier…
Two former students of mine, Fred Carmosino, a Sprott School of Business grad, and Brian Saumure, a Carleton University SOA (School of Architecture) grad started their successful firm, Maple Leaf Design and Construction exactly this way—with launch client money and supplier credit.
What is cheaper—debt or equity? Many people think equity is free. Not so. VCs want to see at least a 20% p.a. ROI and Vulture Funds are aiming for a ROE of ~ $40%. But today you can get a variable rate home LOC for just 2.15% so now you know, debt is much less expensive. Even if you use 2nd mortgage type debt, you may pay 8% to 12%, still cheaper than equity.
But what is cheaper than debt? It’s supplier credit and launch client money! They usually charge you nothing for it. Clients give you their money in the form of deposits, retainers and progress payments for free because they want to buy your products and services, they want you to survive and they trust you.
If you build your business this way, it will have a Cash Conversion Cycle (basically, Accounts Receivable + Inventory – Accounts Payable) that is very short or, better yet, negative. This means that as your sales grow, you generate cash instead of needing to raise more cash—crucial to entrepreneurial, bootstrapped startups.
Lastly, bootstrap capital is much faster than going the VC-route. VCs, if they will even consider funding you, take 6 to 12 months to make up their minds. Banks take… well forever.
So instead of just talking about doing it, go out there and start your new enterprise and, once you’ve built it, hold onto to it.
Professor Bruce M. Firestone, Entrepreneur-in-Residence, Telfer School of Management, University of Ottawa, Founder, Ottawa Senators, Executive Director, Exploriem.org, Broker, Partners Advantage GMAC.
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