While it may sound counterintuitive, an economic downturn is as good a time as any to start a new business. SmallBusiness.co.uk has teamed up with Alan Gleeson, the MD of business plan and marketing software specialist Palo Alto, to look at how keeping a tight control of costs shouldn’t hold back your desire to start a business.
Although certain businesses will struggle to get off the ground in a recession (in particular ones that require significant investment), for others it’s as good a time as any to make it happen. For a start, there tends to be a wider pool of qualified candidates available to choose from 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 term bootstrapping, in this instance, simply means to start a business without external backing such as funding from business angels. 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” (the rate at which a company uses up cash) as is feasible, you increase the chances of your business succeeding. Likewise, without any debt repayments or obligations to shareholders you can afford to be more flexible with your idea. 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 (such as using social networks) are suitable in the industry context.
What does it mean in practise?
Essentially, 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’, 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.
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:
- Purchasing office equipment on eBay
- Using a virtual office assistant system rather than a full-time secretary
- Choosing efax solutions rather than buying a physical fax machine
- Using Open Office or Google Docs for word processing instead of Microsoft Office
- Promoting your offering through blogs, commenting on blogs and other relevant forums
- Hiring staff that are generalists and are happy undertaking a range of varied tasks
- Remunerating staff with stock options rather than high salaries
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 a coffeeshop 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.
Tying up the loose ends
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 of 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 angels or even VCs to take your business to the next level.
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 is the Managing Director of Palo Alto Software, Ltd., creators of Business Plan ProÆ 11.0. He holds an MBA from Oxford University and an MSc from University College, Cork, Ireland. For further information on business planning visit www.bplans.co.uk
