Next week I am going to be doing a panel for the NVTC on how to grow a business without external financing.  The link to sign up is here .  This is certainly a topic that is near to my heart, as I am sure you know from some of my prior postings .  I have felt for some time now that as the economy adjusts to a reality of smaller amounts of Angel and institutional risk capital, entrepreneurs would find ways to adjust.  In other words, I do not believe that people stop being entrepreneurial merely because equity financing is harder to obtain.

Over the last month I have been reminded of how many entrepreneurs remain in the DC region.  Our Amplifier Business Acceleration Program was very well received.  Frankly, we were overwhelmed with applications, and many of them were business ideas that had been significantly advanced without outside capital.  My conclusions from the last month with the Program are: (i) there is a clear need for entrepreneur-friendly assistance in building companies, (ii) entrepreneurship is alive and well in the Washington, DC region and (iii) entrepreneurs have found many creative ways to advance their business without depending upon outside financing.

With the upcoming panel and my recent experience with local entrepreneurs, I thought that I would catalogue some strategies I have seen entrepreneurs use to advance their business in the absence of venture capital or significant outside investment.  Sometimes strategies such as these are described as “bootstrapping.”  As it is generally used bootstrapping is associated with moving a business along until it can get outside funding.  In my view, bootstrapping encompasses a wider range of strategies to expand a business in the absence of external equity capital, or as a way to leverage a smaller outside investment.  Think of these strategies more broadly, rather than confining them to a particular stage of company development -- you might find ways to apply them to your own business, regardless of its stage.

Here are some bootstrapping strategies I have seen used with success.  By success, I mean, growing a business to the point of sustainability and beyond. 

Equity for Services .  Using a grant of equity in an emerging business is a way to minimize cash outlays, and this is a strategy that start ups use liberally.  In some circumstances it can be a very good idea, because it minimizes cash outlay and aligns the interest of the service provider with the entrepreneur’s business.  The trap to avoid is to “pay too much” for the services by granting an equity stake that is much more valuable than the cash would be in the long run.  For example, giving 1% of a company to an early advisor might seem reasonable, but how would you feel if that 1% was worth $500,000 five years later?  If you think that advisor/service provider is worth that amount, then by all means grant the equity. But, otherwise, find another way to pay.

SBA Loans/Home Equity Loans .  Although both of these financing techniques require the entrepreneur to take personal risk by providing direct collateral to the lender (i.e., the entrepreneur’s house or a personal guaranty), they are useful financing techniques.  SBA Loans in particular are something that should be easier for entrepreneurs to get over the coming year, as the Obama Administration has made them a priority.  Putting that aside, the cost of borrowing is always less than the corresponding cost of equity (you have to give an equity investor a higher rate of return), so even when equity can be obtained the use of loans should be considered carefully. Of course, you should not ignore the use of debt generally once a business has sufficient cash flow to support borrowing.  The SBA Loans/Home Equity Loans are focused on here merely because they are more suitable to an earlier business.

Customer Advances .  Often it is overlooked that the best source of capital is a satisfied customer, or a prospective customer.  Sometimes a customer can be encouraged to provide cash more promptly in exchange for better payment terms, or volume discounts.  I have also seen more than one company start with a prepayment by a customer, who is looking to support the establishment of the business.  Never forget that the most important validator for a business is its customer relationships – good customers will want you to succeed and stay in business.

Outsourcing/Nearsourcing .  Rather than raising capital to build a team for a development project, and incurring all of the related costs of employment (equipment, office space, benefits, etc.), it is often possible to use third party vendors for technology development.  As an additional benefit, these groups will often provide services at a discounted rate if they perceive the customer has promise of being a longer term client.  They might also be willing to provide services for equity, although any use of equity for this purpose should be priced with a view to its long term value if the business is successful.

Technology .  Technology allows for businesses to operate virtually (i.e.,. without an office) and to appear large and integrated without a physical presence.  Telepresence allows for customer interactions and team work without face to face travel.  The costs of computing and communications technologies have fallen to ridiculously low levels and every start up should aggressively use technology to keep its office and communications costs low.

Incubators .  Although the concept of incubation may be frowned upon during periods when money is easy to get, in tough times there is a lot to be said for them.  A well run incubator, or incubator program, for example the incubator at the University of Maryland’s Engineering School, can provide a business with many physical and financial benefits in exchange for a small equity grant. For example, office space, computers, access to academic researchers and students and dedicated support for entrepreneurial issues.

University or Government Lab Collaboration .  The Federal Government’s STTR program is designed to encourage collaboration between government funded research and private entrepreneurs.  This money, along with the growing interest of various local universities in promoting innovation amongst its academic community (for example, Mason or UMD), provides opportunities for a business to leverage against the larger resources of these organizations, with the additional benefit of non-dilutive grant money. 

SBIRs and other Grants .  The Federal government and many states (including Maryland and Virginia) have in place various programs to provide grants to encourage technological innovation.  These funds are available for a surprisingly large range of businesses, and have the advantage of being grants and not investments.  Accordingly, they are not dilutive to the founders and do not require repayment.

Licensing .  Although not often discussed as a bootstrapping strategy, a license can be thought of as a way to leverage the capital and assets of another larger company.  In exchange for a grant of a license to another company and participation in resulting revenues (or net profits), the licensing company avoids having to incur the expense and risk of obtaining sufficient capital to build the infrastructure to commercialize its business idea.  Certainly, the upside to the licensor is capped at the license royalty rate, but so is the risk and the need for additional capital to promote commercialization.  There are some traps in licenses to be sure (and probably a good follow up blog), but this strategy shouldn’t be dismissed without close consideration.

Other Contractual Arrangements .  There are three further types of contractual arrangements that allow a business to leverage the strengths of another company.  In each case, the business is able to utilize the existing infrastructure and established strengths of its partner, without having to take the time and incur the expense to develop these attributes on its own. 

·         OEM Agreements.  In an OEM Agreement, a business provides its product to a larger, more established company, which markets the product under the larger company’s name and through its distribution network. This allows the smaller business to utilize the larger company’s established brand and distribution network.  These arrangements are particularly attractive to larger companies who are looking for new products to sell.  Generally these arrangements are more profitable than a license, because the contract party is being provided with a complete product and not an idea.

·         Manufacturing Agreements.   In a Manufacturing Agreement, a business contracts with an existing, established vendor to build the business’ product.  This works well where the manufacturer has a large established manufacturing infrastructure, so that the smaller business can benefit from volume pricing and an experienced work force to build its products.  The big issue here is to ensure that any resulting intellectual property remains with the business hiring the manufacturer. 

·         Joint Venture.  A Joint Venture is a hybrid transaction that includes aspects of a license, OEM Agreement and Manufacturing Agreement. The terms can vary greatly, but the common attribute is that two companies pool their respective strengths to pursue a new business opportunity.  This can be a good way for a smaller company to get many of the advantages of a closer association with an established business, while maintaining a larger percentage of the potential upside.  These deals are tricky to structure, however, and care must be taken that they do not prevent the companies from having an independent future if that is a path they subsequently choose.

There are undoubtedly other strategies and tactics that entrepreneurs can use. The overriding theme though is that a good entrepreneur is always looking at the resources available to him both directly, and indirectly, as a way to grow his business.  Cash is a way to buy resources, but not the only, or sometimes the best way to get resources – even at the best of times (and these are far from the best of times) equity is the most expensive way to raise cash.  A good entrepreneur focuses on what resources he needs and then finds a way to get them. A bad entrepreneur looks for money to buy them.