Building a $50m lifestyle business

One of the more irritating habits of the academic view of entrepreneurship is when people disparage anything other than the next Google as a mere “lifestyle business.” In this view, unless the founders are maximizing their desired exit market cap, they’re just tyros doing it for fun.

I had lunch with a friend today talking about his next startup. He’s going to bootstrap and keep it small, both so he can do tasks that he enjoys and also not spend his whole life chasing after external funding.

For the average entrepreneur, a successful IPO is a fluke in good times and nowadays like being struck twice by lightning. Still, my friend’s plan would be disparaged in many classrooms as a “lifestyle” business, because he’s planning something that he wants to do rather than purely utility maximizing.

One argument is that job creation and wealth creation comes only from these IPO-bound high growth companies. So society — whether it be academic researchers, MBA teachers or government bureaucrats — ought to focus on these IPO-bound companies.

But what if my friend grows his new firm to a $50 million/year business? Is that still a lifestyle business? Over three decades, John Beyster built SAIC into a $7 billion/year Fortune 500 company with 42,000 employees before he finally decided to IPO.

Of course, many of the “lifestyle” businesses stay small. But the majority of the venture-funded rockets crash and burn. The chances of creating the next Google are even less than achieving an IPO that allows the VCs to sell their loser to an unsuspecting public.

And is market cap the only measure of venture success? About a year ago, I got to hear fellow MIT alumnus Sal Khan talk about his nonprofit startup, the Khan Academy. Sal is going to change how we think about education — either at the margins, or perhaps the standard K-16 modality for all of North America. Is this just a “lifestyle” business?

Finally, there are the inherent efficiency and effectiveness advantages of the owner-manager business. Investors, banks, the government, even academic theoreticians go to great lengths to solve the inherent principal-agent problem of having one party provide the capital and another manage that capital. As Enron and Worldcom and Government Motors demonstrate, sometimes these controls fail miserably.

If the owners are the managers, then all that effort is no longer necessary, because there are no abuses to prevent. Who has the most incentive to run a business for its long term success? The “lifestyle” business owner. Of course, success may not be as defined by some external economist or finance professor — but does that make it any less successful?

I hope to play a role in my friend’s new business. Perhaps he (or we) will grow it to a $10m/year business, or even a $50m/year one. I feel better about recommending this model of entrepreneurial development to my entrepreneurship students than gambling on VC and a successful exit.

Ultra-bootstrapping

TiE Silicon Valley is hosting a session next week on what it calls “Ultra-bootstrapping”:

Wednesday, April 14, 2010
TiE Institute - Ultra-Bootstrapping: Building a Start-up without funding.

Event Host
Murrali Rangarajan, Director, TiE Institute

Keynote Speaker
Naeem Zafar, Berkeley-Haas Business School, founder Concordia Ventures

Panelists
AG Karunakaran, President and CEO, MulticoreWare, Inc
Murrali Rangarajan, Director, TiE Institute & Managing Director and Founder, Business Accelerator, LLC

For those who don’t know TiE, it was founded in 1992 in Silicon Valley by Indian-American entrepreneurs, but now has more of a South Asian orientation (with us Euro-Americans also welcome to participate).

The description of the event doesn’t sound very “ultra”, but just the normal definition of bootstrapping:

Learn how to manage your Business Operations tightly to run on minimum cash. Lead from the front. Build your team with the right values. This session will be ideal for professionals starting out, for entrepreneurs who are at that critical growth stage and for team members.

Still, I support anything that encourages and disseminates best practices in bootstrapping to current or prospective entrepreneurs, and hope people will attend.

I probably won’t be able to make it because I’m scheduled to be traveling on business, but I’ll look for it on the TiESV video archive.

Panel on bootstrapping tech companies

Not surprisingly given the membership pool, the MIT Club of Northern California has four activities related to technical entrepreneurship. This includes separate speaker series on semiconductors and clean technology, as well the Venture Mentoring Series for alumni (more at a later date).

One that I didn’t know about is the C3 group (Convergence, Community and Commerce), which put on a panel last month called “The Art and Science of Bootstrapping.” The four bootstrapping panelists were

• Paul Kocher, Founder, President and Chief Scientist of Cryptography Research
• Michelle Munson, CEO and Co-founder of Aspera Software
• Beatrice Tarka, CEO and Co-founder of Mobissimo
• Sridhar Vembu, CEO and Founder of AdventNet

Although I didn’t make it, there is a long report in the Spring 2009 edition of the MITCNC newsletter.

Not surprisingly, the interest in bootstrapping is motivated by the increasing risk aversion of VCs, making it difficult to get seed funding. Entrepreneurs are having to bootstrap off of personal (or 3F) money to grow the business to a point where it’s interesting to VCs.

There are two paragraphs that caught my attention:

All panelists agreed that a company cannot always remain bootstrapped and there are circumstances when the founder should be open to accepting outside financing. Paul Kochar further elaborated that if a company is in a market that is poised to takeoff and there are no barriers to entry for other competitors to come in, moving fast is key to capturing market share. In such circumstances when a company can grow very quickly, it is imperative to look for the type of financing that can facilitate such growth, for example, to develop customer support and sales organizations or to invest in user experience. On the other hand, if a company is in a niche market with no competitors, then one can afford to bootstrap and slow the growth to maintain financial control.

I am guessing from the report that all of the entrepreneurs had high growth aspirations — and hence their concern about growing quickly before the window of opportunity closed. Here is the other paragraph:

Regarding how long a company can be bootstrapped, Michelle said that it is easy to bootstrap in the first two years of a company’s life, but beyond that it was less clear because the window of opportunity remains open only for so long. Sridhar said that if one does not have a big idea and no big discontinuity, it is better to be bootstrapped. Only 1% of new businesses are venture financed. Paul pointed out that some arenas, such as clean tech or semiconductors, are not generally good candidates for bootstrapping.

Actually, 1% is much too generous a number. By my own calculation, funding peaked in 1999 (during the dot com bubble) at about 0.15%, but in the early 2000s averaged about 0.037% — one company out of 2,700.

Obviously some of the other 2,699 companies are those (like my own) that are high-tech startups or have a strong technology component. Many of these are bootstrapped forever, but this normally consigns the venture to slow growth niches.

This is how I would have summarized the event if I’d attended:

Bootstrapping is a way of getting launched and proving viability to outsiders. However, if you are pursuing a rapid growth opportunity, then you will soon need sizable outside funding — either VC or corporate VC. If your competitors have it and you don’t, you will be left behind.

Are you a bootstrapper?

At SJSU, I’ve been working with some faculty colleagues to try to better explain how and why firms bootstrap. (Of course, there is a big question about what “bootstrap” means).

Last night, our Silicon Valley Center for Entrepreneurship had a panel discussion entitled “Bootstrapping Startups: The Pros and Cons.” It was moderated by angel investor, blogger and SJSU entrepreneurial finance professor Steve Bennet. His panel consisted of:

• Jon Fisher, serial entrepreneur, blogger and author of StrategicEntrepreneurism
• Gustavo Alberelli, director of Kennet Venture Partners that specializes in investing in bootstrap companies
• Ilya Ronin, a former software engineer and SJSU alumnus who is one of the three executives of bootstrapping Marpo Kinetics (an exercise machine company)

Steve opened by saying “Bootstrapping is a topic near and near to my heart.” As he noted, current difficulties of raising investment capital have raised the interest in bootstrapping.

Jon had an interesting definition of bootstrapping:

Can I approve with my management team a merger? … Do the team and I own 50.1% of the company. … Do we have the ability to exit when and if we should?

Jon noted — as I have argued for a while — that the IPO exit was extraordinary, and the normal exit for most firms is (and will be) acquisition. Thus, he argued, it is important for entrepreneurs to design their companies to be acquire-able.

Gus Alberelli’s Kennet Partners, surprisingly, specializes in investing in companies that have already bootstrapped to significant financial results. As their home page proclaims:

You’ve funded your growth the hard way: by selling real value to real customers.

You don’t need venture capital to validate your idea: the market has already done that. You need a different kind of capital.
…
The companies we invest in often do not need money to survive. They have options.

But the right investment from the right partner can help them keep ahead of their markets, expand internationally, ramp up their sales forces and lead to greater value for shareholders.

This is a very thoughtful argument for the bootstrap strategy (and their ability to profit from them). They have detailed pages on why this helps entrepreneurs, and how they choose firms. They have an entire page about bootstrapping, and a white paper entitled “Bootstrap Your Business for Success.”

During Q&A, Gus said they looked for two key things: “Do you have a repeatable sales model and is there a big enough market?” Unlike other VCs, they claim to be agnostic as to whether they will keep the founding CEO (and grow his/her skills) or bring someone else in.

I didn’t take as careful set of notes for Ilya (my former student), because he had a one hour presentation to my day class that had many more details. At that session, he listed some of the key bootstrapping challenges:

• Lots of work
• Difficulties in attracting a good team
• Small volumes mean less buying power and higher COGS
• Slower growth
• High level of stress on personal life

Starting with limited funds, the bootstrapper’s way out is to acquire customers quickly that pay the bills. Ilya number one piece of advice:

• Look for customers that are most likely to buy quickly
• Don’t target big segments that will take longer and are less likely to pay off

I am hoping that the panel will end up on the web or iTunes U. If so, I’ll add a link.

Finally, I want to end where Steve started: with a humorous quiz on bootstrapping, crafted by Greg Gianforte, founder of RightNow Technologies. (Angel Tim Keane has the full quiz online). The theme of the quiz is a self-assessment of the reader’s bootstrapping abilities (or proclivities).

My favorite question:

5. Your product does not do everything a prospect wants. You should?
a. Tell them it won't do those things;
b. Get them to pay for the enhancements;
c. Take the order and tell them it will ship in four weeks;
d. Explain why those things are difficult to do and convince them to buy the current product.

This was funny because it was so real: it exactly fits my experience as the head of a software company that bootstrapped from a $12,500 staring investment to a seven-figure run rate.

Update 1:45pm: Steve Bennet has summarized his own views of the event.

Raising capital in difficult times

In the past six months, it’s become even more difficult for otherwise promising tech startups to new or follow-on funding. On October 7, the now-infamous Sequoia PowerPoint deck advised their (mainly high- tech) portfolio companies:

New Realities
$15M Raise @ $100M post[-money valuation] is gone
Series B/C will be smaller raises
Customer uptake will be slower
Cuts are a must
Need to become cash flow positive

While some suggested this was a bargaining tactic by Sequoia to lower valuations, startup companies now face a double-whammy of declining demand by business and consumers and less availability of investment funds.

Of even more concern to the VCs, exit strategies will be more rare, less lucrative and more time consuming:

Increased Challenges
M&A will decrease
Prices will decrease
Acquiring entities will favor profitable companies
IPOs will continue to decrease and will take longer

Since VCs won’t be able to cash in their investments for a long time, they must set aside more money to keep alive a smaller number of companies.

In Thursday’s Wall Street Journal, veteran tech industry reporter Pui-Wing Tam wrote about [also here] the dilemma faced by a small Oakland-based VC fund:

Claremont Creek Ventures recently had to decide which of its young to forsake.
…
Amid the financial crisis and the plunging stock market, Claremont Creek decided to focus on the fund's best investments and stop backing the less-promising start-ups. It wanted to be sure it had enough cash for the next few years for the winners. The venture firm ranked the start-ups in the fund's 16-company portfolio with an A, B or C grade.

"We're doubling down on the As and likely won't invest any more capital in the C companies," says John Steuart, a Claremont Creek managing director. "The portfolio is competing against itself and it's survival of the fittest. It's brutal."

Angel investor and fellow SJSU entrepreneurship teacher Steve Bennet is one of the few who has beat the odds. In his ProfessorVC blog, he explains how one of his portfolio companies raised $6 million in Series C funds.

For those that have already tapped 3F money and can’t raise professional money, the choices are pretty clear: sell the company, stop operations or find a way to bootstrap.

Steve will be moderating a March 9th panel on bootstrapping at the Silicon Valley Center for Entrepreneurship. More details on the program when they are available.