What is boot-strapping anyway?

There are many different answers on this and my view takes it from a “founders’ equity perspective”. What do I mean by this?  The less capital the founders give away early on the more likely they will own a majority stake after several rounds of capital raising.

One of the best ways to preserve founders equity is for a business to grow through internally generated cash, or put another way, sales.  At the start of a business or the launch of a new product for a business, more cash will be flowing out investing in the R&D, marketing, paying staff costs, overheads, than will be coming in from new sales.  

There will always (or should be) a tipping point where income from sales equals outgoings on a monthly basis.  Careful here because this does not mean the company is making a profit for that year, since there will be the previous months of costs that are sitting in the expense account.  However, when the company is generating at least an equal amount of cash to the cash going out, this is a company at its Boot-strap position.  

The Boot-strap position signals something very important to investors.  The problem that the company set out to solve is a problem that customers want solved and they are willing to pay for it.  Some of the risks have been taken out and the issue becomes one of scalability with projections based on a more reasonable data set.

Now with some numbers….

NB. Assume in the below example that the opportunity for the same technology Company A and Company B are working on did not go away due to a 12 month time lag.

• In 2009, Company A has not hit the Boot-strap mark and obtains $400k in capital injection (say, from a syndicate of 15 known contacts) in return for a 40% stake in the Company.  We say the post-money valuation is $1 Million.
• Company B, on the other hand, decided to spend 1 year to reach the Boot-strap mark before it decided to take in $400k in capital in 2010.  The investor in Company B perceived that the investment risks were lower because Company B had more proof points of value creation during the last 12 months - and importantly had customer feedback.  In addition, based on the past, the future milestones and what Company B planned to spend the $400k on appeared (from the investors perspective) to have more certainty that the Company’s shares would increase in value.  The post-money valuation in this instance was $2 Million, with the investor only receiving a 20% stake in Company B for the same $400k injection.

 

1. THE POINT: If $400k capital is only the first of a series of capital-raising rounds, then the founders of Company B will have more equity to play with and will be able to keep control for longer.
2. THE POINT:  If both Company A & Company B sell to a large company in 2013 for $20 Million, then the founders impatience in the first 12 months will have cost them at least $4 Million.  

 

Morgan Cradock will soon be launching a new software product to help companies develop a strategic capital raising road-map.  We really need to know what features or problems you encounter in your own capital raising process.  

Please sign up to our CapitalRaisePro software email list and give us your input.  We’ll let you know when the product is available - probably within the next 3 months.