Your Startup Guru

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The Importance of Bootstrapping

The importance of bootstrapping cannot be emphasized. Most businesses fail because of a lack of cash and bootstrapping’s main objective is to do the most with the least amount of cash.

Bootstrap – adjective

A situation in which an entrepreneur starts a company with little capital. An individual is said to be bootstrapping when he or she attempts to find and build a company from personal finances and/or from the operating revenues of the new company.

The business was a bootstrap operation for the first ten years.”

The importance of bootstrapping

Most startups do not have a bunch of cash lying around.  The importance of bootstrapping is all the more critical for them. Businesses have to make do with what little they have.  We often tell our clients that as the CEO/Founder, they are also the janitor. One potential client wanted to hire a marketing manager for her startup. Hiring a marketing manager was vastly beyond her revenue allowance. She should have allowed us to consult on how to manage her own marketing campaign. She then could’ve saved a fortune by being her own marketing manager.

The temptation to abandon bootstrapping is strong, especially when investors come knocking.  One of my clients attracted large investors with a business plan I had prepared for him.  Initially, I budgeted a modest salary for him in the financial projection.  He saw that there was a good amount of retained earnings (something investors want to see) and had since budgeted a larger salary for himself.  I had to tell him to reduce his salary.  I am not alone in emphasizing this sentiment:

  • A red flag goes up for Mark [Cuban] when a Shark Tank contestant says that he’d be comfortable with a six-figure salary.  Ultimately, Mark and all the other sharks walk away from the deal.
  • Serial entrepreneur Neil Patel, founder of Crazy Egg and KISSmetricsreflects on how glad he was keeping a $5,000/mo. salary even after raising $4,000,000 in seed and series A rounds for KISSmetrics.

Your Startup Guru advised a client to pay himself less and take in dividend income instead because it is taxed at a lower rate.  In business, cash is king, and the CEO doesn’t want to be the kingdom’s worst drain.

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Calculating what equity percentage to give

2000px-Cake_quarters.svgMy clients are often in the position of having to offer equity in their company to potential investors.  However, how does one know what percentage to give?

Well, one way is just by gut.  You got a person willing to invest $20,000 into your company but you don’t know want to give up too control so you offer 25%.  Conversely, on Shark Tank we see entrepreneurs be given very little money while giving up a large portion of ownership in their company.

There are other more quantitative methods such as asset-based, comparable, option-based, etc.  However for a start-up without much in assets or earnings per share data, these methods are difficult because there aren’t enough figures to go by.  Also, if the business is truly unique, then comparisons of “similar” companies don’t exist.

One of the more common measurement for valuing public and private companies used by investment bankers is the Discounted Cash Flows Method.  This is useful because with every business plan and financial projection I create for my clients, I create a cash flow statement.  With this I take the total projected cash flows from each year and adjust their future value into their present value.  This is to adjust for interest (i.e. $100 today doesn’t the same as $100 in ten years).  Then I take the discount rate (risk-free U.S. treasury rate is most common) to calculate the present day equity value of the company in X years using this formula:

dcf formula

The amount of investment capital received is the percentage of equity given.  There is obviously room for negotiation because forecasted cash flows is debatable and the amount of involvement (i.e. sweat equity) the investor wants to put in is also a factor.  Nonetheless, it is a gauge one can use to make sure they’re not giving up too much.


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