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Bootstrap Your Way Through the Cycle*For Red Herring Europe 2009

April 2, 2009

*And why bootstrapping and venture capital are compatible funding strategies

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What Do All These Companies Have in Common?

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They Were All Boostrapped StartupsContrary to popular perception, many of today’s

market leaders initially built their companies through ‘sweat equity’

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In Fact, Four of Them Spent Their First Years Fighting a Recession!Microsoft ('75) - founded off the back of the oil

crisis / stock market crash

Oracle ('77) – launched right into the '79 energy crisis. Tight US monetary policy led to a recession that lasted until '82

Broadcom ('91) - product of Black Monday and the early 1990s recession

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Bootstrapping: Some Definitions

Company that has raised little or no

external funding

Equity mostly held by

founders

Growth funded from cash

flows

Break-even by necessity

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This means a leaner, meaner business

Why Bootstrappers Do It Better, For LongerCustomer focus is baked into the company’s DNA

• Product/service is by definition market-tested

• Outstanding customer service is a necessity, not an option

Management is more focused, has to prioritise ruthlessly

• Problems dealt with quickly, not glossed over with money

Founders retain more control over the business, and the degree of risk they take with it

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Investors Have Become Thin on the Ground...

Angels have gone to heaven

VCs are holding back

reserves for their portfolio

companies

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Investors Have Become Thin on the Ground...

Debt markets are frozen

Small cap stock markets

remain firmly shut

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Investors Have Become Thin on the Ground...

Fair-weather investors, like hedge

funds, strategics, have taken

cover

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... And the Goalposts Have Moved Investors now want to see innovation, traction,

ambition and:

• A countercyclical market opportunity

• Proof of a working, mature sales model

• Demonstrated, recent resilience in tough markets

• Short path to break-even

Hardest hit: early-stage ventures

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How To Bootstrap Your Business Through the Cycle Start with tactical revenues to fund development

• Consulting, NREs, projects

Develop a single, simple product/service and perfect it

Target recession-resilient markets if appropriate, eg education, healthcare, niches in eCommerce or SaaS

• Follow the stimulus money (in US) or equivalent in Europe!

Keep development costs down

• Use cheap infrastructure – hello cloud and open source

Look for a short or negative working capital cycle, eg get paid before you pay your suppliers

• Good examples of this are eCommerce companies like BuyVIP

Rely on creative online lead gen, guerilla marketing, social media promotions

• For an example, check out Bonobos

It’s mostly common

sense

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But Bootstrapped Companies Eventually Run Out of SteamCan’t invest to accelerate growth in a recovery

Founders become overly risk-averse as the value of their nest-egg grows

Top-flight executives are hard to recruit without a strong capital base

Lack of external advisers, independent board can lead to ‘tunnel vision’

Non-contributing shareholders (departed founders, family and friends) can hold the business back and become a distraction

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Case Study: GoViral Set up by 2 founders in Denmark in 2005 to seed viral

videos on blogs and other web sites

Initial revenues generated from consulting projects

• Development of platform funded gradually

The business grew quickly and ran profitably, building out a large publisher network for video distribution

Eventually GoViral reached a tipping point, where

• It needed more experienced management

• It wanted to expand its geographic footprint

• An external board could contribute strategic direction

The company recruited senior executives from Leo Burnett and TradeDoubler, and raised €6.5m, adding an institutional investor to its board

Viral video example:

Fifa Street 3

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Timing Is Key – Recognise the Inflection PointDon’t raise capital when you need it, raise it when

you don’t

• This means you take less risk with your equity

Positive external factors

• Customers are buying

• Market growth is accelerating

• Acquisitions are possible

Positive internal factors

• Sales model or customer acquisition model works and appears to be repeatable

• Constraint on faster growth is internal management capacity

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A Digression on the Importance of the Sales Productivity KPI We call it the Growth Velocity Predictor or GVP

It tells you very simply whether it is worth diluting your equity holdings to invest more in sales

• It’s a measure of the scalability of your business

The formula is: gross profit ÷ cost of sales, eg

• Revenues of €800k @ 70% gm = €560k

• Cost of 2 sales people & marketing = €290k

• GVP = 1.9

• You can apply this to aggregate numbers (historic, forward), or to specific deals/projects

Anything above a 2.0 or 2.5 is great and an equity investment in sales should yield positive ROI for founders

Between 1.7 and 2.0 is OK provided fixed operational costs in the business can be held low

If your GVP is below 1.5 it’s worth reviewing your sales model and pricing strategy to find improvements before raising money

A similar model can be applied to consumer Internet companies using the cost of customer acquisition as the cost of sales

For consumer Internet

services, substitute

gross profit for a measure

of your customer

lifetime value

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Good, Saleable Reasons to Raise Capital Today Expansion of proven sales model with high GVP

Acquisitions or partnerships that lead to rapid acquisition of customers

• In this cycle critical mass is going to be more important than ever

Bolster balance sheet in an otherwise profitable business

Take out non-contributing shareholders

Less good reasons:

• Significant cash out for working founders

• Development of a completely new product/service

• Speculative expansion to multiple territories

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What VCs Dream of FundingBusinesses with:

Recurring revenues and controlled churnSmooth revenue growth and variable costs, no lumpsStandard, documented, repeatable sales modelStrong ‘recession story’Low customer concentrationNegative working capital requirements, eg your

customers pay you first!Realistic business plan with growth in the low-side

case and significant upside if all goes wellClear understanding of, and contingency plan for, the

downside scenario

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If You Can Bootstrap Your Way Through Half that Checklist… ... You can raise capital from a position of strength

As the markets recover, the leanest, meanest companies will become tomorrow’s winners

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Growth equity for US and European TMT businesses

• Capital for sales expansion, acquisition finance, shareholder liquidity

Over $500m under management from offices in London and Silicon Valley

Max Bleyleben, Managing Directorhttp://maxbley.typepad.com/http://www.kennet.com/

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