Bootstrap Finance

The Importance of Venture Capital

High Growth = Need for VC?

• Bhide study of Inc. 500 companies (from 1989)– Median start-up capital was $10,000– More than 80% financed through personal

savings and personal borrowing

Issues with Venture Capital

• It’s extremely time consuming• They won’t always “get it”• They have very specific criteria

– They are looking for “home runs”– They don’t want to invest small amounts– They want to see a clear path to success (while many

businesses actually evolve to success)– They want proven management team

• Funding can remove discipline• Do you compromise flexibility? Lots of performance

pressure• Loss of ownership and control

Bootstrapping vs. VC

Boot Strap Finance Start-up• Get operational quickly• Look for quick break-even,

cash generating projects• Offer high value products or

services that can sustain direct personal selling

• Forget about the crack team• Keep growth in check• Focus on cash, not on profits,

market share, or anything else.• Cultivate banks before the

business becomes creditworthy

Angel / VC Financed Start-up• Create proprietary technology

and build demand quickly• Focus on large, high growth

markets• Offer products or services that

customers can easily adopt• Build a credible management

team• Grow quickly• Stay on strategic roadmap• Restrict bank financing to

working capital requirements

Transition

Transitioning from an Entrepreneurial to a Professionally Managed Company

• Emerge from niche and compete with a larger company

• Offer more standard, less customized products• Change management focus from cash flow to

strategic goals• Recruit higher priced talent • See Greiner HBR article for more on transition

stages companies experience– “Evolution and Revolution as Organizations Grow”

Caveat

• Don’t interpret any of the previous to mean that venture capital has no value

• VCs can bring a lot to your business– Cash– Expertise

• In core business• In extracting the most value from the

– Networks– Reputation effects

• Weight of the evidence is that VCs do add value• The trade-off

– A smaller piece of a bigger pie vs. a big piece of small pie

Building Value

• A very strong vision ( 2010. . RL to year 1980)• Clear positioning of the brand (bridge / luxury)• Building a brand (with minimal advertising)• Conservative growth• Virtually no resources• Incredible discipline/focus• Bootstrap financing

Bootstrap Financing

A. Initially (1992-1996)Andy Spade $ 35,0004 Partners ($20k x 2yrs each) $160,000Operating Cash Flow

1993 (p.15) Est. (45)1994 (p.15) Est. 21995 (p.15) Est. 241996 (p.17) 704 $685,000

Stretching Payables ~$900,000(see 1996 AP on balance sheet relative to COGS)

B. 1997 – Capital Needs

Increase in inventory and receivables requires more capitalDecrease in payables requires more capital

Capital SourcesNotes Payable Officers (p. 17)) $600,000Operating Line of Credit (p. 17) $900,000

Typical Growth?

• Unusually conservative in financing (no debt, no Angel or VC financing)), distribution (highly selective), product focus (very disciplined)

• Extremely lean and Spartan operations• No salaries until business could afford them• Eschewed traditional advertising and

promotional (e.g. freebies to stars)• Power balance and win-win relationships with

external contractors (e.g. home-based manufacturing, showroom owner just starting out)

What’s Easy/Difficult?

Easy (or easier)• Small scale

operations• Stinginess (if it is a

habit)• Planning and market

positioning• Quality control (when

small)

Difficult• Saying no (market

channel discipline)• Executing to a clear

vision• Coping with growth

and complexity

Continue to Grow?

• Opportunities to grow and complexity of the business becoming too great

– Geographic Scope (International?)– Outlets/Distribution (Own Stores?)– Existing Product (New Materials)– New Patterns– New Products

• Stresses already in management• Big pressure from balance sheet

– Huge jump in working capital needs (inventories, receivables)

– New $900k note, big stretch of payables, $600k note to founders (probably unable to pay bonuses)

Continue to Grow?

• Issues– Can they scale up, but preserve the

quality, integrity, and image?– Can they transfer these things to other

merchandise and other kinds of distribution?

– Can the partners do these things?– If not, who comes along? Who gets left

behind? Who comes on board?

Organizational Changes

• Concentration of decision-making, appoint or hire a CEO• Re-allocation of founding partners to appropriate roles• Build layer of operating managers/staff – slowly and carefully• Formalizing some governance arrangements in order to separate

strategic from operational decision-making – Board of Directors or Advisory Board

• Some functional breakdown that leaves Kate and her design skills as the focal point

• Point persons in international markets (i.e. Europe and Asia)• Senior financial manager (e.g. CFO) as internal accounting need and

complexity of external financing increases• Some appropriately scaled ERP to support internal and external

logistics, management information, and transactions• Redesign product development process to reduce cycle time

Evaluating the Deals

• Valuation of the business (Now and in future)• Personal harvest (i.e. individual financial benefit to founders)• Changes in the governance/control of the business• Performance standards

– What they are– The consequences of meeting/not meeting them

• Buyout/harvest provisions• The deal should be:

– Fair to both parties– Anticipate future capital needs– If successful – win/win– Trust

• Need to ask:– What can go wrong/right?

OPTION A - VC

• 40% for Post Money Valuation of $40 million• i.e. Put in 40% of $40m = $16m => Pre-Money

Valuation of $24 million (LOWEST)• Additional annual fee for professional guidance• PRO

– Comes with seasoned CEO– Keeps control with founders– Retain 60% of increased value

• CON– Low valuation of company

OPTION B - Fossil

• Paid in their stock ($14, Trading range $5-14 in last year)• Pre Money Valuation $50 million (80% for $40 million stock)• Buyer has $245 million revenue in 1997, has retail/outlet stores• Image is “America in 1950s” – Fun, fashion humor• Upper Moderate positioning• PRO

– Well-run company– Access to lots of resources– Straight, humble, conservative

• CON– Culture clash?– Trade perception (positioning)?– What happens to stock? Lock up?

OPTION C – Liz Claiborne

• 100% for $70 million– 30% ($21m) Now– 70% ($49m) Earn Out

• Apparel and Accessories– Casual, Career, Men’s– Broad range of price points– Extensive distribution

• PRO– Premium price

• CON– Ability to maintain quality and design– Earn out not assured – aggressive sales targets

OPTION D – Neiman Marcus

• $36 million for 60%• Pre-money valuation of $60 million• Put/Call on remaining 40% in 6yrs at Future Mkt. Value• Strategy to buy brands and use synergy to build business• PRO

– Valuation

• CON – Their competitors are KS’s customers– Will KS keep control of design?– Will KS have to make private label?– It could all be over in 6 years

What They Did

• Went with Neiman Marcus– Sold 56% of company for $33.6 million

• Brand extended into more categories such as stationery, footwear, beauty, accessories, and housewares.

• Continued international expansion and launched the Jack Spade label for men

• Founders exercised put option in October 2006 selling remaining 44% to Neiman Marcus

• Neiman Marcus sold business to Liz Claiborne shortly thereafter for $124 million