To Discuss Main Page

AdMarketing | Funding & Finance | Netpreneur Corner | News Center | Quick Guide | Home

a netpreneur online conversation

negotiating & bootstrapping 

 

On July 18-19, 2002, Ransom Parker, Managing Director of venture capital firm SpaceVest, was a special guest in The Loop email list taking questions from group members on the topic “Negotiating With VCs (And Others).” In anticipation of that event, members of The Loop began discussing issues in negotiations, and it soon became a conversation among entrepreneurs about there bootstrapping experiences and strategies. The online discussion is reproduced here. Some posts have been edited for length, clarity, flow, and topicality. The complete, original posts can be found in The Loop archives, which is accessible to all subscribers.

 

 

Ben Martin: In a conversation I was having this morning, the point was made that for most early-stage companies the majority of negotiations focus on getting the resources necessary to build the company as inexpensively (or free) as possible. In the spirit of discussion, I would like to hear thoughts from others in the group on this point. Does anyone have any examples?

 

Anthony Strande: Building a business is more about generating revenue than it is about conserving expenditures. As such, the real issue is one of getting the product sold, installed, and operating through a succession of customers, each taking less risk and contributing more revenue as market position is gained. I would have to argue that the business-critical negotiations are more focused on achieving a satisfactory risk/expenditure ratio from the viewpoint of the customer rather than from the viewpoint of the entrepreneur(s).

      Yes, the idea of minimizing entrepreneur expenditures should never be discounted. However, the really important negotiations are on the income rather than cost side... and are probably more energy consuming.

 

Chris Carlson: Isn't it quite a Catch-22? Investors want us to build our companies/products as inexpensively as possible *AND* make sure we build in defensible technology and/or intellectual property. In most cases, what two people in a garage can build would be EASILY reproducible by a larger company with resources. Patents? Forget about it. Three years and $50,000 latter you're spending all your time in court!

      It's all about the resources (read $$$s) to effectively execute on a company vision (product, sales, partners, creating barriers to entry) that give a company some valuation. That's what we all need institutional investment for, to rapidly execute on that defensible position, where in most cases it's hard to do organically.

      Having said that, I purposely changed from a hardware model to a software model (albeit running on low-cost Intel appliances) to keep CapEx, COGS, and cost of development low. My first developers worked on their home machines for a while to develop our prototype, something you can't do for a hardware or infrastructure company. We're seeking investment to accelerate on our revenue plan, now making the next discussion valuations!

 

Vineet Kumar: My company, Xyoom Corporation, provides Internet Protocol (IP) Telephony based services and products for business, government, and education to migrate from legacy to secure IP telephony. On the product side of our business we are developing supplementary services software for IP Telephony. To build our product business so we can get off-the-ground our focus is to get the resources we need as inexpensively as possible. We are talking with our potential customers to fund us for the supplementary services that they need. We are talking with IP Telephony vendors to fund us or/and give us free equipment so we can develop the services for their products. We are also TRYING to figure out if Fairfax county provides free space for at least a limited period of time. We are constantly looking for inexpensive and even free resources to get us off-the-ground.

 

Gene Gartner: The one thing I'll say is that some entrepreneurs get fixated on a total cost of a resource. I have negotiated with several where I have put together very flexible payment options/plans and then have negotiations break down. The reason is that they get fixated on the total cost without looking at what the resource can bring them. I think this happens because we still have people thinking of things in a 1990s model of swapping equity for services/resources and it is compounded by business plans that expect to get a service/resource at a fraction of market value.

 

Neil Houghton: An interesting topic. I agree with Anthony Strande that revenue/resource alignment should be first. However, here are some ideas I have about expenses that I thought I’d write down:

 

1. Almost always shop around. I am continually surprised at the range of options and prices given by different vendors for roughly similar products or services, as well as how negotiations are really where effective strategy and financials meet. We have found this to be true in terms of specialized software we bought, engineering services, and terms for legal help. Unlike consumer purchases, where the differences between stores are +/- 25%:

  • the software was similar quality but 1/10th the price of the other vendors,

  • the engineering was more specific expertise and ˝ the cost, and

  • the legal was completely different payment structure and better qualified.

I have found shopping around to be far more effective than just looking for an angle in a one-on-one negotiation.

 

2. Complex partnerships done sparingly. There is a great story about Millennium Pharmaceutical. They used a partitioning of their rights to leverage a very small amount of venture capital into $700 million in partnership deals where they sold drug development rights they didn’t want and got to get more experience, build the organization, etc. But being always on the lookout regardless of deal size can be a real waste of time. These deals, I think, should be limited to two or three major initiatives for a startup. For an example of a painful small partnership, let me share a mistake I made. We wanted to conduct a survey of prices in 20 different countries, and I thought we would approach a few organizations in our field that had operations in those countries and offer them a deal. They could help us do the survey and we would share the expenses. Anyway, after a bunch of phone conferences, conversations, emails, etc. we finally got a couple of groups interested, but they needed some time to think about it. While waiting for everyone’s response I got impatient and called a few vendors to do the survey for cash (~$5K). They all called me back that day, one was hungry for work and underbid, we went with that one, and that vendor finished the survey before the other “partners” finally figured out they didn’t want to participate. Certainly the partnership approach wasn’t worth the time trying, even if they had decided to participate. Perhaps the only thing it does is to keep one’s selling skills operating. There is something really, really elegant about the simple structure of “you give me one of those, I’ll pay you cash.” Responses come quickly. People work hard. The relationship is clear. Disputes are easy to resolve. No time is spent fiddling and selling. Senior management doesn’t need to get involved.

 

3. Free is usually more expensive. As a result of our goal to deliver eyeglasses in the developing world, we have also received a lot of free help, and I appreciate all that we have received. However, there is often a hidden cost, and a reluctance to get the deal terms out and clear early, since it seems so good. But if the other side isn’t in it for the long haul, or if the effort doesn’t hit to the core of the other organization’s mission, things get difficult or end up being counter productive. Accountability is difficult. I think this experience can be generalized to other organizations, where something appears free but really ends up being much more expensive. Maybe this advice should be included in that….

 

Duke Chung: I'd like to contribute my two cents to this interesting conversation based on my experiences starting up Cyracle.

      My experience as an entrepreneur has been to focus on the cost structure of a company. If you look back historically in the past few years, most companies failed because they were so well funded and never had to worry about their cost infrastructure. Their expectations were set incorrectly to begin with, and, when the market crashed, they found themselves helpless or on "life support." I believe the intelligent entrepreneur, who wants to build a long-term, successful business will always look for ways to keep their costs down; which is a fundamental concept of doing more with less and a move toward a more efficient world. Companies who missed the funding-bonanza of the last two years, are the real companies who have survived the crash because they were able to maintain such a low burn rate and are psychologically prepared to continue this process until they are cash-flow positive (or profitable!). These companies set expectations correctly early on and now can benefit from the fruits of a bad economy (i.e. find cheaper rents, cheap furniture from bankrupt companies, low advertising rates, etc.). This is why people say it’s the best time to start a business.

      When you look at an early-stage company, the key cost of doing business is your people (or salary). It’s the most critical asset of any business, and the most costly as well. Finding ways to attract talented people at a low cost is the key to early-stage success. I've been asked many times if they should spend time looking for VC funding or bootstrap their way to success. My answer has remained consistent: Since you're going to be giving away shares of your company anyway, would you rather trade for cash (to pay your early employees) from a venture capitalist, who only cares about their ROI and controls your destiny, or would you rather give it to your people (who will bootstrap with you), and will be there every single hour and day to help you build a successfully company?

   

 

to top

 

Don Britton: I can not agree with Duke more. I feel you should focus on the cost structure of the company. In the early stages, cash is scarce and you need to figure out ways to deal without it. I will admit that we looked at funding for a while because it was the cheapest form of financing a couple of years ago. However, we never spent an enormous amount of time chasing it in comparison to others that I know. We continued to spend most of our time on building a business with a solid foundation which has made us successful today. Other friends and competitors that did obtain funding, in my opinion, spend way too much time chasing the dollars and not truly figuring out a cost effective and correct solution to market problems. At that time, they had the money/resources to make mistakes. We did not. We had to clearly think through our decisions and make sure we were going down the right paths before just jumping in and worrying about it later. It took us a lot longer, but the main point is we are still around and will be around for some time to come.

      Duke's other point about people is the most important. You will never find a more important resource than your people. We make it a rule to surround ourselves with great people. A good team will stick with you through the thick and thin whereas outsiders will not. This is why we spend a ton of time on interviewing, testing and making sure that the people we bring on board or work/partner with are the best. One lesson I have learned is that the wrong person can cost you more than you ever imagined. You are only as good as the people you surround yourself with and good people will attract other good people and resources.

      One comment made earlier was that this whole dilemma is a Catch 22. Well, yes it is but such is life. To me, this is what will differentiate entrepreneurs. The entrepreneur that truly wants it and is hungry will do whatever it take and figure out ways around all obstacles and will not make excuses. A while back, one of my advisers told me that it is the guy who sticks with it and does not give up that succeeds. This is one lesson that I can not agree with more. Where there is a will there is a way and you will find ways to obtain the resources needed without the dollars. This is what the good VCs are looking for. They are looking for the team that will do whatever it takes to be successful. The good VCs (not the late 1990s VC) are not looking for a team with a cool idea that will hopefully stick around when things get tough and resources dry up. I did not realize this when we were looking at VCs a couple of years ago and could not understand why they were not investing. It was not about the idea, concept or business. It was more about proving that our team could make things happen even if the core idea, concept, or business had to change a little.

      Finally, I also agree with Neil Houghton’s earlier point that “free” is usually more expensive. We have received and continue to receive the benefit of a lot of resources for free (in the sense of dollars). However, everything we have obtained or help that we have received without paying money for it came from my giving my time and resources to others without ever asking for anything in return. People who know me know that they can count on me to help them out when they need it. So, in return, when I need something there is always someone there to help me. This again goes back to the point about surrounding yourself with good people. Surrounding yourself with these type of people you will be able to count on them for what you need. While my time may be more expensive that just paying some cash, I think the return way outweighs the cost. I know this is not anything you have not heard before, but if you are interested, I think the book by Harvey Mackay, Dig Your Well Before You're Thirsty, is a good resource to read in regards to this whole topic.

 

Feras Qumseya: I do agree with Duke. While we are gathering some funds for product development, the most critical step of initiating the company was finding the right people who would accept the kind of compensation that early stage companies can offer. Thankfully, we believe that we have one of the best management teams around, composed of diverse and motivated people. This is the real asset all early startup companies should capitalize on first. When this occurs, products develop and negotiations start. However, instead of spending time and money on looking for VC funding, this time should be spent to find the people who will fit your circle (which can be done at VERY low cost).

 

Shimon Shmueli: From my experience as an entrepreneur, there are stages in the life of a startup in which the level of bootstrapping varies. At the beginning, its you and your bootstraps, and lifting is hard. You need to scrape resources from variety of sources; however, this is a very dangerous time in the legal sense, and you need to be very careful. I had a nightmare experience with a provider who helped me pro-bono at a very early stage and resurfaced at the eve of closing first VC round demanding outrageous equity. We were forced to quickly negotiate our way out of that situation and he got significant amount of equity out of the founders' pool. Sounds familiar? it happens, and I think the movie Startup.com documented a similar situation quite well. Free lunches can be very expensive.

      While I am on that, I’d like to be a bit self-serving. One of the characteristics of early stage companies is chaos -- the Primal Soup and the innovations it breeds. However, some discipline and methodologies can be introduced at the very early stages, the "fuzzy front end," and, if done correctly, these can even facilitate innovation. This is one of the very broad set of issues that the Product Development & Management Association deals with. A great organization to belong to. Recently, we organized a local chapter and our first event was a great success.

 

Justin Hitt: Since there is a bit of talk about early stage companies and resources, what does an owner do if a side project turns into something that would require a modest amount of cash to develop but has a good sized market?

      An idea came to me in a dream and after about 2 days of researching feasibility, I documented it. The idea solves the problem of nutritious food for long term space exploration or for food production in harsh environments (like deserts and cold places). The only problem is that I am quite busy with my writing and consulting. I can't just run around chasing every idea that comes to me. Should I package up the ideas (like a research paper) and try to sell them? I looked into patents but they are quite cost prohibited. I was able to verify the technology is available to do the project mentioned in the opening paragraphs. In fact, if several NASA projects and university programs were combined, their technology could produce the idea this year.

      I really must choose one thing to work on at a time. Right now the consulting is reaching the most people and generating some income. Any ideas? Document the ideas and market them, or just stay focused on what I'm doing?

 

Raj Khera: Justin, you might consider writing a proposal for an SBIR (Small Business Innovation Research) grant which are provided by all of the major departments of the government. These aren't easy to get but they can fund your project through an exploratory phase to development. An old acquaintance of mine, John Davis, runs a website, The SBIR Resource Center, to help entrepreneurs find and land such grants. Links to all of the agency pages for SBIRs are at: http://www.win-sbir.com/related.html. Might be worth looking into.

      As to Ben’s original comment that in “most early-stage companies the majority of negotiations focus on getting the resources necessary to build the company as inexpensively (or free) as possible,” I can share my example.

      When I first started years ago, we did as much billable consulting work as we could by day to build up cash reserves and then work on product development during off hours. As the product rolled out, we trimmed back on the consulting to support the product. As the product (which we spun-off as a separate company called GovCon) gained traction, we phased out the consulting, and even sold some of our consulting gigs.

      With GovCon, we traded our products/services for anything we could whenever possible, including accounting, legal, graphics; we even got a T1 connection for a year through a trade. You still have to record it on the books, but you save cash. A few other cost-structure-related things we did:

 

-     partners drew minimal salaries till there was sufficient cash flow,

-     shared some expenses with other firms (such as joining forces at trade show booths), and

-     made a lot of partnership deals to add distribution channels without adding costs.

 

      I also found that one of the other keys to our success back then included living a frugal lifestyle. We didn't need to take as much cash out of the company because we minimized our personal expenses. This left more in the bank to hire staff as we grew. We eventually became the largest government contracting portal online (got acquired in 1999).

      We've used part of the proceeds to fund our new venture, MailerMailer, so that we could bypass the need to generate cash to support product development. But our mindset of minimizing expenses has helped us become profitable quickly and grow every month in an otherwise down market.

 

Mike Weiner: Greetings. Ben Martin asked me to write The Loop group about my experiences in a venture I've been cooking up for a couple years. I don't know if it will be helpful to you in your endeavor, but here goes.

      I have a bootstrapping story to tell. It's been quite an adventure that started with a need to have broadband access from my in-home audio production studio.

      Frustrated by the inability to get DSL to my neighborhood, I decided to order a T-1. While the order was being processed, I realized I only needed it for short bursts during the day, so why not rent it to my residential neighbors for $40 a month? Researching wireless solutions led me to find a number of manufacturer's that had gear in the 802.11 standard, 2.4Ghz unlicensed spectrum. I found one that sent me a 6-pack to trial-run with my neighbors. I set this up, and then started buying additional subscriber units from e-Bay or wherever I could get them cheap.

      We're now up to 12 paying subscribers, with the ability to add several dozens more on the street. Now I am getting calls from people in other neighborhoods asking me to set up a network for their community, too-- about two a week.

      The real excitement came as I realized that I could set up, or integrate existing neighborhood networks that others have set up to build out a locally-focused series of community based wireless networks across the city and the country.

      It has now been two years, and the challenges of trying to raise venture capital have been enormous. Everyone I met with had an opinion about how or why it can't or won't work, for this reason or that. Dozens of business plans sent out. Even winning Netpreneur’s Fast Pitch and presenting this to Draper with a one hour meeting got me nowhere.

      Meanwhile, I sit here with a working network and paying customers awaiting the first tranche of a promised VC equity investment of $40M from a California firm that sees (FINALLY!) the vision and the opportunity and is putting in the money needed to take off.

      Bootstrapping has been a royal pain, but it has forced me to economize on things, keep my operating costs down (I recently ordered a new T-1 that will shave a few hundred dollars a month off my bill) and keeping it very simple. My business model demonstrates a need for $40M over five years to build this into a $200M+ annual business, but my goal is to use only half of that by doing economizing and cost containment as much as possible, including contracting to build our own gear to reduce costs further. I don't need a fancy website, as one VC told me, to build Internet service to my neighbors. I don't need Class A office space. I do need money to hire talent to make this grow, gear up with the equipment, and be picky about where I build my networks. I've also learned that I have to be firm and avoid those who are trying to sell me something I don't really need for my business.

      Words of wisdom? If you believe in the idea and can make it work down and dirty, it still doesn't mean people with money are going to see the opportunity until someone else jumps in first. I have found that, in general, the VC community has some real problems with egos and control that, frankly, caused a lot of the problems we are now facing.

      Stay with it as long as you can. I ran out of my own cash to put into this long ago (18 months ago) but have kept it limping along, nursing it until I found a VC who believed in the idea, me, and the plan, and didn't get greedy by taking so much I would be de-motivated. They are out there, but few and far between as I have found. Keep your idea alive and build it slowly. I approach it like I'm building a house. It starts with a foundation, then you start adding on once the foundation has hardened.

      I never lost faith that I was on to something big. I knew it was true when I started seeing the trend in wireless networks taking place elsewhere, and now I will have a chance to create the dream starting in the next months with the financial commitment from others who see it, too. Don't wait for the phone to ring. Make your idea come alive as much as you can so you really have something to show.

      What does the future hold? Don't know yet, but the picture in my head looks pretty good. Keep your picture strong and it can materialize into reality. It just won't happen at the speed you wanted it to.

 

Brandon White (of GIV Venture Partners): in response to Chris Carlson’s comments about the “VC Catch 22,” you definitely will hear the defensible technology question coming from me, that is for sure. Having said that, from my perspective, I am concerned when talking with entrepreneurs about two things in this regard:

 

1. Is the technology defensible? If so, have you protected it? If not, can we quickly do so with some capital.

 

2. If you have not protected it yet, and if there is a chance that someone else can replicate it, how much of a head start do you have and how long will it take a competitor to get a product like you have to market? If it will take a competitor 18 months to get to market, that is a long time. If you can close a bunch of business and get a lead in the space, if your revenues are good and nearing profitability, then that is something that I and maybe some other VCs can get comfortable with to some degree.

 

      Of course, I did not address the market size question, management team etc., but assume that all is in place with the above given.

      I know the deal from both sides now. When looking at deals, you always should look at it as if you were sitting in the other person's seat, not just your own. It allows insight into negotiations. From our view, the VC, it is about risk assessment. It is not a personal thing against entrepreneurs, it is about making sure the money we are investing fits our risk profile. Remember, VC's work for their Limited Partners. It's not like we do not work for anyone. Our business is not much different then a business an entrepreneur is in, our product that we "sell" is money. We need to make a margin on that money for our investors. So, when we invest in companies, our butt is on the line, too, and that’s the reason you see so much due diligence from us. I think sometimes the entrepreneurs look at VC's as the bad guys, but we are in business too. If you look at our "business model" you gain insight to why we work the way we do and ask the questions, terms, etc., that we do.

      I hear entrepreneurs always saying, “VCs just are only about money and making money.” There is a two-fold answer to that:

 

1. Yes, being a VC is about making money. That's our business model, and it’s really not much different from other businesses—build a product or service for X and be able to sell it for Y, Y being a nice mark up. Our product is money, yours might be software, a service or other product

 

2. I would suggest that VCs like myself are just as passionate about our business as you are about yours. It's a labor of love, it's about taking something and making it bigger then it was when you started.

 

      When you really sit down and look at the business models, you realize that VC's and entrepreneurs are really not all that much different. Remember, we have to raise money, build a business thesis and team, too.

      I just offer this insight because I have sat at both sides of the table, I know what it is like to be an entrepreneur and get asked these really hard questions which sometimes leave you thinking, “Give me a break. I have no money and I produced this great product with great potential in a big market.” Give me the dough and let's roll!" I have also sat on the other side and asked the hard questions and know that if I do not ask the questions and we make a not-too-smart investment that we are in some real trouble because we work for our Limited Partners who expect us to make them money. If we mess up, our careers and the fund’s future are on the line.

            I would suggest that although the entrepreneur often gets a negative feeling from VCs at times, VCs and entrepreneurs are a team at the end of the day. One without the other would not work all that well, and both can learn a great deal from one another. At the same time, they both love what they are doing and have the real bonus of making lots of money together.

 

to top

AdMarketing | Funding & Finance | Netpreneur Corner
News Center | Quick Guide | Home

By using this site, you signify your agreement to all terms, conditions, 
and notices contained or referenced in the Netpreneur Access Agreement
If you do not agree to these terms, please do not use this site. Our privacy policy.
Content copyright © 1996-2016 Morino Institute. All rights reserved.

Morino Institute