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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.
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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 $ 35,000 4 Partners ($20k x 2yrs each) $160,000 Operating Cash Flow 1993 (p.15) Est. (45) 1994 (p.15) Est. 2 1995 (p.15) Est. 24 1996 (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 capital Decrease in payables requires more capital Capital Sources Notes Payable Officers (p. 17)) $600,000 Operating 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)
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 What’s Easy/Difficult?
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