Five serious but avoidable financial mistakes we hear from time to time at a Bootstrapper Breakfast:
- Mistake: using credit cards to finance your startup.
Fix: Pay cash, trade favors, barter, go without, but don’t let your monthly balance roll over and accumulate.
- Mistake: not having a stopping rule for when you need to stop bootstrapping and look for work. This can lead to bankruptcy.
Fix: set a time limit and an expense limit for getting your new business off the ground. Work part time and work on your business part time to maintain break even cash flow.
- Mistake: not keeping your spouse in the loop if they are working and keeping the lights on while you bootstrap.
Fix: treat your spouse as an investor or a board member: provide ongoing detailed accounting of plans and spending.
- Mistake: hiring a full time employee too soon.
Fix: start with contractors, make sure you can at least break-even on a regular basis with the contribution the employee will make vs. the additional expenses incurred–understand all of the expenses you first full time employee will trigger (e.g. workers compensation, payroll service, fixed salary expense (vs. contractor)).
- Mistake: signing a lease on an office too soon
Fix: use co-working space, look for an informal sublet, be clear on why you need an office (e.g. just pay for meeting rooms as needed, barter for lab or working space as needed, look at hourly/day rate offices for conference calls or meetings).
#3 got picked up by Entrepreneur Magazine in a roundup of 7 tips: “Funding Your Business on Your Own? Learn From These 7 Entrepreneurs.” I thought these three from the list were also common and avoidable:
- “Branding too soon” by Rebecca Tracey of The Uncaged Life
This is really investing too much in messaging before you know what works. I have made this mistake and I see others do it as a way to make the business seem “more real” or “like an established company.” Trying things out in conversation gives you the fastest feedback and is the easiest way to iterate if you are deliberate about it.
- “Idealism about costs” by Tom Alexander of PK4 Media
This comes in many forms, but the most serious that he touches on is not understanding how long it can take to get paid, especially by a larger firm. 90 to 120 days from invoice has not been uncommon for many of our clients. Small firms tend to pay faster, and getting paid the first time by a large firm can take much longer than subsequently.
- “Failing to calculate burn rates” by Steve Spalding of Project MONA
This takes several forms, but one mistake is to pay yourself a salary (incurring State and Federal taxes on the “round trip” from your savings back to your bills instead of putting less money into the business and living off of your savings. It’s also better to provide the bulk of your starting capital as a loan instead of equity, so that early profits can be distributed as loan repayments instead of salary or dividends.
Update Thu-Feb-27 (morning): Elia Freedman offered a common critique of this post, In Getting Good At Making Money by Justin Williams and “How to Get Good at Making Money” by Jason Fried. Writing “The Art of Bootstrapping” he observes
The only thing a bootstrapper needs to know: CASH IS KING. Nothing else matters and every decision needs to be made to maximize cash. The articles refer to revenues, but revenue is not cash. Here’s an example: I do a contract development job today for $10,000. When done I submit an invoice and the company takes 60 days to pay. Yes, I have $10,000 in revenues today but I don’t get the cash for 60 days. How do I pay my bills in the meantime?
I am relentless when it comes to managing cash. I have a spreadsheet that gets duplicated and updated with actuals and projections every month. This allows me to make cash flow decisions months before the negative shortfall actually happens, allowing me at various times in the history of the company to ratchet up spending, lay people off, cut payroll or minimize other expenses. Because of this work, I see the company very very clearly on a month to month basis and can make appropriate choices.
I think it’s a fair criticism. An accrual accounting perspective has too much parallax from bootstrapper’s actual cash position and offers a false sense of security. I tried to sharpen the advice from the Entrepreneur round up on “Idealism about costs” toward this but I would add a sixth mistake to make it clear:
Mistake: Using accrual accounting (ignoring the timing–the real cash impact–of cost and revenue items) will kill you.
Fix: Forecast and manage the explicit timing of cash in and cash out for your business. Understand that people will cash your checks immediately but be slow to pay your invoices. Some won’t pay the full amount or even pay at all. Rely on clear understanding and simple plain English agreements, don’t hope that “legal language” in a contract will make a difference to your getting paid (assume any contracts you sign will be enforced against you by larger firms.
I think trust is as important, if not more important than cash. Bootstrappers who focus exclusively on cash without also managing trust and social capital will often fail to prosper as well. Related blog posts:
- “Treat Social Capital With the Same Care as Cash“
- “Keeping Your Customers’ Trust“
- “Conserving Trust In a Downturn“
- “Three Tips For Minimizing Misunderstandings Among Co-Founders“
- “The Business is Everyone’s Business”
- “Experiments Vs. Commitments“
Update Mar 8: this post was included in the Founder Institute’s “Mar 2 2014: This Week’s Must Read Articles For Entrepreneurs.“