EQ Journal Archive 19

No Money Down Real Estate Investing

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Political Economy

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Thought Experiment

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Why Invest in Real Estate

2 Comments

Why Landowners Won’t Sell

Posted on
Sunday 5 September 2010

I have been puzzled for awhile as to why certain landowners,
those with well-located, vacant property, often won’t sell, almost at
any price. Many of them have to pay significant property taxes and
insurance costs. They also have to maintain their properties. (For
example, if they allow litter to collect or the grass to remain uncut,
the City will issue an order and, if they don’t comply, the City will do
it for them (at an exorbitant cost) and bill them. If they don’t pay,
it’ll get added to their property taxes and, if they don’t pay those,
the City can tax-sale their property.)

So owning property is not a cost-less, carefree endeavour.

It’s too easy to say that maybe these folks have an emotional
attachment to their property or they’re ‘richer than God’ and don’t need
the money. Perhaps there is some other logic to their position?

So I looked to an old definition for some help:

Remittance Man, a term once widely used, especially in the West
before WWI, for an immigrant living in Canada on funds remitted by his
family in England, usually to ensure that he would not return home and
become a source of embarrassment.
(Source: The Canadian Encyclopedia.)

For it seemed to me that many of the landowners who hold
centrally-located, choice pieces of property looked a lot like, and
acted a lot like, Remittance Men. Many of them have inherited their
properties, acquired by their families one, two, three or more
generations before. For the most part, they had no debt on these
properties. Their personal cashflow needs were taken care of by other
means. The annual costs of holding their properties were small compared
to their personal net worth. The Adjusted Cost Base (ACB) of these
properties was so low that tax consequences from a sale were
substantial. They could not find alternative investments that would
perform as well or better than simply holding property and letting it
inflate. Land was scarce, in demand, stable and secure over the long
haul. Cities generally are far behind current value (FMV, Fair Market
Value) in terms of property assessment and tax levels and, consequently,
the costs of holding land vacant are quite low.

I put together a theoretical example for a property owner in Westboro
Village, a rapidly gentrifying part of Ottawa. This fictional landowner
owns two adjacent lots, each 66’ by 100’. The total land area he owns
is: 13,200 sq. ft. and property values in the area, circa 2010, are ~
$120 per sq. ft. or about $5.23 million per acre. I uploaded the
spreadsheet with all my calculations in .xlsx format to our server. You
can download it and fool around with it yourself. Get it from: https://www.eqjournalblog.com/WhyLandownersWon’tSell.xlsx.

Basically, what I show is that if he sells his property for the FMV,
he receives (after REALTOR fees and legal fees) just over $1.5 million. I
have used an ACB of $187,500, so he would be taxed on a net capital
gain of $1.315 million. In Ontario, that would mean that half of this
amount would be brought into income and he would pay around $165,000 in
taxes.

So after all is said and done, he would be left with $1.34 million to
invest which he does in GICs or T-bills that pay 3.25% p.a. This gives
him about $43,500 per year in income and, if his marginal tax rate is
47%, he would be left with $23,000 after tax. If he adds this to the
cash he was left with after the sale, he would have $1.458 million in
GICs or T-bills by the end of 2015.

On the other hand, if he had just hung onto his property while paying
property taxes of $35,640 per year and assuming property appreciation
of 4.75% p.a., then after five years his property value would exceed
$1.8 million.

That is, he would be $344,000 better off by not selling.

Now I asked myself, how low would property appreciation have to go to
make the sell option exactly equal to the hold option? The answer is
very low—until property inflation sinks to just .68% per year, he is
better off holding onto the property.

The next question I asked is how much of a premium above FMV does a
would-be, highly motivated buyer have to offer him to get him to
sell—the answer is, a buyer needs to offer at least $380,000 above FMV
to make the two alternatives equal. This is a 24% premium just to make
the two options the same and, in my experience, if the two alternatives
are the same, the idea of holding onto a choice bit of land will almost
always win out.

Remittance men and inheritors of wealth are, if nothing else,
conservative in their decision making*. So if you accept that greed and
fear are two prime human motivators, then both are strongly aligned with
the hold option.

Prof Bruce

* I once asked a friend of mine, an heir to a great family fortune in
Canada, why he had never married. He looked at me, appalled, and
replied: “Why Bruce, if I married, I would have had to share my properties and my life with a wife. I have two dogs instead.”

Postscript 1: When a significant portion of prime lands are owned by
this type of owner, land values will be further inflated because,
essentially, these people are restricting supply.

In most cities, land ownership is highly concentrated. In Ottawa,
there are about eight owners who control more than 85% of developable
lands. This further restricts supply.

Postscript 2: There is strong support amongst economists for bringing
on new lands to achieve a better balance of supply and demand and to
keep housing prices, for one, more affordable. Unfortunately, this is
more than counter balanced by the NIMBY influence on municipal politics
that seeks to restrict the addition of new lands, purportedly to counter
urban sprawl. In fact, such restrictions have nothing to do with
limiting urban sprawl and everything to do with inflating land and
property prices for sitting owners**.

Postscript 3: Old money doesn’t work very hard. If our theoretical
owner had, in fact, sold his property, he more than likely would have
loaned the proceeds to a Bank or a government in the form of GICs or
T-bills. If an entrepreneur was involved instead, that money would be
recycled through the economy in any number of spinoff projects resulting
in a much higher volume and speed of money with much higher rates of
return as well.

** I have always loved Dennis Miller’s definition of an
environmentalist: “An Environmentalist is someone who owns a cabin in
the woods. A Developer is someone who would like to own a cabin in the
woods.”

Prof Bruce @ 12:09 pm

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Development Economics and Entrepreneurship

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Home Building

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Investing

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Property Taxes/Municipal Taxes and Fees

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NIMBY

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Political Economy

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Sprawl

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Urban Design

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Why Invest in Real Estate

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Why Not to Work from Home

Posted on
Thursday 2 September 2010

I’m sure there are many people who work from home and enjoy that experience. I am not one of them.

I had a home office for 14 months and came to really dislike it for a
number of reasons, the most prominent of those: there was no separation
between work and home. It wouldn’t matter what was happening in my
personal life, my office phone would always be ringing, the red
‘message-waiting’ light would always be flashing, emails would be piling
up, faxes would be arriving, parcels delivered, clients wanting to
visit.

It drove me crazy. So we opened up a business incubator in a local
shopping mall (not far from our home) for our not-for-profit
organization, Exploriem.org, and I was its first client. We had been
wanting to do that for our student entrepreneurs and others since 2004
and the fact that I couldn’t stand my home office was the final push it
needed.

Here is my list of why not to work from home:

1. Separate home and work-save your sanity. You’ll have time to
decompress between leaving your office and arriving home to your family.
2. In an office, you have people to bounce ideas off of.
3. Have somewhere to meet a client that isn’t your bedroom.
4. Someone is always there to accept parcels, nothing gets ‘sent back’.
5. Stay on good terms with your neighbours: they don’t have to put up
with more traffic in your residential area, which means you get to
borrow a cup of sugar whenever you want.
6. You’ll have access to better services and office equipment.
7. Having an office to base your business out of creates a more professional image.
8. By working in a shared office space, you can share costs for reception, staffing, meeting rooms, utilities, etc.
9. You’ll find yourself to be more productive, as there are fewer
distractions and interruptions from family and no ‘honey-do’ lists.
10. You’re also likely to shed a few pounds since raiding the fridge is no longer an option.
11. No more sleeping in (though to some this may be a perk of the home
office) but keep in mind the importance of having a routine.
12. Working from home means less recurring contact with others, so with
an office…you’ll feel less isolated. Your social skills improve. You are
also more likely to get promoted since ‘out of sight, out of mind’.

Co-worker spaces are being opened as the proportion of the population
that is self-employed increases if for no other reason than to give a
person access to a ‘rent-a-colleague’: someone to chat with around the
water cooler. (See, for example, this story in the G+M: https://www.theglobeandmail.com/report-on-business/careers/career-advice/on-the-job/article2065882.ece.)

And finally, I finish with a question: “Does creativity flourish in a vacuum?”

Prof Bruce

ps. The Oatmeal.com has a great take on what work from home does to
your social skills but I can’t show it on this Family-rated blog: https://s3.amazonaws.com/theoatmeal-img/comics/working_home/6.png.

pps. Shameless self promotion, for more on our biz incubator, please see: https://minioffice.org/, https://learnbydoing.ca/ and https://exploriem.org/.

Prof Bruce @ 7:12 am

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The Entrepreneur Skill Set: A to Z

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Posted on
Wednesday 1 September 2010

Can you train entrepreneurs or are they just born? I
believe that, in part, entrepreneurship must be learned by doing and
that success in entrepreneurship comes from a combination of personal
attributes and other factors including:

a. a pre-disposition to it;
b. supportive family and friends;
c. education and training;
d. finds the right mentor(s);
e. good timing/able to see opportunity and seize it;
f. focus, effort and check, check, check everything and everyone;
g. creativity and innovation/adds differentiated value to their highly workable business models;
h. openness to new ideas;
i. willingness to change;
j. ability to discover new ideas in the process of doing;
k. high energy;
l. tolerance for risk and stress;
m. acceptance of outside best practices;
n. ability to compartmentalize;
o. ability to sell ideas, products and services/a good negotiator and a sympathetic understanding of human nature;
p. leadership skills and vision;
q. figure things out as they go;
r. dump the losers and keep the winners (know when to quit and when to stay in the race);
s. self motivated and able to prioritize;
t. team player and not afraid to hire up/utilizes the skills of each member of the team to the maximum;
u. impeccable warrior (such as never drink and think);
v. not easily discouraged/confident;
w. able to juggle many tasks and hats at one time;
x. goal setter and a finisher—able to complete things and execute expertly;
y. commitment and passion;
z. a good sized storehouse of luck.

Prof Bruce

Prof Bruce @ 8:51 am

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Development Economics and Entrepreneurship

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Posted on
Wednesday 1 September 2010

Neighborhood Safety and Land Values

Much of neo-urbanist thinking depends for its success on neighborhood
safety. Neo-urbanists want to see increases in both density (more of
the same built form) and intensity (more mixing together of different
uses such as office, retail and residential) in North American cities.
This will help make them more walkable, more public transit friendly,
more affordable and more democratic.

Sustainability requires both affordability and security. As Professor John Callahan once told me: “Nothing is sustainable unless it is also economically sustainable.” Fine. I agree.

But nothing is affordable or economically sustainable, if you prefer,
unless it is also secure. Many years ago, experiments (often referred
to as part of the ‘Broken Windows Syndrome’) showed that a vehicle left
in a downscale neighborhood could remain there for quite some time with
minimal damage. But throw a rock through one of the car’s windows and,
in just minutes, vandals and thieves would descend on it and strip it to
the bones.

It turns out that cities are much the same; if they tolerate petty
crime, vandalism, graffiti or even minor degradation of the public room,
then no value can be created there.

Prima facie, increasing density (by allowing granny flats, duplexes,
apartments above retail and so forth) should increase property values
not decrease them. Higher property income means higher property values,
all else being equal. The ‘all else’ here is neighborhood safety.

In the Glebe (an Ottawa downtown community), there are many in-home
apartments (both legal and grey market ones), there is retail and office
space and even some industrial uses (metal bashing, garages, etc.)
mixed in amongst the fine old homes. Yet the Glebe is one of the most
desirable parts of the City to live in and property values are
terrific—and, interestingly enough, the grand homes with
above-the-garage apartments or attic apartments, for example, sell first
and sell for more. But it is also a very safe neighborhood.

So NIMBY’ites should have nothing to fear from densification and
intensification of their neighborhoods, per se. But we must maintain
civic order for this to be a reality.

Prof Bruce

Postscript: The then Mayor of NYC, Rudy Giuliani, understood this
principle when he implemented a no tolerance policy for vandalism, petty
crime or graffiti in the New York Subway and in the public room.

If you were a Landlord in the City at that time, and your building
had a broken down fence, a broken window, litter in the front yard,
outdoor lamps that didn’t work, a door askew, whatever, you would get a
notice from the City and, if you didn’t fix it within a certain time,
the City would and then bill you for it. Mayor Giuliani was relying, in
part, on the work of urbanist Jane Jacobs. The results were remarkable:
major crime plummeted* and real estate rents and values took off.

(* Other factors such as the aging population also played a role.)

New Orleans will never recover from Katrina unless they make that City safe for its residents.

Prof Bruce @ 8:28 am

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Home Building

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Introduction to Architecture and Urban Design

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Posted on
Sunday 8 August 2010

Modernist Urban Design and Spatial Apartheid

In 2000, I wrote these notes as a way to introduce first year
architecture students to the then heretical notion that architects had
abandoned urban design to urban planners who, through the adoption of
near universal zoning codes, had put an artificial straight jacket on
cityscapes. Rereading them today, they still make a pretty good
introduction to that topic in 2010.

The notes:
1. ‘Modernist’ here refers to the ‘City Beautiful’ movement: the early
20th Century attempt to provide ‘the little cabin in the woods’ or ‘the
castle in the glen’ for the masses.
2. It was a rational reaction to the concentration of tenements in NYC circa 1900.
3. There was a huge horse population, horse dung problem and a high
accident rate between horse drawn transportation and pedestrians. There
was excess density, substandard housing, lack of building, health and
fire codes, tuberculosis and disease; this caused an anti-reaction to
urban living.
4. Reaction carried too far in the ‘City Beautiful’ Movement and the
resulting suburbanization (little cabin in the woods) of the middle and
upper classes. Zoners and nimby’ites had worked together segregated all
uses and introduced spatial differentiation by income class.
5. Inappropriate segregation of uses meant that you could no longer get a
pint of milk locally or walk to your place of employment or anywhere of
interest. Mono cultured suburbs with expensive single family housing
forms were priced out of the reach of gardeners, teachers, child care
workers, firefighters, cleaners, immigrants, factory workers and other
lower income persons. Zoning by-laws abetted this spatial apartheid
resulting in segregation by income.
6. There was a near complete absence of civic art in urban design.
7. Planners produced designs and urban spaces lacking in charm, soul,
density, affordable housing, public transportation and other amenities.
8. In Kanata, for example, clotheslines contravened city by-laws.
9. Riverdale is an imaginary town where Archie, Vernonica, Jughead and
Betty live and where kids can live next to the Pizza Pit. This is where
my kids wanted to live when they grew up.
10. Kanata Lakes is a subdivision where it is 1.6 kilometres to the
nearest shop from our home. Might as well be the moon from the point of
view of little kids.
11. Taxes (development charges) on small homes, ‘granny flats’ and duplexes make it impossible to build affordable housing.
12. Mixing together of economic classes in earlier urban forms had the
unintended impact of providing opportunity for advancement of the
children of lower classes and creating an understanding between income
classes. 19th Century towns and early 20th Century ones tended to mix
folks from different income streams together; folks could learn from
proximity of one income class to another.
13. Property owners reacted negatively to almost any change in land use
because of two primal motivations: greed and fear. They became fearful
that any changes (eg., densification of the neighborhood) would lead to a
decrease in property values even though densification can lead to
increases in value provided there is no breakdown in social order.
14. The reaction to modernist urban deign is neo-urbanism.
15. “New urbanists will win,” said Jane Jacobs.
16. New urbanism is the return to an earlier model of town design based on civic art as well as consensus and mixed use.
17. New urbanism is the search for catalysts and ‘faery dust’ to bring decrepit urban centres back to life.
18. Catalysts include: deregulation of zoning rules, zero side yard and
front yard setbacks, basements, first and second storeys expressing
themselves to the street: the ‘window-on-the-world’ opening of buildings
to the street at grade, theatre of the street urban life, mixing of
lofts, offices, shops, apartments, homes, theatres, entertainment
districts and so forth, mixing of uses provided they meet health,
building and fire codes (everything permitted except what is expressly
forbidden instead of traditional zoning where everything is forbidden
except what is expressly permitted). Anti-catalysts include- racism,
crime, neglact, ‘broken windows’, trash, litter, suburban flight, lack
of mass people mover (subway, light rail), single use zoning, horizontal
workflow of tech companies (building out instead of up), density
deficit, new economy industries, high tech high schools, jobs for
youths, empowering young people, getting them to buy in, high school for
the arts, educated immigrants changing the demographic profile, …
19. Value can only be created where social order prevails.
20. Mayor Giuliani implemented lessons from the ‘Broken Windows
Syndrome’ to help NYC recover from devastating urban ills including a
high crime rate (both major crime and misdemeanors).
21. Police were put on the beat/taken out of their cars.
22. A complete intolerance of graffiti, littering and petty crime as
well as a focused effort to repair all elements of the public room
(street lights, street furniture, fences and all public room-facing
buildings) created an environment hostile to criminal elements: crime
went down and property values up.
23. The lack of tolerance for small acts that debase the public room alarmed civil liberties advocates.
24. De-regulation in some cities allowed organic growth of the city to
re-emerge. Cities that are walking cities with mixed uses like Paris,
London, Tokyo, Sydney were found to be better places to live and work.
25. Other catalysts included: property tax abatement, special federal
tax jurisdiction (tariff-free zone, enterprise zones), abolition of
development charges (eg., then Mayor Holzman, Ottawa), sales tax
holidays on building materials, civic presence (library), return to
market gardening and farming in urban areas, urban forests and forest
views, parks, theatre districts, entertainment districts, commons,
fairgrounds, … the kernel around which the urban area will regenerate.
26. Virtually all economic growth since the discovery of agricultural
cultivation has derived from the synergy that comes with the development
of villages, towns and cities, says Jane Jacobs. City-state economies
are driving the national and global economy. Pre-conditions for economic
take-off (to paraphrase Walt Rostow) of city-states include: rule of
law, education, web enabled, high speed, broadband communications
infrastructure, good government, absence of cronyism, civic order,
meritocracy, mixed use, access to capital and public markets, adequate
land inventory for growth, upward mobility, environmental protection,
adequate and safe municipal services, affordable housing, sanctity of
contracts, encouragement of the arts and culture, adequate density,
strong branding and marketing of city to its residents and visitors,
recreation facilities and quality of life issues, mass people mover,
privatization and commercialization of services where appropriate to
de-politicise decision making and improve efficiency.
27. Villages came about first because of security needs then synergy was
derived from the application of specialization (Ricardo’s theory of
comparative advantage)- Ugh hunts antelopes, Nnn makes flint knives and
Zll produces textiles (sewn animal skins). Trade between families
results from their proximity in villages and later on between villages.
There is a huge increase in well being from specialization and
exploitation of comparative advantage.
28. Villages are first organized on the basis of protection. Then they
become hierarchical and they are based on the FOB principal: ‘Friends of
the Boss’ get the best locations.
29. Today, FOB means friends with the mayor, police chief, fire chief, …
30. Zoning creates an artificial scarcity of land.
31. Beneficiaries are established (often large) land owners and sitting
owners. Suivez l’argent. First time home buyers and renters are worse
off.
32. Kanata prohibited work from home with two or more employees.
33. Each morning homeowners leave their suburbs and BNE (break and enter) specialists move in.
34. Kanata has huge rate of BNE and vandalism; there is nothing for kids to do.
35. Work at home reduces travel time, increases block safety. It is
better for the environment, makes double use of very expensive capital
investments in homes and urban infrastructure.
36. Offices will still be needed for tribal gatherings, synergy, team work.
37. Cyberspace will have some impact here when people ‘goggle’ in to the
metaverse (read, for example, Neal Stephenson’s Snow Crash).
38. The development industry is constantly in conflict with public
authority because so much is now prohibited by zoning by-laws and
regulations.
39. Urban sprawl is what results from segregation of uses.
40. Everything requires a car trip to get to and from origins and destinations.
41. Land use should be determined by the highest and best use for each
site. This is the DAD rule of land development: Dollars are Democrats.
‘The DAD rule is the worst possible rule except for all the others’, to
paraphrase Winston Churchill.
42. Rules used for determining land use include hierarchical rules
(village chief, first officers or nobility, townspeople, expendables),
religious hierarchy, FOB (Friends of the Boss, eg., friends of police
chief, mayor, fire chief, governor and so forth, get preferential
treatment).
43. Urban sprawl results from the application of zoning rules and segregation of uses.
44. This spreads out all uses by separating offices from big box retailers from homes from schools from civic presence.
45. Urban sprawl and city growth are not synonymous.
46. They are often confused but growth at the fringe of a city can
involve mixed use design and the application of new urbanist principles.
47. Urban growth is essential to produce innovation using a greenfield approach.
48. When governments act to prevent urban growth, they are aiming for
the wrong target. Japan tried this by restricting the conversion of
farmland to urban uses resulting in an explosion of land prices, a real
estate bubble at the end of the 1980s, distortion in the entire Japanese
economy and an implosion of that economy in the 1990s which continues
to this day.
49. Urban growth is essential to a healthy economy.
50. Let the highest and best use rule apply: farmland is not a sacred trust and should be treated as any other economic input.
51. If the price of farmland rises because of scarcity and an increase
in farm gate prices then the result will be the reuse of some urban
lands for agriculture: the process will reverse. This is starting in
some US cities where the price of urban land has become negative (eg.,
Detroit, South Bronx, South Central L.A.) and is actually being recycled
as farmland.
52. The housing lifecycle is: the BIG house becomes a shared house
(extended family), then it mutates to apartments, duplexes, triplexes
before becoming a rooming house. Then a gentrification process takes
place where it becomes a BIG house again either through renovation or
teardown. The latter assumes that social order prevails.
53. There can be no value created in an urban context unless social order prevails (the Broken Windows Syndrome).
54. Land rents increase with increasing density despite what nimby’ites think: they are simply wrong.
55. This is the most fundamental curve in urban design.
56. Nimby-ites are wrong to reject density out of hand. Provided social
order is maintained, adding in-home apartments or granny flats increase
land rents and increase land values.
57. Construction of a large office building next to a residential area,
for example, should increase the number of potential customers who want
to purchase or rent those homes to be closer to work, all else being
equal.
58. Land rents can be negative where social order has broken down. That
is, the cost of maintaining the property and paying property taxes is
greater than the annual rents possible in that location.
59. Deregulation of zoning rules should allow a city to densify.
60. North American cities are suffering from a density deficit: the City
Beautiful movement has gone too far. If you allow people to live on the
fringes of the City, it will push up density in the core, all else
being equal. Otherwise, the rent curve (and skyline) of places like NYC
and Ottawa would look the same, which they obviously don’t. Not everyone
wants to live in an apartment above a pub in a congested downtown.
Cities should allow for diversity of choice in housing forms as well as
employment opportunities.
61. The ONLY way to revitalize North American cities is to bring people to live downtown.
62. Land that is vacant is worth more than land with a building on it
because once a building is built, it forecloses on all future options
for building on that site. This is similar to what happens when you buy
an automobile- when it is driven off the dealer’s lot, it loses 30% of
its value because you have decided on all the options (eg., colour). A
new purchaser will buy it from you but only at a reduced price because
it represents a whole range of options that you have chosen instead of
the future owner, even if it is only a day old.
63. The internet is needed to support an architectural practice
including: design drawings, scheduling, billing and construction
certification. What is going to happen to the profession in the era of
the web- demands on architects in the bizarre world of municipal
approvals and in the land of nimby’itis (not-in-my-back-yard syndrome)
are up and fee-for-services is down. Why pay an architect $6,000 to
design a new home when 100s of designs and working drawings are
available over the web for $350?
64. The web is blowing everything to bits, to paraphrase a recent book
title. If as a profession, we don’t ‘get the web’, we’re toast.
Architects must learn that their practices are subject to the same rules
as other entrepreneurs: their compensation is tied to the value they
create and their productivity. They need to market their services and
extend the ‘franchise’ in order to escape the vise that the profession
is currently in. Architects must learn the difference between a J.O.B.
and entrepreneurialist culture: an entrepreneur tries to create lasting
value that is independent of the founder or individual practioner.
65. The web could be a huge boon to achitects. Architects will place
their knowledge and portfolios on their personal web sites: all their
Intellectual Property will be there and they must find ways to exploit
their IP. The web may allow architects to sell their designs many times
over- to use and reuse whole designs and parts of their work for many
clients and customers. They can retain ownership and copyright of their
IP and they may still be receiving royalties from their body of work
even when they are relaxing on a beach. Architects have to figure out
how to do this in order to counter current trends in the profession.
66. Architects must learn to justify their designs not only on the basis
of costs but also on the basis of benefits. Over-reliance on costs
means that architects are constantly being forced to cut- budgets and
their fees too. If we can show that our designs increase benefits
(whether measured in revenue dollars or, say, an increased visitor count
for a museum), then we can generate increased value for our clients and
customers and ourselves.
67. Robert Kaplan in his work, ‘An Empire Wilderness‘, maintains that
global economic and technological influences are undermining the
nation-state.
68. While economic progress is related to healthy city-states, throwing away the nation-state would be a mistake.
69. This would represent the triumph of narrow, parochial, regionalist
and ethnic interests over the sharing of risk and pooling of resources.
Meaningful progress on global policies on pollution, social policy,
trade policy, peace keeping, science policy, disease prevention and much
more will be retarded.

DRAMATIS PERSONAE

Prof Bruce @ 12:23 pm

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Internet– the Internet is Eating a Hole in the Global

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Sources of Bootstrap Capital: The List

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Posted on
Friday 6 August 2010

We are attempting to compile a more complete list of
Bootstrap Capital sources that will be helpful to entrepreneurs (and
intrapreneurs)as they build new services, products and enterprises of
all types including for-profits, non-profits, charities and NGOs.

No list can be complete and this certainly is not. If you can add to
it, please use the comments section at the bottom of this page or send
them to: @ProfBruce on Twitter.com.

If you think that bootstrap capital is something only needy startups
use, think again. Large firms such as the Disney Company also use BC as
they did when then CEO Mike Eisner acquired the Mighty Ducks of Anaheim
expansion franchise from the National Hockey League in 1993/94. The
franchise fee of $50 million was paid as follows: $25 million to the
League and $25 million to the LA Kings (then owned by Bruce McNall). But
the Kings were paid $5 million per year for five years, a form of
Seller Take Back (STB) financing (or Vendor financing), a prime source
of capital for startups (and other smart organizations such as Disney).
In addition, Disney got a $20 million leasing inducement from Ogden
Corp. (then owner of the Pond, now called the Honda Center where the
Ducks play) to sign a longterm building lease plus Disney put in place a
$30 million line of credit secured by the new asset (the franchise
itself). If you total that up, Disney basically acquired the team for a
negative $20 million, a fine example of Bootstrapping.

It also demonstrates another important aspect of BC; it is often free
capital. The $20 million dollar leasing inducement that Disney received
from Ogden did not require any interest payments and, in fact, there
were no principal repayments either, ever. The Vendor financing Disney
got from the Kings was, in effect, an interest-free loan for five years.
Try getting that from your Bank.

Free or ultra low cost capital can radically change your IRR
(Internal Rate of Return) on a project and your ROE (Return on Equity)
too. The two most important influencers on a project’s rate of return
are: upfront costs and the passage of time. If you can reduce or even
turn your upfront costs negative, the impact is large.

Fortune 500 companies are usually looking to return at least 20% to
22% on equity. By using these techniques, you (and they) have a great
opportunity to achieve that and thus you can stand out from the crowd
inside established organizations.

Using Bootstrap Capital instead of the corporate treasury may also
get you a promotion if you work for a large, established firm. Say you
work at Cisco and you are an intrapreneur who knows how to use these type of self-financing techniques. Suppose you went to your boss and said: “I
have a project that will take two years of R&D at a cost of $10
million but I have three launch clients each willing to pickup $2.5
million of that cost and take the first six months of production.”
It is likely that your idea will get an enthusiastic hearing. More
enthusiastic than a colleague who has a competing project that took the
same amount of time to develop and cost as much but they hadn’t lined up
any launch clients or gotten hard commitments not only to buy the
product but throw in some (bootstrap and free) capital to develop it
too.

So here is our list:

1. Soft Capital: Mom, Dad and rich Uncle Buck; basically this is a
family and friends round of financing either formally or informally
organized. Angel investors may also take part at this stage.
2. Home equity loans. This is the number one source of equity for
entrepreneurs across the globe. It is usually accessible at low cost
(i.e., low interest) and can be put in place relatively quickly. Student
entrepreneurs should, in my view, make home ownership an early priority
not only as a storehouse of value but also as a way of diversifying
their asset mix and doing some creditor proofing too. The home would
normally go int he name of the spouse or partner with the lowest risk
profile. For more on creditor proofing, please refer to: https://www.eqjournalblog.com/?p=526 and https://www.eqjournalblog.com/?p=1138.
3. Business plan competitions for cash (e.g., the Wes Nicol Competition
or the Celtic House Competition.) Student entrepreneurs get very good at
this and often use it to supplement their startup capital.
4. Future customers or launch clients are another large source of
startup capital. Home buyers in Ontario, for example, can be asked for
deposits of up to $40k in advance. Launch clients are important for
other reasons as well: they give the new enterprise additional
credibility and feedback on their offering that often results in changes
in the product, service or business model.
5. Future suppliers can often be persuaded to extend long term credit to
the entrepreneur(e.g., Vendor financing of 30, 60, 90 days or more) or
invest cash in your business since they have a lot to gain if you become
another (good) customer of theirs. They will probably want a long-term
supply agreement though. (In 2009, trade credit (or supplier credit)
surpassed bank lending as a source of finance for business in the US. TC
amounted to $2.15 trillion this year versus $1.5 trillion in bank
lending (which was down more than 6.5%, year over year) according to
data from the US Federal Reserve. For more on Trade Credit, please see: https://www.eqjournalblog.com/?p=610.)
6. Strategic partners. (For example, Ogden Corp. was a strategic partner
of the Ottawa Senators Hockey Club—in return for a 30 year arena
management deal plus a F&B rights deal, they invested, loaned and
guaranteed significant capital to/for the nascent team.)
7. Micro capital lending and grant programs. For example, the GOC’s
(Government of Canada’s) SBL (Small Business Loan) Program is run very
effectively by the Canadian Chartered Banks. SBLs are available up to
$350,000 and the GOC will guarantee 90% of the loan so that if the
enterprise fails, the founders are only (personally) responsible for
10%.
8. Supplier rights, product placement and licensing fees. For example,
Molson Brewery purchased pouring rights for the Corel Centre (now
Scotiabank Place) and the Civic Centre after the City of Ottawa was
awarded a franchise by the NHL in December 1990 but before they
commenced play in October of 1992.
9. Patent or other IP licensing fees and royalty payments. Noma
Industries purchased the rights to LED Xmas light strings designed by
the author.
10. Consulting services. A lot of entrepreneurs support their startups
by providing consulting services at the same time. Eseri.com, started by
PhD entrepreneur, Bill Stewart, provides lightweight Internet-based
(actually cloud-based) desktops that use widely-available and proven
freeware. Eseri is based in Ottawa and Montreal and was started with
nothing—Bill still gives $1,000 per day seminars on project management
software so that he can fund his real passion—building a great business
of his own. For more on this, refer to: https://www.eqjournalblog.com/?p=752.
11. Partners can bring cash to a business or they can bring sweat
equity. The latter reduces the capital the enterprise requires while the
former adds to the capital base of the new company. You have to be
careful though: “There are still two chairs in Heaven waiting for the first two partners to get there and still like each other,”
Anon. Also, if one partner has access to significantly more financial
resources than the other, he or she may well end up owing 100% of the
business, squeezing out the other partner or partners.
12. Debentures (mostly a form of debt). Family, friends, angels may
prefer to invest their money in the form of debt with equity conversion
rights or equity bonus.
13. Financial leasing of fixed assets (such as computers and phone
equipment, photocopiers and the like although it can apply to almost
anything. I have heard of financial leasing for, of all things, roller
coasters.)
14. Receivables factoring. If you have clients with strong credit, you
can sell your receivables for cash. Car dealers sell their car leases
and loans for cash.
15. Publisher’s advance on a book or manuscript.
16. Sponsors. You can get people to sponsor practically anything. A
couple of young REALTORS I know raised donations (cash and in-kind) for a
local food bank last year while raising their profile in the community.
By getting sponsors on board, their costs for the food drive were
negative. Sometimes, it’s as simple as just asking for donations and
sponsorships. For more about this, please see:
https://www.eqjournalblog.com/?p=400.
17. Trading activity: buying low and selling high. In essence, you are
taking advantage of arbitrage opportunities or asymmetrical information.
One domain name registrar I know found out what percentage of dot-CA
holders did not have their dot-COM equivalents while the dot-COM
equivalents were still available. He sold a ton of dot-COMs that way by
making the owners of the dot-CAs aware that they could have their
dot-COM extensions. Early in my career, I did a lot of trading up.
Check out this story: https://oneredpaperclip.blogspot.com/.
This person traded a paper clip for a pen and traded the pen for a …
and then for a generator and then for a snowmobile and then for a truck…
His idea was to eventually get a home for himself (which he succeeded
in doing).
18. Credit cards (oft used strategy but dangerous because of high
interest costs and what can happen to you and your credit rating if you
fail to make payments).
19. Scientific R & E, D Tax Credits from the GOC, IRAP Grants.
20. Finding capital where you least expect it. For example, a services
company extracted capital ($800,000 of it) from its below-market office
space lease deal: https://dramatispersonae.org/CapitalFromLease.htm.
21. Reverse or Negative Pledging of Assets. Years ago, Olympia and York raised 100s of millions by not
pledging the value of their office towers to anyone. They extracted
mega loans from their Banks based on the value of their real estate and
based on their agreeing to not pledge their assets to anyone… It’s
another dangerous strategy because you can end up over-leveraged which O
& Y did.
22. Co-guarantor. You can often borrow someone else’s (stronger) credit
rating. For example, Suite Leases for Scotiabank Place (when it was
called the Palladium) were pledged to support construction financing.
Basically, the Bank was loaning money on the strength of the covenant of
lessees. Of course, you could also ask Mom or Dad to co-sign for a
loan…
23. Accretive buying. This occurs when you buy another company using the
target company’s balance sheet as collateral. That way, you may end up
with more cash on hand after the purchase is complete than you had
before. Disney’s acquisition of the Mighty Ducks is an example of this.
More recently, a financial advisor I know by the name of Tim bought a
book of business from a retiring colleague. He took over the advisor’s
clients in return for monthly payments to the soon-to-be retired
individual equal to a percentage of the commissions he would have
received for the next three years. This was accretive to Tim– the cash
he pays out every month is less than what he receives and it’s
guaranteed: if any clients leave, the commissions are reduced
accordingly. The reason Tim got the opportunity was because the selling
broker trusted him.
24. Accretive Selling. When you sell products or services with third
party customer financing in place, you end up with more cash after the
sale than before (e.g., Leon’s don’t pay a cent until…. (OAC). Leon’s
than turns around and sells the sales contract for cash.
25. Employee ESOPs (Employee Stock Ownership Plans). Employees can
invest part of their earnings back into the company. Wesley Clover (an
Ottawa based business incubator) uses this extensively not only as
another source of capital but as a way to keep highly skilled staff from
leaving and to provide further performance incentives for them.
26. Pre-sold services. For example, here is an example from Craig deSchneider, a former student: “In
looking for some start-up capital for our automotive related business,
myself and my partner offered potential investors future discounts
through our business. In selling automotive parts, we had accounts set
up with distributors, accounts which could only be set up through having
a business license, tax numbers, and some negotiating, so the average
person off the street does not have access to these discounts. We set no
specific investment amounts, simply the most the person could afford.
We kept these contributed amounts a secret among the different investors
as we offered them all the same return. Therefore, in return for a fair
investment, we extended to our investors cost prices for all of their
future purchases through our company. The only limit we set on this
agreement was that the investors’ annual purchases could not exceed our
company’s sales revenue from our average monthly sales figure (not
including cost purchases made from investors). The overall idea was to
provide our investors a very fair return on their investment, and at the
same time, these investors would promote our company. Why you may ask,
well the greater our monthly sales were, the greater the amount of goods
they could buy for themselves at a cost price.” Basically, Craig and his partner turned their investors into customers and their customers into investors. Nice going.
27. Collectibles sales and auctions. Here was a new one to me. Michael
Moshier put the original version of his SoloTrek flyer up for auction on
eBay, hoping a museum would pick it up. It didn’t even fly but by
January 12th, 2003, the bidding on eBay had already reached $6.5 million
USD: money he planed to use to fund his Trek Aerospace startup. Cool.
28. Extended family savings and investment fund—an old style of
acquiring start up capital is to have the extended family contribute to a
pool of funds to help family members acquire or build businesses.
29. Seller Take Back (STB) mortgages—typically used in real estate
transactions, the Seller provides some or most of the financing for the
sale by way of a (first or even second) mortgage back to the Purchaser.
30. Sweat equity. Don’t underestimate the contribution you make to the
enterprise in ways that are unpaid and often not sufficiently
recognized. Youth and energy count for a lot.
31. Investor syndicate or investment club. You might form your own club
and some of that investment could be used for funding your new
enterprise provided that you disclose and get the agreement of the other
investors.
32. Retainers (typical for consulting services or legal and accounting
services) and deposits on sales. Lawyers do it but more startups should
be asking for retainers and deposits on sales contracts.
33. Collecting early and paying late (boosts cashflow in the short term). Delayed payments.
34. Progress payments on contracts. Advances for work-in-progress.
35. Advance ticket sales. We sold $22 million in season tickets for the
inaugural Senators season 22 months in advance of the first game. These
funds are impressed with a trust and are, in fact, a liability on your
balance sheet: they can not be recognized as an asset or cashflow until
you start actually delivering the service (i.e., playing NHL games).
36. Becoming a reseller (this is big in the Internet age where you can
set yourself up for practically nothing as an agent to resell services
such as domain names or web hosting). There are a huge number of things
that can be resold on the Internet—many sites generate large revenues by
reselling ads powered by Google or other providers. Check out this
silly site which generates up to 8,000 ‘facts’ on Chuck Norris and got
18 million hits in December 2005. Really the purpose of the site is to
generate clicks (by asking people to rate the ‘facts’) which generates a
new ad and maximizes revenues for the site’s owner: https://www.4q.cc/chuck/. Or have a look at this site: https://www.milliondollarhomepage.com/.
Here the young person (age 21, based in the U.K.) apparently wanted to
pay for his tuition and so he created a million pixel home page. You
could buy an ad for $1 per pixel (minimum ten pixels) linked to your
site. He sold all 1,000,000 pixels so guess what? He got his tuition and
a lot more. I presume the ads are for a limited time so he also has the
chance to resell the million pixels over and over again. The site gets a
LOT OF TRAFFIC… Remarkably, this might be a sustainable business (a Personal BusinessFor Life!)
37. Importing.
38. Distributing products for other companies. Bundling their products
and services in with your own can often add large margins for you since
the cost of providing those products and services are often paid for by
the suppliers: you take a percentage of the sales you create for them.
39. Exporting.
40. Exploiting signage rights.
41. No money down, land speculation. Buying more land than you require,
developing a portion of it and selling the balance at a higher price per
acre since it is more valuable due to the fact that you have added
value in the form of the now completed first phase.
42. Using OPM (other people’s money)—raising funds through vehicles such
as limited partnerships. Using leverage in your transactions– borrowing
money at rates that are less than the IRR (Internal Rate of Return) on
your equity. This ‘gooses’ your returns. Finding deals and getting paid a
finder’s fee, often in terms of equity at no cash cost to you, the
finder.
43. Asset flipping. Buying low/selling high.
44. Buying under power of sale or through foreclosure (again, mostly real estate related).
45. Buying distressed companies or divisions of companies and turning them around.
46. Day trading.
47. Asset speculation.
48. Franchising.
49. Branchising.
50. Training and uniform fees (e.g., GradeATechs.com required each of
their contractors to be “Grade A” certified before they could provide
services to clients and customers and get access to the billing system
and the appointments calendar (a system called GASnet). To be certified
the contractors had to pay in advance to take the course…)
51. Pre-sales in real estate allows you not only to ask for cash
deposits but also may give you access to Bank or private lender
financing. For example, if you pre-sell 50% of your condo or townhouse
project, you can usually qualify for construction lending where, in
essence, your Bank or private lender is advancing you money to build the
condos or townhouses on the basis of the strength of the credit ratings
of your customers (buyers) and not your credit rating per se.
52. The same type of thing can help you a lot if you are a manufacturing
business—if you have a guaranteed supply contract with a credible
client or customer, you can often finance against that.
53. Land options—sometimes you can convince a landowner to give you an
inexpensive option to buy his or her land at a fixed price at a later
date. You can then use the time to set up a sale office and begin
pre-selling. As discussed above, you can then take cash deposits (which
are impressed with a ‘trust’ in that the money doesn’t really belong to
you until you actually have delivered the condo, townhouse, single
family home, whatever), finance against Agreements of Purchase and Sale
executed by you and your clients, approach a Bank or private lenders for
funding (often through a mortgage broker), arrange for private equity
lenders or other investors to invest in your project, etc.
54. I learned about a new method of bootstrap capital from my (then) 13
year old daughter, Jessica. One of her best friends lives in a single
parent family. Her friend’s parent is unable to work and lives on a
modest income. However, every year they are able to take a family
vacation to a nice destination in a rented van. How do they afford to do
that? Bootstrap capital. They take with them five other kids—each kid
pays $250 for a week’s holiday—that’s a total of $1,250, enough for a
camping holiday and some neat adventures too. It pays for the gas, the
van rental, food and a few outings. The kids’ parents contribute cash
and their children, Jessica’s friend and her parent go for ‘free’ but
they provide the opportunity. Everyone wins…
55. Finding money in the deal flow itself. When we built Scotiabank
Place, the contractor was able to complete in 22 months instead of
30—the extra 8 months in a larger structure not only raised revenues
over what the Sens could earn in the much smaller Ottawa Civic Centre,
it saved about millions in interest payments owed on borrowed money
during construction.
56. Getting your partners to lend you the money you need to fund your
portion of a new enterprise. A young entrepreneur became a 1/3 partner
in a restaurant franchise in a great location because his other two
partners loaned him his share of startup capital. Interest and
repayments came out of his 1/3 share of profits. After seven years, he
owned his interest free and clear. Why did the other two investors agree
to this deal? Because the young entrepreneur was the operating partner
of the restaurant– his participation at both the operating level and
ownership level were crucial to the success of the new store. Here’s
another example of how to turn sweat equity into cash equity.
57. Create a Foundation or a Not-for-Profit to fund a worthwhile project you support.
58. Create one business that helps launch a 2nd. This is what former
student Ryan North did with Dinosaur Comics which built a big community
for and around him which let him start Project Wonderful which turned
profitable 14 days after launch.
59. Run a competition like Shopify.com did. It was called ‘Build a
Business’ and it allowed startups to build their business on Shopify’s
e-commerce platform. The fastest growing company after 3-months would
win $100,000. But during the competition, nearly 1,400 new stores signed
up which generated more than $3.5 million in sales on their platform
and over 66,500 orders. The competition was widely covered on
influential blogs including the NYT. So between margins generated during
and after the competition and the value of the earned media they
received, I would guess that the cost of the competition would, in fact,
be negative and, hence, a source of bootstrap capital.
60. If your enterprise ever gets into trouble, sometimes you can just
ask for cash—from existing clients or suppliers and they will just gift
it to you. Surprised? Don’t be. They have a vested interest in your
survival.
61. You can get other types of support from suppliers, customers, your
alma mater, business incubators or even friends and relatives or
competitors (more on this later): they can provide you with low cost or
no cost office or production space; lend you equipment for free; do some
testing or R&D; even second staff to you for a period of time to
help you get started. Sometimes, all you need to do is ask.
62. You can make use of more social capital in the form of free or low
cost advice or introductions (never make a cold call, for example: do
some research on the target company and get an introduction if you can)
from prestigious law and accounting firms, knowledgeable friends and
relatives, former professors, advisory board members and many other
sources provided they see future potential either, directly, from having
a relationship with you and your new firm or through you to your own
network of contacts.
63. Many firms will use barter to get going: for example, a tech company
might exchange running a server to provide communications and Internet
services for a Landlord and other Tenants in the building in return for
lower rent.
64. Many types of Guerrilla Marketing are, in fact, also a form of
bootstrap capital. GM happens when you substitute ‘brains for money’
when marketing your firm. Earned media (basically, free mainstream
coverage and Internet exposure) is the desired goal of publicity stunts
and other forms of GM. Earned media can be much more valuable than other
forms of advertising: not only can you gain more exposure, faster and
at lower cost, you also gain credibility for your product and services
by having third parties talk and write about them. For more on GM,
please see: https://www.eqjournalblog.com/?p=643.
65. Strategic partners. If you look at your enterprise as part of a
business ecosystem, you can often find others in that ecosystem that
will help you. They may not be direct suppliers or customers, they could
be suppliers to your suppliers or customers of your customers. You may
find ways to exploit those relationships even if there are two or more
degrees of separation from you. For example, if your company fixes
windows for commercial landlords where the seals have failed, you might
find that your clients are not only the building owners and their
property managers but the original glass manufacturers, who may be
looking for after-sales service alliances that fix a problem for them
and they may be willing to help you get off the ground.
66. Co-opetition can be a huge source of capital. When Microsoft was
under investigation by US and European authorities for its monopoly
practices, it was to their advantage that the only viable alternative
provider of operating systems at the time (Apple), survive. Apple’s
on-going viability was in doubt and Microsoft loaned the firm the funds
they needed to get through a tough time. Homebuilders like to hunt in
packs—if a potential homeowner doesn’t like your product, they can often
march across the street and buy from an alternative supplier and, of
course, vice versa. So marketing by one becomes, in a way, marketing for
all. So if you think you have a product with a lot of differentiated
value, you could perhaps convince an established player to back you with
some of their capital…
67. Keep your operating or capital costs under control or reduce those
costs. If you can’t keep your costs under control, you are DOA.
Substitute independent contractors or sub-contractors for employees.
Reducing capital costs is a form of Bootstrap Capital since that is
money you don’t have to raise.
68. Entrepreneurs often can make a meal from the discards of others.
They might find a large company, often a publicly traded one, and
convince them to sell them an under performing division. It’s hard to
imagine but Bloomberg did this recently to McGraw-Hill when they bought
BusinessWeek for a measly $5 million, well within the range of what an
entrepreneur could have accomplished. A large US-based company was
closing up shop in Canada recently and it was possible to buy both its
plant and Canadian business for somewhere between 30 cents and 60 cents
on the dollar. Such transactions can lay the foundation for an
entrepreneur’s entire career since they can often operate these castoffs
more efficiently as well as raising sales and revenues faster. As a
result, they can experience outsize returns. For a young person willing
to move around, a good place to look would be in the publicly available
documents of a publicly-traded firm.
69. Entrepreneurs can often share resources with larger companies. They
might get office space for free or at a reduced cost, borrow lab space,
get an experienced employee seconded from the larger company to the
startup, get occasional use of specialized equipment, share warehouse
space, … Web 2.0 tools are amazing with so many available for free or
practically no cost. These let you set up a website, blog, social media
presence, do basic accounting, make and receive payments, process credit
cards, backup your data, transfer data, do your accounting, what have
you for no money or very little money. It is much easier to start a
business in the 21st Century than at any other time in recored history.

There it is. My list. For more examples and fuller discussion of Bootstrapping, please see: https://www.eqjournalblog.com/?p=1162.

Prof Bruce

Prof Bruce @ 8:20 am

Filed under:

Bootstrap Entrepreneurs– Case Studies

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2 Comments

Bootstrap Capital—The Last Word

Posted on
Monday 2 August 2010

Introduction

How can you start a great business with no money down? How do you get
‘table stakes’ so you can have a place in the game? The rule today is,
if you have cashflow, you will get financed, not the other way round.

There really are no ‘no money down startups’; there are only those with little money down. In reality, every business requires some
investment. What we are talking about is starting a business with an
amount of money that is really de minimus with respect to the size of
the opportunity.

Years ago, Mark McCormack showed how he could start a world-leading
sports management business (IMG, International Management Group) with
$500, his law degree and Arnold Palmer as his first client. Mind you, it
doesn’t hurt if your first client is Arnold Palmer.

Probably less than 1% of all startups ever get any funding from VCs;
that means that at least 9,900 out of the next 10,000 new enterprises
will be compelled to use bootstrapping as their only means to success.
Some observers feel that bootstrapped businesses, ones that start with
‘nothing’, are actually or can be stronger enterprises because they are
more focused on results and their clients as well as efficiency and
economy of effort. They certainly appear to be hardier if they manage to
get past their first few years.

I defined ‘Bootstrap Capital’ on UrbanDictionary.com this way:

Also known as self-capitalization, this is how most start-ups
actually capitalize themselves. Sources of bootstrap capital include:
soft capital (Mom/Dad/Rich Uncle Buck), home equity loans, supplier
credit, consulting, credit cards, retainers, deposits, progress
payments, receivables factoring, partners, sponsorships, guarantors,
pre-sales, launch clients and more. Bootstrap capital allows the
ownership to keep control of their own enterprises and not lose them to
VCs and other debt or equity holders.

“Two former students decide to start a home building business.
They have no capital so they: 1. find a friendly landowner who allows
them to set up shop in a field and pre-sell homes with no money up front
to the landowner (who gets paid when the homes sell); 2. they pre-sell
10 homes and take deposits of $20,000 per home so now they have $200,000
in their bank account; 3. they get 90 and 120 day terms from their
suppliers so that the suppliers also get paid when the homes sell; 4.
they take their 10 Agreements of Purchase and Sale and pledge those to
the Bank for a LOC (effectively borrowing their clients’ credit scores).
After two years, they have $800,000 in the Bank and own 100% of the
business. This example demonstrates five sources of bootstrap capital:
supplier credit, pre-sales, launch clients, deposits and guarantors.”

Synonyms: capitalization/self starter/start with nothing/soft capital/home equity/start up

Having real cashflow from clients and customers is the basis on which
survival of all enterprises ultimately depends. Terry Matthews (founder
of many tech businesses including Mitel, Newbridge and March Networks
to name a few) tells his acolytes: “Get close to the customer—early and often.”
He insists that all new personnel in his startups spend six months in
sales so they understand their customer better, understand their
products and services better and can explain what it is they actually do
in under two minutes. They also get an appreciation of how hard it is
to earn a dollar and how competitive it is so they understand at a nano
scale level that they also have to control costs or they will fail.

We used to do the same thing at the Ottawa Senators—start everyone in
sales so that the next time a star player or his agent insists on an
extra half million, everyone in the organization understands how many
season tickets or hot dogs or signs have to get sold to actually pay for
that.

Perhaps people who win the ‘megabucks’ lottery and the person who
inherits their money experience similar fates. Many million-dollar
lottery winners are worse off five years after their big win than
before—by that time, they have blown their dough on ‘can’t miss’
opportunities and they have no J.O.B. to go back to. Moreover, they may
have picked up some bad habits like drug or alcohol addiction along the
way. Many multi-millionaire athletes today also end their careers with
nothing.

People who inherit their money may not actually lose it, although
many do. They might just sit on it—old money could be invested (and
usually is) conservatively in, for example, T-bills and it doesn’t do
much of anything. It may earn 3% to 4% these days, less after tax. In
the hands of an entrepreneur, that money would be put to work—typically,
entrepreneurs will earn 20% to 30% on the money invested with them.

Also, someone who has earned it for himself or herself knows how hard it is to do it and they are less likely to throw it away.

The number one thing I get asked in my classes and in the speaking and consulting that I do is: “How can I raise $3 million from Angels or VC to start my business?”
I often get asked this question right after I have spoken about
self-capitalization or bootstrap capital. So I know the concept is
foreign to most people and that they have a hard time grasping the use
of OPM (Other People’s Money). The only way I know how to get the point
across is by analogy and example. So I will give you a few examples
below and then I will give you a list of sources of self-capitalization.
It will be a partial list—which is all it can be: there are as many
varieties of bootstrap capital as there are ideas out there in the minds
of clever entrepreneurs.

Is Lack of Access to Capital Really the Problem for Startups or is it the Lack of Guts?

Is lack of access to capital really the main barrier to entry for
most entrepreneurs? I believe that the stated lack of access to capital
by many would-be entrepreneurs is more of an excuse than anything else.
Here is my (absolutely unscientific) bar chart of what I think are the
main sources of capital for startups. (I leave it to a future grad
student to prove it or disprove it.)

Home Equity Loans
*************************************************
Soft Capital #
***********************************************
Supplier Credit
********************************************
Consulting
*****************************************
Pre-sales/Launch Clients
*************************************
Credit Cards
*********************************
Deposits, Retainers ##
******************************
Receivables Factoring
****************************
Financial Leasing
*************************
Partners/Debentures
*********************
Trading/Speculating/Reselling
*****************
Strategic Investors/Partners###
***************
Banks
***********
VCs
*******
Government Grants/Tax Credits
******
Angel Capital
****
Franchising
***
Accretive Buying/Selling
**
ESOPS####
**
Sponsorships
**
Patents and Royalties
**
Collectibles Sales
*
Business Competitions
*
# Mom, Dad, Rich Uncle Buck, co-guarantors
## Plus Progress Payments and Draws
### Investment by competitors, near competitors, future clients and future suppliers
### Employee Stock Ownership Plans

This is just my experience talking—who knows I may be wrong but most
entrepreneurs are, by definition, people without money. Again, in my
experience, people with money are not entrepreneurs, they are called
‘old money’ and, as discussed above, old money anywhere, tends not to do
very much—it sits around collecting coupons not starting high-risk new
enterprises.

I always laugh when my students in entrepreneurship at the Telfer
School of Management at the University of Ottawa go to a Bank for the
first time and ask for a loan to start a business—and then get refused
because their only ‘collateral’ is their student debt. It took 2006
Noble Peace Prize winner Muhammad Yunus of the Grameen Bank to realize
that a bank’s real job is to lend money to people who need it—a
completely novel thought, it turns out.

Dr. Yunus also realized that the way out of poverty for the vast
majority of people on this planet is to become (at least at first) micro
entrepreneurs. In fact, Grameen Bank lends on a priority basis to
people who have the greatest need and the least money! And you know
what? Their loan loss ratio is tiny and they make a profit too.

Canadian Banks would probably prefer to do zero small business
lending. It takes very few bank resources to approve a home mortgage,
give out a credit card or make an auto loan. Banks think nothing of
approving a $350,000 home mortgage—if your credit score (or your Beacon
Score) is high enough—in minutes. But go to the Bank for a small
business loan of $350,000 and you will find that: a) they need a massive
amount of data from you and b) they need an expensive infrastructure in
terms of on-the-ground bank managers, loan officers and back office
types to approve your loan application. I believe if it weren’t for the
fact that successive Finance Ministers lean on the Chartered Banks in
Canada, they would choose to turn down every small business loan
request.

The reasons most VCs aren’t interested in most startups are as follows:

1. Most business startups don’t have the growth prospects to attract VC funding.
2. Most startups are in industry sectors that don’t appeal to VC funds anyway.
3. Most startups should be much further along in their development
before they go after VC funding, if they ever do. If their business has
real cashflow and real customers and clients, they are on a much more
even footing with respect to negotiating a fair agreement with VCs, if
that is what they choose to do.
4. Finally, it is much more efficient for Canada if VCs fund more mature
companies that are at a stage where large capital injections are: a)
less risky, b) more inclined to be put to wise use by (now) experienced
entrepreneurs.

So if you plan to start a business and you don’t want to give up
control and a ton of equity to VCs and Vulture funds, learn everything
you can about self capitalization—you’re going to need it. And instead
of just talking about doing something, go out there and start your new
enterprise and, once you’ve built it, hold onto to it.

A Few Examples

“…we work in a business of tough competitors,” said Jerry
McGuire in the film of the same name. When I was a boy, there were about
3 billion people on this planet. Now there are nearly 7 billion. If you
are a young person today entering the workforce or starting a new
enterprise, you not only have to compete with more people in your own
nation but all those clever, hard-working folks overseas too. I would
guess, in an inter-connected, Internet-savvy world, it isn’t twice as
hard today; it’s probably more like a factor ten times tougher.

If your city-state is going to succeed in this Century, it will need a
successful entrepreneur class who will have to be tough competitors. To
that end, these city-states will have to provide far more intensive
education for all ages and stages of life. They will need unconventional
mentoring for startups as well as much more effective promotion and
sales of their products and services. Plus, when warranted, they’ll need
to celebrate their achievements.

You’ll note that I didn’t say they will need more bank financing or
more VC funding. That’s because I think that early-stage companies
should focus on and rely on building real cash flow—finding real launch
clients and holding onto real customers. I have been doing work in this
area since 1999 and it proves that, if you wear an old suit long enough,
it will eventually come back in style. And that has happened here—the
world has come to share this view.

Not only is it better for new enterprises to self-capitalize (since
the Founder(s) retain ownership and control over their companies instead
of losing it to VCs), it is better for VCs (they should be looking for
the ‘tall poppies’, i.e., investing in more mature/profitable companies
and more mature entrepreneurs who have built real businesses) and it is
better for your nation as well since the country will see more
employment from more startups that are more sustainable and it will
serve to ration a scarce commodity—capital.

As I said above, most people can not really grasp the idea of
bootstrapping a new business. I can give a three hour lecture on the
subject and a dozen examples but, the following week, I’ll be asked a
question by a student entrepreneur: “Sure, that worked for Eseri.com but
I still need $3 million to start my business, don’t I?”

Eseri.com, started by PhD entrepreneur, Bill Stewart, provides
lightweight Internet-based (actually cloud-based) desktops that use
widely-available and proven freeware. Eseri is based in Ottawa and
Montreal and was started with nothing—Bill still gives $1,000 per day
seminars on project management software so that he can fund his real
passion—building a great business of his own. He also uses stock options
to keep his core group of developers on the job. Plus he leverages what
money he puts in with GOC (Government of Canada) IRAP grants.

In the Great Depression of the 1930s, King Clancy built the old Maple
Leaf Gardens the same way. He paid his workers with script—if the
‘Carleton Street Cash Box’ had failed that script would have been
worthless. Fortunately, for their workers and Toronto Maple Leaf fans,
it wasn’t and they were able to redeem it for more familiar currency and
feed themselves and their families.

In the US, the number one source of finance for SMEEs in 2009 was
supplier credit. Sometimes called Trade Credit (TC), it amounted to
$2.15 trillion and dwarfed bank lending to SMEEs of just $1.5 trillion.
As entrepreneurs well know, Canadian Banks have a habit of lending money
only to people or businesses that don’t need it; i.e., they only lend
when they have adequate collateral. Loan to value ratios typically are
in the 50% range for commercial lending—entirely useless to
entrepreneurs who, by definition, start with almost nothing.

Suppliers, on the other hand, want a new enterprise to be
successful—that way they will have helped create a new client for
themselves. If you are going to start, say, a new fencing and deck
company, the way you bootstrap it is: you arrange supplier credit from a
friendly lumber store and you get funding from your clients too.

For example, when former student Siavosh Noruziaan’s new company,
Empire Fences and Decks gets an order for a new deck for $8,000, he asks
his client for a deposit of 50%. The other 50% gets paid when his crew
finishes the job. He then orders $5,000 worth of materials from his
suppliers who have extended credit to him*. Perhaps, for example, they
have given him 45 days to pay for what he just purchased. Now he has got
$4,000 in cash in the bank and $5,000 worth of supplies on site—so he
has enough cash to pay his workers and himself until the job is complete
and then, with the balance in hand, he’ll have enough to pay his
suppliers…

(*Home Depot actually gives Siavosh 6 months to pay and Kott Lumber about 60 days.)

If you think through this model for a minute, Siavosh’s main sources
of equity are: a) his clients and b) his suppliers. His Cash Conversion
Cycle is negative (more on this later) and the more sales he has, the
more cash he has on hand, a happy situation.

Some other former students of mine, Fred Carmosino, a Sprott School
of Business grad, and Brian Saumure, a Carleton University SOA (School
of Architecture) grad started their successful firm, Maple Leaf Design
and Construction exactly this way—with launch client money and supplier
credit.

First, what is cheaper—debt or equity? Many people think equity is
free. Not so. VCs want to see at least a 20% p.a. ROI and Vulture Funds
are aiming for a ROE of ~ $40%. But today you can get a variable rate
home LOC for just 2.15% so now you know, debt is much less expensive.
Even if you use 2nd mortgage type debt, you may pay 8% to 12%, still
cheaper than equity.

But what is cheaper than debt? It’s supplier credit and launch client
money! They usually charge you nothing for it. Clients give you their
money in the form of deposits, retainers and progress payments for free
because they want to buy your products and services, they want you to
survive and they trust you.

If you build your business this way, it will have a Cash Conversion
Cycle (basically, Accounts Receivable + Inventory – Accounts Payable)
that is very short or, better yet, negative. This means that as your
sales grow, you generate cash instead of needing to raise more
cash—crucial to entrepreneurial, bootstrapped startups.

Lastly, bootstrap capital is much faster than going the VC-route or
asking Angels for funding. VCs or Angels, if they will even consider
funding you, take 6 to 12 months to make up their minds. Banks take…
well forever*.

(* Canadian Banks only lend money to people who don’t need it—like people who have inherited their wealth.)

I realized recently that the flip side to bootstrapping yourself to entrepreneurial success is negative cost selling.

In the case of Maple Leaf Design and Construction, their source of
capital which was essentially supplier credit is a form of negative cost
selling for their suppliers. Let me explain.

Maple Leaf was able to convince a friendly landowner to provide them
with options on their land, basically at no cost. The landowner would
only get paid when Maple Leaf completes and sells a home. So the lot
owner is getting paid by the home buyer not Maple Leaf.

From the lot owner’s perspective, he had land that wasn’t moving. In
effect, the landowner could have gone to a home builder (Maple Leaf, for
example) and said: “You can have an option on my land for six months
for $2 per lot provided that you come up with great floor plans and
designs, put signage and a trailer on my property and sell your homes to
homebuyers…You only need to pay me when the home is built and the
property is sold.”

For Maple Leaf, they pay $2 for each lot. (The reason they pay
anything at all has to do with common law—an agreement has to have
offer, acceptance and consideration. The $2 is the consideration without
which the agreement would not be legally binding.)

Now if they take a $20,000 deposit with each home sale, their cost
for the lot (in terms of cash) is a negative $19,998. That is an
attractive selling proposition for the landowner to use and a compelling
value proposition in the eyes of Maple Leaf.

Now what about other suppliers such as drywallers, plumbers, truss
manufacturers, electricians, roofers and so forth? Could they use this
approach too? Sure. If you are new to a market, you can use it as a
competitive advantage—go to home builders and offer them terms. Again,
you are prepared to wait to get paid in exchange for helping the builder
win more business.

Now there is risk in this approach—you may be giving up your lien
rights or, if you are the friendly landowner, what do you do if the home
builder collapses mid-project? Half completed homes on your property
may have a negative value. If you have postponed your Seller Take Back
Mortgage (basically, the lot price you and the builder have agreed to
which has been secured by way of a mortgage in favour of the landowner)
to a Lender who is providing construction finance (and they are in first
position), you may get nothing for your land if there is a problem.

Bootstrapping and negative cost selling may be flip sides of the same
coin but both have risks associated with them. That, of course, is the
nature of entrepreneurial approaches to anything—the risk profile is
much higher but it is the only way entrepreneurs can start a business in
a tough, competitive world that really doesn’t want to give them a
break. The harder you work, the luckier you get.

For a nascent homebuilder, like Maple Leaf, suppliers not only
extended credit for everything from concrete foundation work to trusses,
lumber and drywall, lawyers, architects, structural engineers,
surveyors, soils engineers and other professionals may also consider
extending credit for their services until completion of a sales
transaction. The reason they do it? Every time they successfully prop up
a startup like this, they have created a new (often very loyal)
longterm client for themselves.

Again, Maple Leaf started with two forms of equity: a) client
deposits and b) supplier credit from not only the usual suspects but the
landowner too. For this equity, Maple Leaf paid nothing—no interest and
they gave up no shares in their new firm either. They also reduced the
amount of capital they needed for their first project—from more than $5
million to zero.

They initially wanted to build 15 homes with average selling prices
of $400,000. To do that they required 15 lots (with an average price per
lot of $90k) for $1.35 million. The cost to construct each home
(all-in) was around $258,000 which gave them a gross margin of 13% on
each house sold. So they needed another $3,870,000 for construction
costs. So in a traditional approach, Fred and Brian felt they would have
to have $5.22 million to get their business off the ground.

But with a friendly landowner willing to postpone payment for each
lot until completion, this amount was reduced by $1.35 million, right
off the bat.

Their suppliers gave them credit for 50% of construction costs,
another $1.935 million in funding. Plus they were legally allowed to
collect $40k in cash deposits from homeowners for another $600k in
funding*. This still left a funding gap of $1.335 million. But wait,
they had contracts with homeowners worth $6 million on which their Bank
would give them an operating line of credit based on a LTV (Loan to
Value) ratio of 50%. This meant they had access to another $3 million
which implies a funding surplus of $1.665 million. So they actually
turned a $5.22 million problem into a $1.655 million opportunity, an
incredible turnaround of nearly $7 million in their situation. Note that
the Bank is not financing them—it is actually financing the homeowners
who presumably (at least at that time) had better credit ratings than
Fred and Brian.

(* These deposits are insured by Tarion Home Warranty Corporation in
Ontario to a maximum of $40k per home. The deposits are obviously
impressed with a trust and are not for Fred and Brian to buy fast cars
or take a great vacation in Los Vegas…)

Now Maple Leaf could not have done any of this without sales, which is the sine qua non of Bootstrap Capital.

Here are the calculations for Maple Leaf:

1-Aug-10 Maple Leaf Model

Selling Price $400,000
Lot Price $90,000
GPM $52,000 13%
Cost of Home $258,000
No. of Homes 15
Total Sales $6,000,000
Construction Cost $3,870,000
Lot Costs $1,350,000
Gross Profit $780,000 13% Check
$780,000 Check
$6,000,000 Check
Capital Needed $5,220,000
Landowner Credit ($1,350,000)
Deposits Received from Buyers ($600,000) $40,000 per home
Trade Credit Available Until Completion ($1,935,000) 50%
Funding Gap $1,335,000
Bank Financing ($3,000,000) 50% LTV
Funding Surplus $1,665,000
Turn Around $6,885,000

More about Trade Credit

In 2009, trade credit (or supplier credit) surpassed bank lending as a
source of finance for business in the US. TC amounted to $2.15 trillion
that year versus $1.5 trillion in bank lending (which was down more
than 6.5%, year over year) according to data from the US Federal
Reserve.

Trade credit or supplier credit is a key source of funding for most
enterprises and especially for startups, it’s crucial. Now again, I ask:
“Why would they do that?”

• First of all, they do it because they trust the business they are providing credit to, to eventually pay them.
• Secondly, they want to expand the market and their market share—one of
their key weapons for doing that is to provide credit to the firms that
buy from them.
• Thirdly, this tends to lock clients into their business
eco-system—once the client has been approved for trade credit, they tend
to buy from the same source over and over again using their approved
credit facility on a revolving basis.
• Fourthly, once the client establishes good credit, they can always
apply for a higher credit limit and expand their business further using
OPM—Other People’s Money, i.e., credit extended by their supplier or
suppliers.
• Fifthly, suppliers expect to be paid not by their clients but by their
clients’ clients—in the case of the homebuilder, for example, cashflow
is actually coming from homebuyers. So the supplier is actually funding
(indirectly) the credit rating of their client’s homebuyers.
• Sixthly, suppliers want their clients to stick around for a long time.
They will often go out of their way to help out a loyal client who
perhaps gets into financial difficulties by giving them better terms on
their financing, forgiving portions of their debt or even trading debt
for equity. If a bank hears you are in trouble, they’ll more than likely
call your loan. Most suppliers will remain supportive (to a point).

Let’s look at another business—the promotional products business.
We’ll call the business Acme Promotional Products. Again, Acme’s clients
will be a prime source of capital if the business takes, say, deposits
of 50% on each order, up front. The business might also arrange trade
credit with suppliers—maybe they pay 1/3 down with each order and the
balance 30 days after delivery.

Let’s look at Acme’s cashflow. Let’s assume that they do only one
transaction in their financial year in the amount of $300 and their cost
of goods sold is $200. They pay 1/3 of the order up front to their
supplier (i.e., $66.67) but they get a deposit of 50% from the client or
$150.

A good indicator of what their cashflow will look like is to calculate their Cash Conversion Cycle (CCC)?

The CCC is an important tool for entrepreneurs to use—if it is 0 or
negative, then entrepreneurs can probably grow their businesses without
the need for outside funding.

You can determine your CCC as follows:

CCC = ART + INVT – APT,

Where:

CCC* is Cash Conversion Cycle,
ART is Accounts Receivable at Year End,
INVT is Inventory at Year End,
APT is Accounts Payable at Year End.

(* To make it easy for you, you can download a spreadsheet in .xls
format from our server at:
https://www.dramatispersonae.org/BusinessModels/CashConversionCycleMeasurement.xls.
You simply insert the figures for ART, INVT and APT and the spreadsheet
will automatically give you your CCC number.

You may prefer using our CCC calculators in your browser, so we also
put them up for you at:
https://sheet.zoho.com/public/profbruce/cashconversioncyclemeasurement.)

For Acme, we can figure out their CCC as shown in postscript 2 below.
In this simple model, their Cash Conversion Cycle is a healthy -61
days. What this tells you is that the faster that Acme grows the more
cash they will have on hand.

This is a non-trivial advantage for them. If they had to rely on
their Bank to fund their AR, they are vulnerable to a change in Bank
policy, the appointment of a new Account Manager, rumors spread by a
competitor that might frighten their Bank into calling their loan and
lines of credit or an overall downturn in the economy that results in a
decrease in Bank lending. In this case, Acme is relying instead on their
customers and their suppliers to provide them with their financing.

What if Acme, instead of asking for half down from their clients only
got paid when the order was delivered? What happens to their CCC? It
becomes a horrible +122 days. So even though they are only giving their
suppliers 1/3 down on each order, waiting to get paid by their customers
means that they have to find outside financing for each order and now
they are in hock to and reliant on their Bank, with all the attendant
downsides I described above.

Of course, if they don’t pay anything to their supplier until they
get paid, then their CCC will be exactly 0 which is better than +122 but
not as good as the payment plan, receivable plan and inventory
management system we started with. Seemingly small changes in company
policies can produce big changes in your CCC and cashflow so this is an
area that needs more focus and attention.

Most entrepreneurs and many businesses do not give enough thought to
this. We had one client of ours, a top notch advergaming firm, nearly go
out of business despite: a. fantastic growth in their order book, b. a
client list to die for (including several Fortune 50 and Fortune 500
companies) and c. having tremendous technology and creative resources
within the business. Each time they signed a contract, they had to hire
more, highly paid tech developers and build their ‘pipeline’ to deliver
the product. They forgot to get any money up front from their clients
and didn’t even receive progress payments when they hit certain project
milestones. For complex projects that lasted a year or more, they had to
wait until delivery plus 30 days to get paid—it was feast or famine for
them.

As a result, they needed huge amounts of capital from their Bank,
which predictably enough put them in a precarious position. I was called
in when the Bank had called their loan and the firm was threatened with
extinction. We got the Bank to agree to a 90-day standstill agreement
and then we asked their client base for help. Practically all of them
came to their assistance.

Now their biz model calls for 1/3 deposits up front with each new
contract and progress payments that always put the firm out front in
terms of cashflow. Only 10% is due upon final delivery. Their CCC went
from over +300 days to a -40days and the firm went on to do really great
things.

If you think this only applies to SMEEs, you’re wrong. Think about
Dell for a minute. They don’t build computers until they have an order
and they require that you pay 100% (and sometimes more than 100%) up
front. Once they have your money, your PC is built by a Dell supplier
who only gets paid, say, 30-days after delivery. I guesstimated Dell’s
CCC at -45 days. In fact, it may be better than this—Dells tries to
upsell you on ‘value added’ services like a full, multi-year extended
warranty for parts and service that they hope you will never actually
use or they will never actually have to deliver (remember ‘Dell Hell’?)
The impact of Dell receiving > 100% of the price upfront on their
cashflow is a big plus for them, not so much for you.

So one of the keys to Bootstrap Capital is to not need startup
capital in the first place! You can help do that by looking for
financing in the deal flow itself; i.e., start with a CCC that is
negative. You can get capital from your clients and from your suppliers
and you should try to get as much as you can (within reason) from both.

Sometimes your suppliers can be coaxed into giving you not only trade
credit but cash too. If you are an automotive company, for example, a
good place to look for the cash you need to fund the required R&D
for a new car line would be from your suppliers. They will ‘sponsor’
your efforts in the hopes of securing supply contracts for the new
assembly line. Think this only applies to large firms? Think again. Many
startups could find funding in sponsorships except that they just don’t
think in those terms.

One of my students wants to start her own women’s fashion and design
firm in Montréal and she isn’t sure where she will get her startup
capital. Every VC and Angel Investor she has talked to has turned her
down—not a field they are interested in.

Instead, we sketched out a program to ask perfume companies, jewellry
firms, fashion magazines and bloggers, wineries, distilleries,
breweries, sunglasses manufacturers and others to sponsor her first
event in Montréal; after a successful launch there, she will go on tour
of major cities in Canada, the US, Europe and Asia and her sponsors will
go with her.

Why would they each contribute money to this? Again, first of all,
because they trust her. Secondly, she is passionate about what she does.
Thirdly, she has a very different approach to fashion and design which I
can’t disclose here. And they want to be associated with something
avant garde like this.

We calculated Acme’s CCC as follows:

Dec. 22, 2009 CASH CONVERSION CYCLE (CCC*) MEASUREMENT

CCC Measurement- Promo Products Biz** Number Units

Accounts Receivable at Year End (AR) $150
Days Per Year 365.25 Days
AR x Days Per year $54,787.50 Dollar-Days/Annum
Annual Sales $300 Dollars/Annum
AR x Days Per year/Annual Sales 182.625 Days ART

Inventory at Year End (INV) $0
Days Per Year 365.25 Days
INV x Days Per Year $0.00 Dollar-Days/Annum
Cost of Goods Sold (COGS) $100 Dollars/Annum
INV x Days Per Year/Annual Sales 0 Days INVT

Accounts Payable at Year End (AP) $ 133.33
Days Per Year 365.25 Days
AP x Days Per year $48,700.00 Dollar-Days/Annum
Cost of Goods Sold (COGS) $200 Dollars/Annum
AP x Days Per year/Annual Sales 243.5 Days APT

CCC* -60.875 Days

* CCC = ART + INVT – APT
** For demonstration purposes only.

Payables Down 0.333333333 0.666667 In 30 days
One Sales Transaction

Sponsorship as a Form of Self-Capitalization

When we were trying to Bring Back the Ottawa Senators in 1990, a team
that hadn’t played a game in the NHL in nearly 60 years, we had a lot
of help. We signed up 500 Corporate Sponsors at $500 each plus 32
Original Corporate Sponsors at $15,000 each for the Ottawa Senators
before the franchise was even awarded. Perhaps more impressively, we
sold 15,000 PRNs (Priority Registration Numbers—reservations for season
tickets for a team that did not yet exist) to the public for $25 per
PRN, non-refundable.

Of course, no one buys one season ticket, so these were sold in
groups of two. For their $25, potential season ticket holders got a nice
form signed by Cyril Leeder (now President of the Ottawa Senators and
Scotiabank Place) and a bumper sticker. PRNs were sold in twos and
fours, mostly to individuals and SMEEs.

Jim Steele (now head of Sens broadcasting) told me he got into an
argument with a guy on the phone late one night in November 1990 (the
team was awarded by the NHL on Dec. 6, 1990), got dressed, went down to
the bar where the guy was, convinced him of the merits of supporting the
cause and came away with 50 bucks for 2 x PRNs.

What that should tell you is that sales is not about somehow pushing a
button and all of sudden, hundreds or thousands of clients line up to
give you their money. This is about down-in-the-trenches street fighting
for each sale, one by one. That’s just as true for IBM as it is for the
most modest business person like the very successful middle-aged guy
who sells Polish sausages on Laurier Avenue in Ottawa outside the
University building where I work.

When Kevin Rose and his co-founder wanted to populate their news
agglomeration site (the hugely successful and delightful Digg.com), they
didn’t try to send out a mass email or advertise on TV, they called
1,000s of people themselves, one at a time, and asked them to
participate in the launch.

There is still no substitute for ‘shoe leather’.

In the case of the Sens, we raised more than $1.1 million from
sponsors and another $5.4 million from land owners in the form of Seller
Take Back Mortgages. STBs are another form of bootstrap
capital—essentially, the landowners who sold us about 600 acres for what
would become Scotiabank Place and associated development, provide some
of the financing for us to acquire their holdings.

The total campaign including the cost of visiting with all the
Members of the NHL’s Board of Governors, preparing the bid,
participating in meetings, buying the site for a MCF (Major Community
Facility) and so forth was about $9.7 million but sponsorships and STBs
significantly reduced that to about $3.2 million in cash.

Oct. 10, 2009 Sens Sponsors: Bring Back the Ottawa Senators Campaign

Corporate Sponsors $ 250,000.00 500 $500 each
Original Corporate Sponsors $ 480,000.00 32 $15,000 each
PRNs $ 375,000.00 15,000 $25 each
Total Sponsorship Raised $ 1,105,000.00
Campaign Costs
Scotiabank Place Site and Lands ($7,200,000.00) 600 acres $12,000 per acre
Campaign Costs ($2,500,000.00)
Sub-Total Campaign Cost ($9,700,000.00)
Seller Take Back Mortgages $ 5,400,000.00 75%
Net Cost of Campaign $ (3,195,000.00)

Now I hear all the time that this is fine for larger businesses like a
NHL hockey team but that it doesn’t apply to a small startup. But I
find that if you think about it for a minute, you can apply this
practically anywhere.

A couple of guys I know were in my office last week—they have a
series of products they are trying to get off the ground—a curved golf
club, a curved hockey stick, a curved walking stick and a curved ski
pole. Their company (pleasantly called WOW) believes that, for example,
their curved driver helps duffers hit the ball straighter while their
curved hockey stick they say helps make a player’s shot ‘heavier’. (I
wrote a piece of the science behind a hard versus heavy shot in hockey: https://www.dramatispersonae.org/HeavyHardShotsVersusFastSlapshot7December2006.htm).

I cautioned them against a GO-BIG-OR-GO-HOME strategy; it almost
never works for these types of gadgets. I told them to use a go slow
approach. Build a 10 cent website using a platform like Yahoo! Small
Business (https://smallbusiness.yahoo.com/ecommerce/),
go to a few trade shows, ask a few high profile folks to try their
wares and endorse them if they like them (but don’t offer them any money
because they don’t have any to give away), trade links with some
friends on the web to boost their Google page ranking, basically, do
stuff that is inexpensive.

Their goal (which I set for them) is to build a sustainable PB4L
(Personal Business for Life) that within a few years will earn $120,000
per year PROFIT, spilt between the two of them. If one of their gadgets
takes off terrific. If not, a PB4L that produces some income will be
better than nothing and they will take great satisfaction from it.

Their idea when they walked in the door was to raise $10,000 to
$20,000 from, say, 30 people and then blow it all on big product orders
from China, an advertising campaign, a presence in major retail chains,
investment in celebrity endorsements, getting major distribution players
to back them and so forth.

This approach usually spells disaster. If you have a game you have
invented or a gadget of some kind, the established players in those
industries don’t want to hear from you. Parker Brothers, Milton Bradley,
Nike, what have you, don’t want unsolicited proposals—they will simply
return them to you unopened with a form letter saying ‘we didn’t look at
them and don’t send us any more’. The reason? They are deathly afraid
you might claim later that your product is similar to one they were
already developing. They have found juries only too willing to believe
(often justifiably) that a large corporation has essentially stolen an
idea from a small scale inventor and damages (especially in the US) can
be huge.

Plus these established players hog all the shelf space and don’t want to share it with you.

For every Air Hog or Trivial Pursuit there are millions of ideas,
concepts and patents that never amount to anything and often cost their
inventor everything. For every Robert Kearns, the inventor of
intermittent windshield wipers who won a multimillion-dollar lawsuit
against Ford, there are hundreds of thousands who gave up.

I believe you have better odds of making a fortune by buying a Lotto 6/49 ticket than you do with most gadgets or gizmos.

So aim low, go slow, don’t risk too much money and you may get a pleasant surprise on the upside.

The guys also asked me if they could sell their ideas to one of the
established players. To those of you who follow my writings, you already
know the answer to that—no. Ideas are abundant and cheap. Large players
buy cashflow and market share; in my experience, they won’t pay a
farthing for just an idea.

Another thing that can really assist these guys is for them to get
some sponsors. This was a new idea for them and we discussed how it
might work:

1. They believe, and I agreed, that the curved driver was probably the best gadget to start with.
2. I told them that the golf audience is a highly desired one by advertisers but hard to reach.
3. What if they put the logos of a few sponsors on the shaft of each driver?
4. Law firms and accounting firms want to reach this audience and they
have (at least in Canada) restrictions on how they advertise. Adding
their logos and website URLs on the shafts of these drivers would suit
them perfectly.
5. Other potential sponsors might include high end autos, a beer company
and purveyors of luxury goods, maybe even resorts and hotels.
6. Every time a golfer drags that driver out of his or her golf bag, they see these logos—they aren’t zappable like TV ads.
7. They continue to work for the life of the club—maybe five or more years.
8. The clubs might retail for $200 and cost about $60 each. Perhaps they
could put five logos on their drivers for, say, $6 per club so half
their costs are covered by sponsors!
9. If the average golfer plays 12 rounds per season and brings his or
her driver out 18 times, then the cost to the sponsor for 1,000 clubs is
$4.63 per thousand views. This is the fundamental measure of
advertising efficiency, known as CPM (Cost per Thousand, the ‘M’ in the
Roman numeral for thousand).
10. That is a very reasonable CPM; CPMs can vary from $5 for newspapers
to $15 or more for glossy magazines to as much as $60 for highly
targeted web ads. Mail drops in Canada can cost 15 cents each when
delivered by CPC (Canada Post Corporation) which obviously works out to
$150 per thousand. So $4.63 to deliver a highly valued audience is a
pretty good value proposition.
11. Co-op advertising is the way of the future—more brands will be
sharing the same space. If you are selling a high end car why not have
an attractive person modeling top end clothes and jewelry to help defray
some of the costs. That is, sponsors can have sponsors! Firms will pay
to have their products placed in other ads!

Here is how you calculate CPMs:

Oct. 10, 2009 CPMs for Golf Driver

Average 12 rounds per year
No. of Holes 18
Use of Driver 18 100%
Views of Driver 216 per year
Life of Club 6 years
Views of Driver 1296 during life of club
Cost of sponsorship $6
Cost of sponsorship $6,000 1,000 clubs
CPM $4.63

Sponsors dollars help defray your costs but sponsors can become
delivery channels too. When the guys from WOW sign up a sponsor, the
agreement might look like this:

A. They sponsor 1,000 clubs at $6.00 each.
B. They agree to sponsor another 1,000 clubs after the first 1,000 are sold.
C. They agree to buy (at a reduced price, say, $175 instead of a retail
price of $200), 20 clubs per year for the next three years.
D. They have to pay 50% of their sponsorship on signing and the balance within 6 months.
E. They pay for their first 20 clubs—50% on signing the Sponsorship
Agreement and the balance within 30 days of receipt of their order.
F. They agree to feature WOW on their Partners Page of their website and
all of the co-sponsors too. They link to all of them and WOW and their
co-sponsors link back to them—they cross promote and raise everyone’s
page rankings in Google.

If you look carefully at the above, you will see that there is an
emphasis on cashflow. Under this model, if they sign up five sponsors,
they will end up with $23,750 right up front—enough to pay for their
first order of clubs, go to a few trade shows, set up a simple website
and have some money left over. They will also be expecting another
$23,750 after they deliver the clubs to their sponsor and collect the
balance of their sponsorship.

Here is their simple cashflow model:

Cashflow Model
No. of Sponsors 5
No. of Clubs 1,000
Cost per club $6
Cost of Sponsorship $6,000
Deposit $3,000 50%
Purchase of Clubs 20
Purchase Price $175 per club
Purchase Price $3,500 for all clubs
Deposit $1,750 50%
Cash on hand $4,750 per sponsor
Cash on hand $23,750 total

Just as important, their sponsors will do something with the 20 clubs
they have been ‘forced’ to buy—they will give them away at golf
tournaments that they host, they will give them to favored clients and,
guess what, they have now become powerful distribution channels for WOW.

I find sponsorship opportunities everywhere. A couple of young
fellows came to see me recently and I sketched out a plan for them to do
some ZERO COST GOODWILL MARKETING for their new business, Acme
Enterprises in Nashville (the names and places and numbers have been
changed).

They wanted to do a food drive for the Nashville Food Cupboard and
they wanted to offer as an incentive to get people on board a draw for
tickets to a Titans game. They had arranged to get a private suite from
the Titans for $2,000 (a reduced rate from what the normal commercial
value would be) subject to their being able to find the money. They had
30 days to come up with the dough.

Here is the program we set out for them:

1. They decided to support the Nashville Food Cupboard, a worthwhile cause.
2. It would not only help the Food Cupboard which was experiencing a
shortage of food and a simultaneous increase in demand as the economy
worsened but it would also help build their brand and that would help
Acme earn the trust in the community and that would mean that Acme could
better compete in a tough marketplace and sell more of their services.
3. They got a favourable rate from the Titans for a suite ($2,000) but
still had to find the money to cover it—they just didn’t have it in
their budget for this year but knew they needed to do something to help
the community and to help themselves.
4. Everybody who brought in food donations would get one ballot for every item—you bring in ten cans and you get ten ballots.
5. They would hold a draw and the winners (there would be four of them) each get a pair of tickets to the suite.
6. Then they would go out and sign up four other local businesses to co-sponsor the food drive.
7. Each sponsor would throw in $500—for that, they each got the right to
accept food donations in their place of business (driving more traffic
to their stores and offices). Plus they each got two tickets to the
suite.
8. The suite holds 20 people—four winners of the draw would use 8 seats,
the four co-sponsors would use 8 seats and the two owners of Acme would
each get one. Plus they held back two seats for the Nashville Food
Cupboard—one for the Executive Director and one for a guest of the
ED—presumably a key sponsor of the Food Cupboard would also like to
attend.
9. Donations would be accepted at Acme and the other four locations for three weeks prior to the game.
10. Every Friday would be dress down day and every employee would wear a
Nashville Food Cupboard t-shirt. On the back would be the names of the
four sponsors and Acme.
11. The employees would receive these really well designed t-shirts for free.
12. Each co-sponsor would pay 125% of the cost of the shirts—Acme would
pay nothing—since they are putting in their share in the form of SE,
sweat equity. After all, they are organizing the whole thing, putting in
lots of hours including helping the Food Cupboard’s truck make the
rounds and pick up the donated items. Plus they are driving a lot of new
customers to the four co-sponsor locations.
13. It would be a fun afternoon at a Titans game, hoping they can win a
game this season (the Titans are off to an 0-4 start in 2009).
14. They would also put out media releases—announcing the food drive and later the winners with happy smiling faces everywhere.

This is the model we sketched out on a piece of paper for the guys:

So sponsorship applies not only to large businesses like pro sports teams but to startups and SMEEs as well.

How to Find Sponsors for Practically Anything!
More on How to Find Launch Clients
More about Useful Co-opetition
More about Strategic Investors
Social Norms v Commercial Ones

For entrepreneurs and intrapreneurs working with NGOs,
Not-For-Profits and Charities, getting sponsors is always top of mind.
But I have found that you can get sponsors for practically anything.
When I worked with the NHL’s Ottawa Senators, a (hopefully) for-profit
business, we obviously spent a lot of time and effort on this. But less
high profile businesses should also be looking at this not only as a
source of potential new revenues but also as an opportunity to co-brand
with other organizations for the benefit of both.

It turns out that organizations prefer being called ‘sponsors’ or
‘partners’ rather than ‘advertisers’. It’s like Disney World where
employees are not employees, they are cast members and customers are not
customers, they are guests. What you call someone or something
matters*.

(* As told above, wen we were campaigning to Bring Back the Ottawa
Senators, we called the new building we wanted to construct to house our
new expansion franchise, the ‘Palladium’. When you name something, it
takes on a life of its own. Tolkein’s Middle Earth Elves understood
this. Names are important.

In Ottawa’s Official Plan (the document that controls the shape that
the City will take in future years), MCFs (Major Community Facilities)
are called ‘Palladiums’; this has become a class of land use of its own.
Although the stadium is now called Scotiabank Place, the street that
runs past it is called Palladium Drive so the name should live on for
quite some time but perhaps not as long as Ents live, which is several
thousand years.)

I have often wondered why we don’t see more co-branding. If I was
selling high end cars, I might co-brand with a top fashion house and an
exclusive watch maker: sell all three brands at one time, share
advertising costs (whoops, sponsorship costs) and leverage one brand off
the other two. Perhaps people who buy those watches will like high end
suits or dresses and people who like the cars will also like fantastic
watches.

(I should also refer you to an earlier article I wrote: “Who Pays Whom” that will shed a bit more light on a related issue: https://www.eqjournalblog.com/?p=1481.)

Question: So why do corporations and individuals sponsor any organization or an event in the first place?

Answer: In part, because of their internal values and, in
part, because they want to enhance their own goals. In this essay, we
will address the latter motivation.

People are highly motivated by two emotions – fear and greed.
Organizations may sponsor an event, say, because they fear, if they
don’t, one of their competitors will. This happens a lot with categories
like telecommunications. If Bell hears that Telus is trying to ‘horn
in’ on their sponsorship of, say, Opera Lyra, they’ll redouble their
efforts. The old saying is: “Treat them mean and keep them keen.” Nothing like a little competition (and fear) to up sponsorship involvement.

What about greed? To appeal to their greed, you have to know and
understand your target sponsor’s business almost as well as they do.
This is similar to negative cost selling whereby you are able to show a
potential client that some combination of the benefits you create for
them and reduced costs outweighs the cost of buying your product or
service. (More on this concept at: https://www.eqjournalblog.com/?p=732.)

Launch Clients and Co-opetitors

Finding launch clients for practically anything is very similar to
finding sponsors: you follow the value chain in both directions.

First, you look at who benefits from your new product or service.
Second, you look at your supply chain and ask: should the people I buy
from also buy from me? When I ran the Ottawa Senators, I would ask: “Is this guy who is fixing our plumbing, a season ticket holder? If not, let’s find another plumber.”

Your accounts payable is a great source of potential launch clients
and a possible source of launch capital* as well. Suppliers will often
provide you with interest-free loans to buy their products and can
sometimes be induced to go beyond that and invest in your new
enterprise. They do this because, if you are successful, they have
helped create another customer for themselves.

(* For more on how to self-capitalize/bootstrap your enterprise, please refer to: https://www.eqjournalblog.com/?p=1162.)

In any event, your bookkeeper/accountant and his or her list of AP can be and should be part of your sales team.

There is another direction you can go in to look for launch clients.
You can look for strategic partners and co-opetitors*. This is like the
TV series, LOST, first they went back in time, then they went forwards
in time and, in their last season, they went sideways (to an alternate reality).

(* Co-opetition is when you sometimes compete with your competitors
and sometimes co-operate with them, thus, they become ‘co-opetitors’.
For example, REALTORS compete for listings and buyers but co-operate
through their online MLS system where all (or most) listings are
deposited. They typically will share commissions 50/50 when one is a
listing agent, representing the Seller, and the other is a buying agent,
representing the Buyer.)

So you can slip ‘sideways’ to look for people who have a strategic interest in your success and these people may also be competitiors.

If you have a solution for failed windows (the vacuum seals often
fail in less than 15 years), perhaps you would look for investment and
first orders from commercial building owners. But you might also go to
window wall manufacturers even though you are potentially cutting into
their sales of replacement windows. They might see that it is in their
best interests to also offer a cheaper solution to their clients (i.e.,
building owners). They could be investors in your business but they
could also be clients since they could become resellers of your service.
They would now be able to offer, in addition to, replacement windows, a
cheaper, faster, less disruptive alternative (resealing windows or
allowing condensation to escape through newly installed air valves.)

For example, the owner of a PODS franchise I know is looking at investing in
https://www.frogbox.com/, a
business that markets reusable plastic moving boxes. These are a
replacement for (mostly) throw-away cardboard boxes and could, at least
in theory, cut into the demand for PODS. But the owner of the PODS
business is a forward-thinking kind of guy and feels he might as well
benefit from this potential new entrant in his marketplace; it is coming
anyway. This is a strategic move for him in his marketplace.

In the sports business, arenas and stadiums may be operated by
another team’s arms-length management company: another form of
co-opetition.

To look for co-opetitors, ask the question: “What is the nearest substitute for the product or service we offer?”
For repaired windows, it is obviously new ones. For a new home, it is
an existing one and for a new single family home, it may be a townhome.
For one type of fast food, it is a different type of fast food.

Home builders often compete and co-operate. They know that if a Buyer
doesn’t happen to like a competitor’s home they might walk across the
street and buy one of theirs and vice versa. They know that a Buyer of a
townhome from a competitor might one day trade up to a single family
home they build and that, as people age, they might trade down too.

Petrol companies, fast food, homebuilders, even tech firms often
benefit from this type of competitive synergy. Marketing efforts by one
benefit all firms in the marketplace as someone who samples the wares of
company ‘X’ is likely to look at competitive products as well.

When IBM came into the marketplace with its first PC in the early
1980s, Apple stood to benefit as the overall market for PCs took off
even if their market share dropped. This is just as true for
Blackberry-maker RIM today as Apple emerged as a key competitor with its
iPhone series. Of course, you have to be able to keep up with your
competition or you will cease to exist.

Now here is an equation for you to think about. In a co-opetitive marketplace, you could see demand increase by 50%, viz:

.667 + .667 = 2.0

Huh?

Well, suppose that 1/3 of your potential clients prefer another type
of product, say, the brick homes built by a competitor. And further
suppose that 1/3 of their potential clients prefer the stucco homes that
you build. In the current market, you are both losing 1/3 of the
visitors to your sales offices to other alternatives elsewhere in the
City. But if you decide to co-locate in a new real estate project where
your sales centres will be right across the street from each other, then
the 1/3 of customers you might have lost and the 1/3 they might have
lost might now be retained (obviously, you would not capture them all as
if you lived in a closed system but, at least, you both now have the
opportunity to try top retain them whereas before they were just going
elsewhere.)

So Demand (DD) has increased from time 1 to time 2, viz:

DD(1) = .667 + .667 = 1.334, customers lost = .333 + .333 = .666,
DD(2) = .667 + .667 + .333 + .333 = 2.0.

So the overall market share of these two builders has increased by
50%; a remarkable, real world example of synergy between erstwhile
competitors. Co-opetition is a powerful force.

Back to Sponsorship… So What are Sponsors Looking For?

An upcoming event at the Telfer School of Management (planned for
March 2011) will be a conference on CSR, Corporate Social
Responsibility. A group of students organizing this event came to me
asking: “How do we get sponsors?”

Well, we need to ask and answer a series of questions to help them develop a strategy.

1. What do these students have that potential sponsors want? Basically, what do they have to trade?

Answer:

• Access to Telfer and top students

2. Why do sponsors want access to students?

Answer:

• Recruit them.
• Sell them cars.
• Sell them insurance.
• Sell them credit cards.
• Sell them mortgages.
• Sell them REALTOR services.
• Sell them furniture.
• Sell them legal services.
• Sell them accounting services
• Basically, sell them all the things that new graduates are going to need within the first five to seven years > university.

3. Who sells cars, insurance, credit cards, mortgages, REALTOR services, furniture, legal services, accounting services, etc?

• Answer this and you have your list of potential sponsors.

4. So let’s say they approach a Bank to sponsor the CSR Conference, what should they say?

Answer:

• Well, what they shouldn’t say is: “Give us money because we’re
poor but nice students plus CSR is a good cause. And, oh, we have a
great website that we can add your logo to.”
• They should, instead, follow the French dictum: “Suivez l’argent.” Here is a model of how this all might work:

Getting Sponsors: A Model

As an example, a Bank sponsor might be allowed to set up a booth to
recruit students and to issue credit cards 1 week < the conference
and 1 week > the conference in the Telfer School of Management
(perhaps in the lobby of the Desmarais Building, a valuable location to a
potential sponsor). With every credit card applied for or issued, the
students might also get a free, co-branded Bank/CSR t-shirt, creating
yet more leverage for the sponsor and the conference organizers.

5. If the Bank sponsor gave the CSR Conference, say, $2,500 as a sponsorship fee, what is their ROI and is that even important?

Answer:

• Yes, whether they make it evident or not, the Bank is expecting a Return on Investment, ROI.
• To recruit a single top notch student might cost $15,000 and up through conventional recruiting tools and procedures.
• That recruit could add to the Bank’s top and bottom lines. Let’s guess
$14,000 in his/her 1st year, $35,000 in years 2, 3, and 4 and they stay
for four years.
• Credit cards are one of the most profitable Bank lines. It is also one of the most competitive.
• So if we just look at recruiting and credit cards (forgetting about
Bank insurance and mortgages as well as investment services for now), we
get:

ROI = -2,500 + 15,000 + 25,000 + 35,000 + 35,000 +35,000 + N*V,

Where N = # of credit cards sold to students during the sponsorship deal,

And

V = the capitalized value of each credit card issued.

• We are assuming that the Bank recruits just one student
• As you can see, ROI is likely to be highly positive.

We call the above approach: Negative Cost Selling. Basically, what you are telling each sponsor: “The cost of your sponsorship will be more than offset by the benefits it generates and we can quantify this for you.”
The benefits are made up of either higher marginal revenues or lower
marginal costs or some combination of the two. It is your job to show
that the benefits are greater than the costs. Be specific.

If you go into each sponsor presentation equipped with this type of approach, your success rate is bound to improve.

Strategic Investors

These are people who invest in your new enterprise because it is
strategically important for them to do so or because they do it for
social reasons instead of commercial ones.

I recently advised Angella Goran who is working to get JOK Wear off
the ground (a line of women’s and men’s sports wear that uses
bamboo-based natural fibres that don’t retain odours) to go after
strategic partners* rather than Angel investors or VCs. The former are
far more likely to act faster than the latter and ask for a lot less.
They usually don’t want any equity either. Perhaps Angella can do a deal
with a large chain store to give her a pre-order of $2 million with 10%
($200k) cash down and the balance on delivery. Then maybe she can
factor her receivable for cash giving her access to a significant amount
of funding up front.

(* For more about Strategic Investors, please see: https://www.eqjournal.org/?p=2406.)

Why would the chain do this? A) Because they like her product, B)
they like and trust her and C) they might ask for a 2-year exclusivity
agreement– to keep it out of the hands of one or more of their
competitors.

This is what AT&T did with Apple and the original iPhone: they
gave Apple an unbelievable deal including access to a portion of their
subscribers’ CMRR (Committed Recurring Monthly Revenues) in return for
an exclusive period, mainly to keep the iPhone from Verizon.

Apple did it again with the iPad, asking companies to pay $10 million just to be featured at the launch.

If it is OK for a hugely profitable company like Apple to engage
strategic investors, it’s OK for startups and the rest of us too.

Notice that in return for the strategic investment (in the form of a
pre-order) Angella gives up no equity, takes on no debt, has no monthly
repayments and still gets access to capital. Of course, she has to
deliver on her promises (to deliver) which is where trust comes into
play.

Another form of strategic investing is via social norms– where people
would refer to give you the money rather than lend it to you or invest
it for a return. If you ask a $550 per hour lawyer to do some pro bono
work for a worthy client, they might very well agree. But if you offer
them $80 per hour for the same thing, they might tell you off in a huff.
This is the difference between commercial and social norms. (For more
on this, please see: https://www.eqjournal.org/?p=2527.)

There is a wonderful site that epitomizes this that you can visit at: https://www.kickstarter.com/.
You can put your project on their site and raise money from people who
want to see the project go forward and are willing to contribute
financially to that. In return they get, nothing (!) at least in terms
of Rate of Return.

If you are launching, say, a children’s book and need some startup
cash, maybe the donors (parents) will get a thank you postcard, a
calendar, fridge magnets, an autographed copy of the book, a producer
credit, a pack of ten copies, a personal author appearance and photo
session in return for various-sized contributions. (See: Twig the Fairy
Storybook project, https://www.kickstarter.com/projects/twigthefairy/twig-the-fairy-storybook?ref=category).

Launching a Children’s Book?

Bloomberg Businessweek (Oct. 30, 2011) report that anywhere from 39%
to 58% of the projects placed on Kickstarter.com reached their crowd
funding objectives: https://www.eqjournal.org/kickstarter-vc-bbw-oct-2011.pdf. The projects do not draw down any of the funding until all the funding has been committed to try to reduce the failure rate.

There are hundreds of ways to bootstrap* your new enterprise and the
Internet has made things much more interesting, accessible and wondrous.

(* For more on bootstrapping your way please see: https://www.eqjournal.org/?p=1162.)

ADDENDUM

Christie Lake Kids, an Ottawa-based charity that helps children
referred in to its programs at age 9 by Social Agencies or the Police,
is one of my favourite charities. I have suggested to them that they may
be able to offer a national or regional chain of stores a strong value
proposition based on a co-branding approach, which goes something like
this:

Feedback Loop: Suivez L’Argent

The question is: could CLK show a national chain that their volume
and bottom line will increase by more than the cost of their sponsorship
during, say, a two week period during which a percentage of sales go to
CLK? Is the fact that a percentage of sales goes to benefit the kids
during that period enough to drive more customers to their stores? Of
course, CLK would have to show that the increase in sales did not just
cannibalize sales that they would otherwise have had at other times of
the year. CLK might also be able to show that the chain’s association
with the charity brings not only immediate higher volumes and better
bottom line but also new lifetime, customers who might not have
otherwise thought to shop there.

Both organizations could benefit from this co-branding effort – CLK
could get a sizeable, recurring new revenue stream and the national
chain ups its CSR status and its sales.

Raising Capital by ‘Issuing’ Script
(Tapping Sponsors/Co-Branders/Strategic Investors and Partners for Free Capital too)

There’s nothing new about raising money by issuing script. The
Reynolds Brothers ran a sawmill (established in 1870 by Orson L.
Reynolds) in the Adirondacks that in addition to central logging and
operating the mill also ran the company store and developed other
sources of income including catering to boarders as well as selling
merchandise to loggers in logging camps. (Source: Reynoldston, New York
History of a Mill Town).

When they needed to raise money, they issued script like the $5
promissory note I show below to pay their bills or to fund new ventures
or additions to existing ones.

The script says it is: ‘Due to the Bearer…In Trade At…’ What that
means is that the bearer of the script cannot redeem it for cash, i.e., a
sovereign banknote of the nation (the United States of America). The
fact that it is redeemable only ‘In Trade’ is key. Presumably, Reynolds
has a margin on each trade so a $5 note with a GPM (Gross Profit Margin
of say 40%) only costs them $5/(1 + .4) or $3.57. It’s a good deal for
Reynolds but is it a good deal for a supplier, equipment maker or
labourer who accepts script instead of banknotes?

The answer is: it depends. If you can’t get any other work, $5 in
credit at a Reynolds Company Store, $5 in cigarettes or candy from a
Reynolds vendor (which you could then trade for other stuff) or $5 in
Reynolds products (milled lumber) might be better than watching your
family starve or having you join them in that unfortunate predicament
circa 1876 even if you know in your heart of hearts that it’s only
really worth $3.57.

Conn Smythe built Maple Leaf Gardens in a six-month period during the
Great Depression (1931) at a cost of $1.5 million. He funded it partly
with script. If the ‘Carleton Street Cashbox” as it later became known
had not lived up to its name, that script might have become valueless.
Nevertheless, for an out-of-work ironworker back in the day, it beat
unemployment. They could always find someone in the gray market to take
script off their hands (at yet another discount) so they could eat
today. It is what it is.

Canadian Tire issues script (CDN Tire money) that can only be
redeemed at their stores. Disney issues Disney Dollars at the exchange
rate of $1 DD = $1 USD. They can be converted back to US currency but
only at Disney Parks. Hardly anyone does that and Disney has several
billion dollars of DD on its balance sheet where they sit as liabilities
lest a horde of grandkids and their grandparents suddenly show up at
their theme parks clutching millions of DD they found moldering in their
parents’ sock drawers.

Don’t think that script is relevant to you? Think again. What are
gift cards really? The lesson was not lost on Tracey Clark owner of fair
trade coffee house, Bridgehead in Ottawa where she issued several
million dollars of script to help fund her recent $15 million expansion.
She is building a new HQ for her growing coffee empire and new factory
in a trendy part of Ottawa.

Tracey is a cautious, conservative entrepreneur who bought the assets
and name from a bankruptcy trustee years ago and has painstakingly
built a successful chain of coffee houses in Ottawa. She has an aversion
to debt but not script.

Her customers bought script in denominations of $250, $500 and $1,000
to help her get this expansion done. It’ll open later in 2012. Now why
would they do that? Because: 1. they love Bridgehead coffee, 2. they
love the ambiance of her stores and free wi-fi, 3. the fact that she is
local and able to stack up to and compete with mega chains, 4. she’s an
underdog, 5. they want to feel like they helped make it all happen, 6.
they trust her. But there’s another reason– they get a 20% return.

How’s that? Tracey gives them $1.20 worth of trade value on every
Bridgehead Dollar. That’s a lot better than putting a $1,000 into a
savings account and getting .7% p.a. It’s true, on $1,000 in a Bank
savings account today, you’ll get $7 in interest for the year. If you take off Bank fees, it’ll be obvious that you are paying your Bank to take your money from you.

Now what about Tracey? Say her GPM is .6. The cost of $5 in script is
them 5 x 1.2/(1+.6) or $3.75 so you can see Tracey’s cost of capital
for expansion acquired this way is a negative $1.25 per every
$5 raised. Negative perspiration for Ms. Clark. Now try getting that
kind of deal from your Bank where they lend you money at interest rates
less than zero. Not going to happen.

Recently, I met with Andrew Craig owner of Major Craig’s Chutney who,
like the gentleman he is, recently acted in Quantum Entity Short Film.
(The film will be released in May 2012 and you can read the Foreword of
the Book at: https://www.eqjournal.org/?p=2932.) He’s a true volunteer for the acting gig not a voluntold, really.

He told me the backstory on his three year old business. Turns out
his great, great grandpappy served with British forces in India circa
1884. While there, Major James Craig experimented with ingredients and
cooking methods for all kinds of chutneys and brought those with him
back to the British Isles where a subsequent generation somehow found
their way to the wilds of northern shelf Canada and brought the knowhow
with them and the written recipes waiting to be rediscovered by Andrew
in 2009. Thus was https://www.majorcraigs.ca/ born– if you need North India, Cranberry, Jerk, Butternut and Beer (yum) chutneys, well, now you know where to go.

Andrew came to see me today and, well, it’s a pretty tiny business.
He needs a bit of capital to expand and he can’t take on any debt or
partners (it’s a PB4L, Personal Business for Life). Why no debt? Cuz he
can’t yet support any. Why no partners? Cuz if he has a partner (or
takes on any debt) it won’t be long before either the partner owns his
family recipes or the debt holders do (i.e., the Bank or other lenders).

So what’s a progeny of Major James Craig to do nearly 150 years
later? Issue script and find strategic partners and sponsors, that’s
what.

His clients, distributors, food prep supplier, his label printer, his
ingredient growers, he has a lot of people in his business ecosystem
who want him to grow and succeed. If he issues script to them in $25,
$50, $100, $200 and $500 amounts with a premium of 15 to 20%, that’s a
pretty good deal for them and even better deal for him– same as for
Tracey Clark.

There is some other cool stuff Andrew can do to raise more ‘free’
money. If you look at the image below, you’ll see that strategic
partners are everywhere, you just have to see. It was there
staring poor Andrew in the face all the time. He was looking but not
seeing. One of his suppliers is fast-expanding Beau’s Brewing. There,
right there on the label! How much are they paying Major Craig to be
co-branded this way? Nothing.

That has to change. What I want Andrew to do is put five strategic
partners on his label, his new website (when he raises the ‘free’ cash
to build a decent site) and in his nice Xmas gift boxes (see the last
image I have included near the end of this post) which are perfect
vectors to carry his strategic partners’ messages to his clients– things
like teensy recipe books, coupons, tickets, biz card, promo items, what
have you.

How much of his equity does he give up to get their sponsorship money? Zero.

How much interest are they charging him to give him their dough? Zero.

In fact, he doesn’t even have to repay the money since it is a
sponsorship/marketing/advertising cost to them, i.e., an expense. Truly
free money for Andrew.

For more on this subject, please read: How to get Sponsors for Practically Anything (https://www.eqjournal.org/?p=1649) and Strategic Investors (https://www.eqjournal.org/?p=2406).

One other note I should add. I suggested to Andrew that he sign up
his sponsors for two years. He just isn’t going to have time to start
over every year at ground zero. He will also give his sponsor partners
an option on a third year at the same cost provided they exercise that
option at least 6 months prior to the end of the term of their
agreement. After that, if he is as successful as we hope, the price will
increase so this is a big benefit to his sponsors. (For more on
non-linear selling please refer to: https://www.eqjournal.org/?p=25.)

Lastly, Andrew can use his Xmas packaging as a vector to deliver his
sponsor messages. In a way, he could learn something from
LooseButton.com: they deliver their monthly Luxe Boxes to subscribers
and get paid on three sides of their biz model. See: https://www.eqjournal.org/?p=2748.

Or he could do worse than copy the Manpacks.com biz model– they
managed to turn products (men’s underwear, cologne, razor blades, etc.)
into a service by delivering their stuff monthly or quarterly or semi
annually and developing a nice recurring revenue model for themselves.
See Manpacks and the Tipping Point, https://www.eqjournal.org/?p=2455.

Regular chutney delivery service anyone?

Bootstrapping the Ottawa Senators

In 1987, when the idea of Bringing the Ottawa Senators, a team that
hadn’t played a game in the NHL for nearly 60 years, first occurred to
me, Cyril Leeder, Randy Sexton and I believed that an expansion team
would cost $35 million. It tuned out the NHL wanted and would get $50
million for both the Sens and the Tampa Bay Lightning, granted
conditional franchises in December 1990 and full membership in the
League in December 1991.

Cyril being a CA wanted to know how Terrace Investments Ltd., our
real estate company, would finance this acquisition. I had a plan to
bootstrap it. This involved:

1. Acquiring 600 acres of land on a major highway (Highway 417 or, as it is known in Ottawa, ‘The Queensway’).
2. Buying the lands for (what turned out to be) $12k per acre.
3. Rezoning the lands for a MCF (Major Community Facility).
4. Putting a NHL-calibre arena and a NHL team in the middle of this land
assembly and driving up the value of the surrounding property, now
owned by us.
5. Keeping 100 acres for the arena (called Scotiabank Place today) and the team.
6. Selling the remaining 500 acres for at least $112k per acre realizing
a $100k per acre premium which would yield $50 million which would then
be loaded into security trucks and taken to John Ziegler’s office (the
then President of the NHL) on Park Avenue in NYC to pay for the
franchise.

It was a simple plan that went awry as many plans tend to do. We had
an agreement in early 1990 with the Premier of the Province of Ontario
(Liberal David Peterson) to support us by: a) building the required
interchange on Highway 417 at public cost*, b) giving the rezoning of
the Palladium lands (as the stadium was referred to in those days) a
priority review and c) coming to Palm Beach in December 1990 to tell the
Board of Governors of the NHL what a great place Ontario was to locate
more NHL teams…

(* It is difficult to privately finance a piece of public
infrastructure sine the day you complete it, it becomes the property of
the MTO, Ministry of Transportation Ontario. It would be like me trying
to place a mortgage on your home. To this day, the Palladium interchange
is the only privately financed interchange in the Province.)

Unfortunately for us, Mr. Peterson called an election that summer,
two and half years early, with the result that he was replaced by a NDP
government led by Bob Rae. Mr. Rae and his government had other
priorities which meant the three undertakings given us by the Peterson
regime were set aside and, instead, we had the Government of Ontario
implacably opposed to the rezoning of the Palladium. As a result, after
we won the franchise at the NHL’s winter meetings in December 1990, we
faced off against our Provincial Government in a 13 and a ½ week OMB
(Ontario Municipal Board) in the summer of 1991 which we ‘won’ but it
was a Pyrrhic victory for the company and for me personally—we did get
the 100 acres approved for the arena but not the other 500 acres. As a
result, the company took an $80 million write down of its assets—$50
million on land value and another $30 million for the cost of the
interchange that would now have to be built with private funds.

So we turned to other forms of bootstrap capital to try to make up the difference:

1. We sold the arena management and F&B (Food and Beverage)
rights to New York based Ogden Corp for a 30-year term for $20 million.
2. We did a parking deal with United Parking for $1 million.
3. We sold the radio rights to CHUM Broadcasting for a rights fee of $250k.
4. We sold $22 million in season tickets in December 1990 for a team that would not play its first game until October 1992.
5. We sold the mid-week TV rights for $5 million.
6. We sold the pouring rights for the new building to Molson for $5 million.
7. We sold the naming rights (first to Corel Corp and later to the Bank of Nova Scotia) for $27 million for 20 years.
8. We pre-leased 100 private suites in the new building at $100k per year for five and ten year lease terms.
9. We pre-leased space in the new building to the YMCA and a number of restaurants and other firms.
10. We sold millions in merchandise both when we had the team and when it was only an idea.
11. We sold $25 million in limited partnerships to 62 brave souls who also became known as Founders of the team.

In other words, we scrambled.

This was in addition to the money we had raised when we were just trying to get the team (also described above) including:

a. sale of 15,000 PRNs (Priority Registration Numbers) entitling the
bearer to claim a season ticket when and if we got the team;
b. sale of 500 Corporate Sponsors at $500 each;
c. sale of 31 Original Corporate Sponsors at $15k each.

Bottom line, as Al Davis, owner of the NFL’s Oakland Raiders, said: “Just win, Baby.”

Executive Travel Apartments—Reducing your Capital Requirements

A student recently introduced me a new form of Bootstrap Capital, or
at least, one I hadn’t considered before. It seems obvious to me now but
I think it takes some creativity to apply it to any business model.

She is in the Executive Travel Apartment (ETA) business—those are
extended stay suites that executives use and many prefer to a long stay
in a hotel room.

It is a very capital intensive business: she needs equity to buy her
units, renovate them and furnish them. She can reduce her capital needs
by mortgaging the units using high LTV (Loan to Value) ratios and
leasing (or leasing to own) the furniture she needs for each unit. Still
her equity requirements are non-trivial.

She came up with a very inventive method of expanding her budding
empire without having to bring in a partner or sell her soul to finance
companies.

A form of bootstrapping is to lower the level of capital you require in the first place.

She can charge about $3,500 to $4,500 per month for her ETAs, about
$120 to $150 per night for a one, two or three bedroom unit which is
fully furnished, the Internet and TV work, the VOiP phones are on and
there is a starter kit (soap, salt and pepper, bread, milk, etc.) on
hand. Just let yourself in using the lockbox combination, and relax,
you’re home.

Because these are ETAs, she comes under the Innkeepers Act and not
the RTA (Residential Tenancy Act) so she is much less likely to have
trouble with her tenants than a typical residential tenancy where
delinquency is high, collections are tough and getting rid of them
(evicting them) is even tougher.

A typical unit can cost her $200,000 or more to buy (with anywhere
from 5% to 25% equity required), $20,000 to renovate and another $10k or
so to furnish. So each unit can easily consume $70 or $80k of equity.
Other ETA operators solve this problem by selling the units to investors
and keeping management in their hands plus a share of ownership.

She came up with another way—what if she went to residential
landlords and told them: “I will lease some (or all) of your units for
repackaging as ETAs.” From a Landlord’s POV, that takes him or her out
of the purview of the RTA and he or she now only has to manage one
tenant (the ETA operator). The ETA operator worries about furnishing the
units, renting them out, managing and maintaining them, etc.

In the buy scenario described above, she will need $80,000 in equity
per door. If she rents each unit out for $4,000 per month and has a
mortgage at 6% with a 20 year amortization period, she will be left with
a NOI (Net Operating Income) after deducting a vacancy allowance,
marketing costs, admin and contingencies of about $1,077 per unit per
month.

If she sublets units from a cooperative Landlord at $1,400 monthly,
she is left with less—just $766.49 per month per unit. This is because
she is paying less on her mortgage than she is in rent to the Landlord.

But in the first case, she needs $80k of equity; in the second case, she only needs $30k.

Now her simple ROE (Return on Equity) is 16.2% p.a. when she buys her
own units versus a whopping 30.7% when she rents them instead. (See the
spreadsheet below.)

Now this model ignores the wealth effect of owning your own units
(the annual paydown of your mortgage principal, in effect, by your
tenants) and real estate inflation (that goes solely to the equity
holder).

If I took those factors into account, the ROEs would probably be a
lot closer*. But that doesn’t matter if she can’t afford to expand her
business because the equity demands of the first model are too high for
her to handle.

So the obvious choice is to do both—own some units and sublet some.
As her cashflow improves, she should probably be buying relatively more
of her units.

But at least initially, from her POV, her capital requirements have
dropped from the $70 to $80k per door range to $10 to $30k per door and
her ability to grow the business faster has just taken a quantum leap
upwards.

Another client recently showed me how he could acquire inventory for
his retail store at a negative cost to him—other retailers are paying
him to feature their products and services in his outlet store. They pay
him a monthly fee for this plus they give him a percentage of each of
their products or services that he sells for them on consignment.

We are now busy applying this philosophy to other types of businesses with great effect.

* If we take into account the wealth effect and the impact of real
estate inflation, the two rates of return (this time measured using the
IRR instead of the simple ROE ratio) are, in fact, closer. In the ‘buy’
scenario, the return increases from 16.2% p.a. to 22.8% while for the
‘sub let’ scenario, the return remains that same at 30.7%.

The latter doesn’t change because, in this model, I have assumed that
when she sells the business at the end of year 7 (an arbitrary time
line, I might add), she realizes exactly what she put in initially for
renovations and furnishings. Of course, in reality what she gets for the
business would depend on what she and a Buyer agree to which could be
greater or less than this amount. Nevertheless, in order not to bias the
comparative analysis, it seemed reasonable to make this assumption.

You can examine the spreadsheet below or download it in .xls format from my server at: https://www.ottawarealestatenews.ca/ETAs.xls.

ETAs

Buy the Units

Cost per Unit $200,000
Equity ($50,000) 25%
Mortgage $150,000 75%
Interest 6% p.a.
Amortization 20 years
Monthly Payment ($1,089.81) to Lender
Renovations ($20,000)
Furniture ($10,000)
($30,000)
Interest 10% p.a.
Amortization 7 years
Monthly Payment ($513.51)
Total Cost ($1,603.32)
Monthly Rent $4,000
Marketing ($320) 8%
Vacancy ($480) 12%
Other ($240) 6%
Contingencies ($280) 7%
NOI $1,077 per month
Equity ($80,000)
ROE 16.2% per annum
Year
0 ($80,000.00)
1 $ 12,920.15
2 $ 12,920.15
3 $ 12,920.15
4 $ 12,920.15
5 $ 12,920.15
6 $ 12,920.15
7 $ 167,186.31 $ 12,920.15 $ 124,266.15 $30,000
IRR 22.8% p.a. Assumes the business is sold
and the sale price of the biz
R.E. Inflation 2.75% equals the investment in
Selling Price $ 241,825.90 furniture and renovations.
Agency Fees ($12,091.29) 5%
Legal Fees/Closing Costs ($1,105.00)
Net $ 228,629.60
Principal Repaid
1 ($5,436.91)
2 ($5,763.13)
3 ($6,108.91)
4 ($6,475.45)
5 ($6,863.98)
6 ($7,275.81)
7 ($7,712.36)
Total Principal Repaid ($45,636.55)
Mortgage Balance Due $104,363.45
Net to Seller $ 124,266.15 on completion

SubLet the Units

Cost per Unit 0
Equity 0
Mortgage 0
Monthly Payment ($1,400) to Landlord
Renovations ($20,000)
Furniture ($10,000)
($30,000)
Interest 10% p.a.
Amortization 7 years
Monthly Payment ($513.51)
Total Cost ($1,913.51)
Monthly Rent $4,000
Marketing ($320) 8%
Vacancy ($480) 12%
Other ($240) 6%
Contingencies ($280) 7%
NOI $766.49 per month
Equity ($30,000)
ROE 30.7% per annum
Year
0 ($30,000)
1 $9,197.84
2 $9,197.84
3 $9,197.84
4 $9,197.84
5 $9,197.84
6 $9,197.84
7 $39,197.84 $9,197.84 $30,000
IRR 30.7% per annum Assumes the business is sold
and the sale price of the biz
equals the investment in
E&OE. furniture and renovations.

The Last Word

We are attempting to compile a more complete list of Bootstrap
Capital sources that will be helpful to entrepreneurs (and
intrapreneurs)as they build new services, products and enterprises of
all types including for-profits, non-profits, charities and NGOs.

No list can be complete and this certainly is not. If you can add to
it, please use the comments section at the bottom of this page or send
them to: @ProfBruce on Twitter.com.

So here is our list:

There it is. My list. If you have a source that you would like to
add, please use the comment form below or email me:
bruce.firestone@century21.ca.

Prof Bruce

Postscript: If you are still interested in the subject after getting
this far in this article, I wrote another piece on how to bootstrap a
lunar colony: https://www.eqjournalblog.com/?p=864.

Appendix

Recently, I had a chance to sit down with a former student and look
at the deal structure he was planning to put in place with two partners
to open a new restaurant franchise in Baltimore. They needed to raise
$1.8 million, part of it debt, part of it equity. They wanted to start
with a LTV (Loan to Value) ratio of 50/50 so that meant they needed to
raise $900k in equity. They had already secured (via a long term lease)
an excellent downtown location and a bank loan for $900,000, contingent
on raising the balance in the form of equity.

Each of the other two wealthy partners were prepared to put in
$400,000 and Bill (not his real name—other facts have also been changed
to protect the identity of the individuals involved) had saved $70,000
of his own money and secured a soft capital loan from his aunt for the
remaining $30k.

This would give each outside partner 44.4% of the business and Bill,
11.1%. The trouble was Bill, although still young (just 29), was the
only partner with experience actually managing a pub. So he was
expecting to put in the most hours operating the new franchise and yet
he had a tiny share in the enterprise. To assist him, the other partners
were willing to enter into a shareholder agreement that would let Bill
buy more equity over time (to get him to a 20% share eventually) using a
complicated formula based on the FMV of the shares less a certain
percentage.

What I suggested instead was that they all go in as equal
partners—1/3 each right, from the get go. Bill’s concern was, of course:
“Where will I get $300,000? I put everything I own on the table just to get to $100k.”

The answer is that you can often capitalize a business (or your share
in it in this case) right from the deal flow itself. It’s easy!

I told Bill: “What you’re going to do is ask your partners to
each loan you $100,000 for seven years and you’ll agree to pay them
interest at 6.5% p.a. But for the first two years, while you’re building
the business, there won’t be any principal or interest
payments—interest will be capitalized. Then over the last five years,
you’ll pay monthly principal and interest to them.”

Bill’s next question was: “Why would they agree to that?” Here’s why:

1. Bill is in possession of asymmetric information—he is the only
skilled operator amongst the group and they need him. His partners
should not even think about going into this business with no
experience—they’ll get eaten alive by the competition. Bill has leverage
he didn’t even realize.
2. In many ways, his partners are better off by lending Bill their money
to become an equal partner. A happy managing partner is a productive
one. Plus they will have a Bill deeply ‘intricated’ into the business—he
is on the hook personally for one third of the loan from the Bank and
he owes them personally $100k each. That means, if the business goes
broke, their risk capital has been reduced by $100,000 each—because Bill
still has to pay it back using his own resources, which means he’ll
have to go get a JOB to repay the loans.
3. They are making a return on their capital (6.5%) which isn’t
particularly great but for two middle aged investors, it’s still better
than most of their IRAs and other investments are paying (from 3.15% to
6%).

From Bill’s point of view, this solution is elegant because, based on
his cashflow projections, he will never actually have to pay these
loans back himself. Huh? That’s because Bill estimates, based on his
experience, that the franchise will produce a reliable stream of free
cashflow of ~ $325,000 annually from year 3 to year 7. Bill’s share of
free cashflow is one third or $108,333 less what he has to repay to his
partners over the five years from year 3 to 7 ($54,383 annually). So his
actual distribution is a net of $53,949 per year. So the business is
actually repaying his partners, not Bill.
During that period, Bill is still seeing a great ROE: he is receiving
nearly $54,000 a year from the biz on his actual out of pocket
investment of $100k or nearly a 54% p.a. rate of return. After he pays
off his two partner loans, his ROE (in year eight) jumps to over 108%
p.a.

So Bill has, in part, bootstrapped himself to a one third ownership
position in a valuable concession by looking for capital in the deal
flow itself. He is on his way to becoming wealthy—he will have created
an ‘annuity’ for himself—reliable, reproducible, recurring cashflow
produced by an asset he owns or controls.

Prof Bruce

Postscript 1: Many student entrepreneurs, when they are building
their PBSs (Personal Balance Sheets), forget to add their equity and
sweat equity. Just as Bill should not forget that he has leverage based
on him being the only partner to actually have experience in this
business, he should also show on his PBS (in addition to his cash
investment of $100,000), the SE (Sweat Equity) he has created. To do
that is easy. If we use a capitalization rate of 9% (a pretty typical
rate for this type of franchise and location), Bill’s share of the
business can be valued at $1.2 million after year 7 (when he has retired
the partner loans). After deducting the initial $100k outlay, Bill will
have created about $1.1 million in value through his own efforts after
just seven years. It’s hard to save your way to wealth (hardly anyone
can actually do that) but you can invest your way there as Bill plans to
do.

[You can see all the numbers in the spreadsheet below or you can download it from our server in .xls format at: https://www.eqjournalblog.com/DealStructure.xls.]

Postscript 2: I was involved in a transaction like this at about the
same age. I had no money but wanted to buy a 62 acre piece of industrial
land in Kanata (a western suburb of Ottawa).

The Canadian economy was in a tough recession and, as a famous Frenchman once said (Baron Rothschild in 1871): “Buy (real estate) when there’s blood in the streets.”
This is easier to say than do because: a) people tend to run in
herds—there is tremendous psychological pressure to sell when everyone
else is selling and buy whenever everyone else is buying, b) Banks won’t
lend you any money when times are tough—they too are subject to herd
pressures—so financing dries up. The answer? Bootstrap it!

I had the opportunity to buy the property for just 15 cents per sq.
ft.—a price that hadn’t been seen in Ottawa since the Great Depression.
The landowner, who was in trouble, was willing to finance half of the
transaction for a period of three years. The balance I would have to
find in cash. That meant I needed more than $200k to close.
I managed to find two wealthy investors, each willing to put up one
third and to lend me one sixth. They wanted 8.5% interest on their loans
but were willing to capitalize their interest for three years. Again,
they were willing to help me because they needed me—I was in possession
of asymmetric information and skills. They need me to find the land,
negotiate its purchase, put Seller Take Back financing in place and then
find a Buyer when the markets and the economy came back a few years
later.

We bought the land for just over $400k and, luckily for us, less than
three years later both tech and the land markets bounced back, we sold
the property for about 90 cents per sq. ft. or ~ $2.43 million. Each
partner received their one third share (plus principal and interest in
the case of my two outside partners and one third less principal and
interest, in my case).

[All the numbers are shown below or you can download the spreadsheet from the link provided above.]

This example demonstrates a few things about deal structure, deal flow and bootstrapping yourself:

1. Bootstrapping often involves an early stage of trading—where you
trade in whatever markets you have some knowledge and expertise, gaining
advantage from asymmetry. You need to generate ‘table stakes’ and many
entrepreneurs start this way. You have to watch it—if you keep flipping
assets, you eventually will “flip ‘til you flop” so you have to know
when to stop and build and hold instead.
2. Bootstrapping also involves looking for finance in the deal flow—in
this example, I used two sources—the original owner loaned us half the
purchase price and my partners financed me.
3. I was able to use a form of NCS (Negative Cost Selling) on the
partners by showing them what I thought the deal would look like. I used
a spreadsheet much like the one below except I felt a seven year period
was more appropriate—land cycles tend to be five to seven years in
Ottawa and I just felt more comfortable showing a lower return and a
longer payout. The fact that there was a payout in just under three
years was a bonus. The original pitch was that they by investing $100k
each, they would see a return of $650,000 after seven years, an IRR of
30.7% p.a. Their cost of investing? A negative $550,000! I also realized
you can bootstrap finance this way: NCS is the basis upon which they
could borrow from their future earnings to finance me today. They
agreed.
4. Lastly, don’t cry for the original owner—he inherited the land for
free from his family. Don’t shed any tears for the tech company who
bought the land—in the years since they bought it from us, it has gone
from 90 cents per sq. ft. to $8.00! And think how well the two
co-investors did. They each put up about $100k (including the amount
they loaned me to buy my share). Less than three years later, they got
each got a cheque for $785,000. This represents an IRR (Internal Rate of
Return) of 97.9% p.a., a heck of a lot better than a GIC from their
Bank which today pays around 3.15%. Of course, my IRR is infinite since I
had no money at all invested. Still I can’t gloat—all that money (and a
lot more) went into the Ottawa Senators, where it remains to this
day—only problem is, the team is owned by someone else!

Spreadsheet:

Feb. 14, 2010 Deal Structure: Bill and the Restaurant Franchise

Deal A

Capital Required $1,800,000
LTV Ratio 50%
Debt $900,000
Equity $900,000
Partner A $400,000 44.444%
Partner B $400,000 44.444%
Bill $100,000 11.111%
100.000%

Deal B

Capital Required $1,800,000
LTV Ratio 50%
Debt $900,000
Equity $900,000
Partner A $300,000.000 33.333%
Partner B $300,000.000 33.333%
Bill $300,000.000 33.333%
100.000%
Loan from Partner A $100,000.00
Loan from Partner B $100,000.00
Bill Borrows from A and B $200,000.00
Term 7 years
Interest Capitalized 2 years
Balance of Term 5 years
Interest rate 6.50%
Amount of Interest Capitalized $13,000.00 year 1
$13,000.00 year 2
Principal Owing after Year 2 $226,000.00
Repayment to A and B ($4,531.95) monthly
($54,383.41) annually
Expected Cashflow from Operations $325,000 annually from year 3 to 7
Bill’s Share of Cashflow $108,333.33
less amount paid to A and B ($54,383.41)
Bill’s Net Share of Cashflow $53,949.93
Bill’s Equity $100,000
Bill’s ROE 53.9% p.a. from year 3 to 7
Bill’s ROE 108.3% p.a. after year 7
Capitalization Rate 9.00%
Bill’s Share of the Business Valued at $1,203,703.70 after year 7
Bill’s Sweat Equity Valued at $1,103,703.70 after year 7

Deal Structure: Land Transaction, Kanata ON
Area 62 acres

43,560 sq. ft. per acre
2,700,720 sq. ft.
Price $0.15 per sq. ft.
$405,108.00
Seller Take Back $202,554.00 50%
Term 3 years
Interest 0%
Equity Required $202,554.00
Partner M $67,518.00 33.333%
Partner N $67,518.00 33.333%
BMF $67,518.00 33.333%
100.000%
Loan from Partner M $33,759.00
loan from Partner N $33,759.00
Term 3 years
Interest 8.50%
Interest Capitalized $5,739.03 annually
$17,217.09 over 3 years
Sale Price $0.90 per sq. ft.
$2,430,648.00
Less Amount Owing to Original Landowner ($202,554.00)
Net to Partners $2,228,094.00
Distribution to M $785,065.54
Distribution to N $785,065.54
Distribution to BMF $657,962.91 $2,228,094.00 check
IRR (Partner M or N)
0 ($101,277.00)
1 0
2 0
3 $785,065.54
IRR 97.9% p.a.

Prof Bruce @ 12:19 pm

Filed under:

Bootstrap Entrepreneurs– Case Studies

and

Bootstrap Capital

and

and

Build and Hold

and

Business Models

and

Cash Conversion Cycle

and

Negative Cost Value Proposition

and

Financing

and

Investing

and

IRR

and

Micro Capital Lending

and

and

No Money Down Real Estate Investing

and

Personal Business for Life, PB4L

and

Pre-selling, Finding New Clients, Keeping Existing Ones

and

Sponsorship

16 Comments

On Leadership

Posted on
Saturday 31 July 2010

(This article contains elements that are probably best
read by persons over 22 years of age. Why is that? Human brains take 22
years to mature and complete their network of interconnections. Teenage
brains and young adult brains are so impressionable that they are like
the majority of the characters in George Orwell’s Animal Farm—likely to
think the last thing they are told is cool. This essay describes some of
the elements that I think go into forming a leader some of which it
would be unwise for the unwary to try to duplicate.)

Are leaders born or does their environment shape them? It is undoubtedly a combination of both.

Leaders project confidence. They understand the ‘way the world
works’. They have a mental map against which they can quickly test their
theories. They can form plans. They can quickly react to changes in the
environment. They know when to attack, when to retreat and when to sue
for peace. They can bargain. They can play act. They can change their
personalities to suit the circumstances. They can inspire, cajole,
browbeat, uplift and face down other people. They know in their bones,
humans are more productive and happier when arranged in a pecking order.
In a crisis, they can instantly organize people around them to save as
many and as much as possible. If circumstances require it, they quickly
know how to get as many people and as much material across the chasm as
fast as possible. They can put round pegs in round holes and square pegs
in square holes effortlessly to get the most out of a team. They set
goals, let everyone know what those are and then make sure they achieve
them.

In the opening scenes of the now-completed TV series LOST, I thought
the writers got it about right when, after Oceanic Flight 815 crashed on
a mysterious island, a pecking order instantly formed around Jack
Sheppard, a doctor, John Locke, an adventurer and Kate Austen, a jail
bird.

If you think about it, these three characters had between them all
the characteristics of what you might expect to find in a leader: from
the great training, intellect and education of Jack to the physical
courage and prowess of John and the wiliness and toughness of Kate.

For me, I realized that I was expected to be a leader at an early
age. In fact, from the time I was nine, whenever something bad happened
in our family (a blown-out tire needed changing or my little brother
needed saving from falling into a tub of near-boiling water) all eyes
focused on me, even with adults in the room. When I was in a wolf cub
pack of 6, sixes (that’s 36 cubs), I was the one with three stripes on
my sleeve—the Senior Sixer calling out: “A-ke-la we’ll do our best!”

I went to an all-boys school that was pretty tough back in the day.
Students fought, they defended themselves. They ran in gangs. But they
never thought to involve either parents or teachers in any of those
battles. I got knocked out (twice) by school bullies but on returning
home with a broken nose or black eyes, it would never have occurred to
me to tell my mother or father anything. If they asked, it would always
be a sports injury. But they never asked.

Helicopter parents? Are you kidding? In my day, the parents believed
kids were better to be seen but not heard; in fact, even better: not
seen or heard. Since we had no TV or computers, kids left their homes in
the morning and did not return until they got hungry or the other kids
had gotten tired and gone home so you did too. Parents never even asked
where you were and you would never have told them.

We ran in packs. From the age of 7, we rode the streetcars in my
hometown, everywhere. We floated rafts on the mighty Ottawa River. We
ran from the police at night, jumped fences, hid in the woods, made camp
fires and settled scores on our own.

We played team sports including tackle football with no pads or
helmets. We played on the outdoor hockey rink in freezing temperatures
from 10 am to 10 pm and only left because they turned off the lights and
locked the shed door where we could warm up. I would play on one team
which would win then, when the score got too lopsided, switch sides and
the other side would start winning.

We were out on the street at 1, 2 and 3 am from the age of 11 or 12. I
could get out of my parents home by climbing out the window and scaling
(up or down) the stone trellis.

We had our own club house. We raced soap box cars. We crashed our
bikes into each other in complete darkness. We were in the cadet corps.
We knew how to make gun powder from scratch and how to build pipe bombs
and we exploded a ton of them using flashbulbs as igniters.

We discovered girls together. We went on road trips to California. We
hung out in Santa Cruz and Berkley in 1969. We experienced donut stores
where you would total up your own bill and make change for yourself
based on the honour system. We watched mountain men from the hills in
California come into the City with kilos of dope needing to be dried. We
watched the anti-war movement turn violent.

We avoided getting mugged in a street riot like the one staged by the ‘McGill Français’ movement in Montreal.

We flew hang gliders in Australia the very first year they came to
that country and avoided being among the 80 or so young men who lost
their life that way that year.

Bruce Firestone Hang Gliding in Australia circa 1973

Bruce Firestone Flying Prone

We went rock climbing in New Zealand where the weather can change in
an instant and got socked in on a mountain side by six inches of snow on
the cliffs—this after a day of 70 degrees Fahrenheit. We found another
way off that mountain that night and did not die in the ensuing rock
slide caused by our escape.

You have to laugh at the expectations of leadership in the US where
they expect their leaders to have a solid map of the way the world works
but no real experience in it because they are looking for perfection in
their leaders. People like former President Bill Clinton had to resort
to prevarications like: “Yes I did but I did not inhale,” or “I did not,
never sleep with that woman.”

You cannot have it both ways—an authentic leader but one with no real
world experience, no testing of their mettle, no mistakes made on the
way. Otherwise what you get is Tricky Dick Nixon, who never got the
girl. Be careful what you wish for—ask for perfection and you just might
get it. Poor you.

If you want to do great things like bring back a NHL team for your
hometown that hadn’t played a game in nearly 60 years (the Ottawa
Senators), it’s going to require a total commitment of mind and body and
soul. And it’s going to require leadership.

Bruce Firestone in 1994 after leaving the Sens

I am not recommending a reckless, fearless approach to life but maybe
that’s what it takes to be a leader, formed by the crucible of life’s
pressures and crises.

Prof Bruce

Postscript: there are many other stories that could have been
included here but they will have to wait until I am an old man before I
can tell those—by that time, those involved may have passed on
(including moi) and no one will care.

Postscript 2: Scott Adams, Dilbert creator, says leadership is about
getting people to do things they know are not in their best interests.
WRONG. This is absolutely not what leaders do, at least, not successful ones in RL (Real Life).

Here is my definition of what a leader is:

“A leader is a person who chooses from among many alternatives, some
of which s/he has generated and some of which came from inside or
perhaps from outside their organization, the right path for his or her
tribe* getting buy-in from the whole organization as well as its entire
stakeholder group and making sure that all its resources are deployed
optimally to achieve their common objectives that are serving not only
to further the interests of its individual tribal members and the
organization but also a broader purpose for humankind,” Prof Bruce,
Ottawa, Canada July 2011.

(* I am using ‘tribe’ here in the same sense as Dave Logan et al in their 2008 book, Tribal Leadership: https://www.eqjournal.org/?p=2656.)

Postscript 2: The Misfits

We have been entering the Ottawa DragonBoat Festival for the last
four years and have had great fun doing it. This interest in
DragonBoating grew out of our family’s involvement with Red Pine Camp
(RPC) over the last dozen years. RPC is a wonderfully special place that
I believe helps develop the leaders of tomorrow. It has certainly
helped our five kids become the kind of young adults that they are
today.

Last year we had two boats racing—the Misfits (the successor to our
original RPC boat) and an all-rookie boat, Exploring the Wilderness. The
Misfits were capably led by Fred Carmosino and Anne Makhoul. Amazingly,
the Misfits came first in the Challenge Cup with the 11th fastest
overall time (out of 180 entries). This showed me that doing well in
DragonBoat racing was not all about youthful strength but more about
teamwork and timing and technique—even fit middle aged Red Piners can
contribute to success.

I was looking after the other boat—the all-rookie boat. We had more
paddlers than we needed and so in the first qualifying race (you get two
races to qualify—only the top 60 boats advance from the Saturday heats
to the Sunday finals). Well, I have been-there done-it so I let the
others take the boat out without moi.

As a sidebar, none of the boats we have ever entered have failed to qualify for the finals.

Well, Exploring the Wilderness came in 135th and the crew came in off the water arguing with each, bickering actually.

After that, I sat everyone down on the ground in their positions in
the boat and we did dry-land practicing for an hour. I tongue lashed
them. I harangued them. I told them: “For smart people, don’t tell me
that you can’t count to six, then sixteen and then three,
f@3*&%#!!???” These are the strokes they have to remember to get the
boat started, ‘out of the water’ and planing. Without absolute
precision and timing, these huge boats (there are 22 people in each boat
and they weigh a lot—over 1,000 lbs. empty) wallow: it’s like plowing
the water. You could have a boat full of paddlers as strong as Hercules
but if they are out of sync, they will be beaten by the meekest group of
stringy techies on the water.

Never, in two previous hour long practices on the water and in one race, had these guys ever got it right. They were hopeless.

When we got into the boat for our last qualifying race, I told
everyone to be quiet, focus, and get in the zone. I had never coxed
before but I was in the front of the boat to call this race and I have a
BIG voice.

Well, they got the start exactly right and went from 135th to 52nd
(by far the largest improvement of any boat on the day) and they
qualified for the Sunday Finals. The only difference between the first
and second race results was … leadership. It makes a huge difference to
real world results.

My wife, Dawn always raises her eyebrow at me when I tell stories
like these; Mr. Big Shot. Sorry about that. This is a self-serving story
no doubt about it. But the fact is that leadership is an intangible but
very real force. I noticed it from the time I was a little boy.

When things got hot, everyone in the room looked at me for the answer.

As I get older, I like this less and less and now try to avoid those
situations. But it does follow one around, possibly forever.

I asked Peter Patafie, a self-made millionaire who runs hugely
successful Patafies Inc., a moving and packaging supplies business in
Ottawa, to come speak in the Magic from a Hat Lecture series I run at
Carleton with Professor John Callahan. Peter said that his priorities in
life were:

1. His business.
2. His family.
3. Himself.

I could hear my class suck in their collective breath when he said
this. Where’s the balance in his life? Well, Peter wouldn’t mind me
saying, he is proud of it, in fact, that he grew up poor. He was the
youngest ever employee of the Chateau Laurier Hotel—at age
12, he worked slop in their kitchens to support his family.

Peter asked: “What is the number 1 cause for the breakdown of
marriages in NA?” “Is it that you fell out of love with each other?” “Is
it that you found someone new?” No, it’s money troubles. You think you
know pressure, just wait until bill collectors are calling you, hounding
you day and night for money on unpaid bills. See how long your marriage
lasts.

So Peter said take care of your business first so you can take care of your family and yourself too.

If you want to be a Leader and you want to be an Entrepreneur, forget about balance.

John Kelly also gave a speech in the Magic series and he talked a lot
about balance. John had a hand in creating Nabu, SystemHouse, JetForm
and many other organizations. After hearing his speech and his talk
about getting a balance in your life, I asked John how many hours a week
he is working now? “Oh, I don’t know, between 70 and 80 per week,” he
answered. Some balance and John is not a young person anymore.

One of the things I do now is I give others the courage and
confidence to start new things, to go out on their own and take some
calculated risks. That is what good coaches do. So while I am not on the
field throwing pitches, I can be in the dugout helping send in the
plays (or whatever Baseball Managers do…)

But it is up to the Entrepreneurs and especially the next generation of Entrepreneurs to throw strikes.

Prof Bruce @ 3:45 pm

Filed under:

Rules? There are no rules in entrepreneurship.

and

and

and

and

and

and

and

Why Businesses Fail

No Comments

Magic Marketing Button, MMB

Posted on
Saturday 31 July 2010

(Examples from the Mini Storage Industry, a Specialty Camera Manufacturer and an Internet e-Commerce Platform, Shopify.com)

If your enterprise cannot connect efficiently and cost effectively
with customers and clients, you’re dead. This is the sine qua non of
marketing.

It also means that each enterprise (non-profits, charities,
for-profits, even NGOs and gov’t departments) needs to have a ‘magic
marketing button’—a button they can push that ‘makes the phone ring’.
It’s an ‘easy button’, so to speak.

Blue Heron Storage

We ran a mini storage business a few years ago called Blue Heron
Storage Corp (BHSC). Its MMB was the simplest imaginable—a postcard that
looked like this:

Side A-

Side B-

When BHSC had a few vacancies, all the site manager had to do was
print up 500 or 1,000 of these postcards (at a cost of ~25 cents each)
and distribute them through CPC (Canada Post Corp) to homes and
businesses in selected areas of the City. Then head back to the site and
wait for the phone to ring and the sheds to fill up again.

It was low cost, low risk, effective marketing. It turns out that
most calls about mini storage come from women—they are fed up because
their spouses have too much stuff in their basements, garages and
cupboards. But most site visits are by men—bringing trailer loads of
stuff that they are only going to store for ‘a couple of months’. Two
years later, their stuff is usually still there.

So the MMB generates demand but the site manager still had to complete the sale through a separate
sales process which essentially meant agreeing to a month to month
lease (since the customer only needed the place for ‘a couple of
months’) and getting him to actually sign it.

Picture Inc

More recently, I had a chance to catch up with Glenn Schmelzle, Founder of Marketing What’s New.
We were talking about one of his clients—a high end, specialty
commercial camera manufacturer which we’ll call Picture Inc (PI, not its
real name).

PI and Schmelzle were working on an online tool which helps users
spec their camera requirements. In essence, it’s a ‘physics engine’
which allows potential clients to design a specialty camera with
features that meet their requirements.

This is a tool that, in effect, goes on the front of PI’s website to
engage potential customers, first, in the spec development and, second,
hopefully in purchasing one of PI’s systems. But what Glenn and I wanted
to do was make the tool a standalone site that could become a
destination in itself. To do that, PI will have to accept (as yet
unknown) that the tool could spec camera systems not actually made by
PI.

This would be similar to Kris Kringle (in the 1947 film, Miracle on 34th Street)
working at Macy’s as a sales clerk advising a customer to go to rival
Gimbels for a product they don’t stock. It was considered heresy at the
time but eventually the tactic was widely adopted, customer service took
on new meaning and ultimately the idea of co-opetition would be better
understood.

But this new tool can do a lot more than help clients spec camera
systems (itself, a non–trivial problem with 1,000s of options to choose
from). Using crowd sourcing, a d-base could be added that would permit
each client to see what other clients who have the same problem (such as
picking out defective products on an assembly line) did to resolve
their issues.

Today, you can take it one step past web 2.0 too: you can add a
social media component that would facilitate clients learning from each
other. This might allow, say, a new client to query an earlier client
who had generated a successful spec for their system and for them to
comment back on the new client’s spec as well.

Now this approach takes guts—many companies are afraid of
competition, afraid of opening up their backend systems to clients,
afraid of letting one client to talk to another.

But think about the ultimate propose of your enterprise—at a
minimum, don’t you think you should treat your clients at least as well
as you would treat yourself?

If you were buying a new product, say, wouldn’t you want the best
price and best service, wouldn’t you want to know what other people who
faced the same problem also did and, lastly, wouldn’t you want to talk
to some of them so: a) you could learn from them and b) if you did
decide to buy a PI device, you could get an independent reference on the
company and its products and services?

Sure you would so why not enable all of that in your new (indispensible) MMB?

If you do all of this, an interesting thing will happen to you—your
enterprise will become integrated into a business ecology where you will
feed and be fed—and you will find customers and clients ‘magically’
appear early and often and they will come back to you over and over
again and sustain you and your business for a long time.

Shopify.com

Fast growing, Ottawa-based Shopify.com builds an e-commerce platform
that competes with Yahoo Stores, Amazon and a bunch of other heavy
hitters. One of their key differentiators—they can have your new e-store
up and running and selling in minutes, at least a couple of days faster
than their competition. They also take a smaller piece of your pie.

They ran a six-month ‘Build a Business’ contest with a prize to the
winner of $100,000, cash. The eventual winner (the Dodocase, a
protective case for iPads made by a SF-based startup) sold > $1
million of their product in three months. For Shopify.com, the cost of
the competition was, almost certainly, negative.

During the competition, nearly 1,400 new stores signed up which
generated more than $3.5 million in sales on their platform and over
66,500 orders. The competition was widely covered on influential blogs
including the NYT.

So between margins generated during and after the competition and the
value of the earned media they received, I would guess that the cost of
the competition would, in fact, be negative.

Negative cost marketing which is hugely effective to boot has to
qualify both as a MMB and GM, Guerrilla Marketing. Putting this type of
engine (i.e., the competition) in front of your biz model so that
clients connect first to the competition and then to Shopify.com is a
new form of business model and we are going to see a lot more of this.
Business modeling is truly evolving into business ecology.

Prof Bruce

Postscript: Another interesting example is the manner in which Tony
Greco and Greco Lean and Fit Centres use their charitable foundation
(The Foundation to Fight Obesity in Children) as a MMB. Involvement in
their Foundation by kids fighting obesity is almost certainly going to
lead to adult participation in Greco programs—either by the kids when
they grow up or by their parents dealing with fitness issues themselves.

Prof Bruce @ 9:22 am

Filed under:

Guerrilla Marketing Research

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and

and

and

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Franchise and Concession

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Guerrilla Marketing

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Internet– the Internet is Eating a Hole in the Global

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and

and

and

and

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Value Differentiation and ‘Pixie Dust’

and

Value Proposition

6 Comments

Creditor Proofing (Part 2)

Posted on
Saturday 24 July 2010

I have written extensively over the years on this subject*.
Creditor proofing is not about hiding assets or income from your spouse
or the IRS or CRA, it is about doing smart things early in your career
and then later on as well that can pay big dividends for you in terms of
being tax efficient and providing for yourself and your family if
things don’t go well.

Recently, Mark Sherboneau from Foundation Private Wealth Management
and Susan Tataryn, Ottawa lawyer and CA, have been working with us on
the issue of creditor proofing for entrepreneurs, even from the earliest
stages of their careers.

Most financial planning groups are not interested in entrepreneurs
until they have at least six figures or preferably seven figures of
liquid assets. But Mark and Susan have worked out a system that will
allow entrepreneurs to set up a trust at an early age with minimal
startup costs.

The trust would be:

1. run by a trustee or trustees;
2. the trustee can be a corporation or a tripartite group of three (trusted) persons;
3. the beneficiaries of the trust would, in most cases, be the settlor
(the person making the gift himself or herself) plus members of their
family and possibly a charity or their alma mater, for example;
4. the division of the trust when it is wound up would probably not be
specified as to which beneficiary gets what: this would be subject to
discussion between the settlor and the trustee(s) at that time, with the
trustee(s) making the final decision;
5. the settlor would set initial conditions for the trust such as it is
not to be wound up until age 55 (60 or 65) which would prevent the
beneficiaries from accessing the funds in the trust until a certain age.
This is to protect the beneficiaries essentially from themselves since
most people can not resist buying cool stuff if they could get their
hands on the money;
6. the funds invested in the trust would most likely be invested fairly
conservatively in vehicles like corporate class mutual funds so that
almost all taxes are deferred to the trust windup and, when it is wound
up, capital gains taxes would apply which improves tax efficiency by
quite a margin;
7. the trustee(s) are obligated to protect the gift as best they can;
8. benefits are distributed according to the settlor grant, the
settlor’s wishes and knowledge and best practice of the Trustee(s);
9. the Trustee(s) have legal title (not the beneficiary) so that the assets can not be attacked by creditors;
10. the diversity of interests of the beneficiaries means that a
premature windup of the trust is unlikely since all beneficiaries in
every Province of Canada (except Alberta) have to unanimously agree to a
windup which means the trust is resistant to external pressures from,
say, creditors or a money-hungry beneficiary.

This structure is designed to give the entrepreneur some financial
assets that would be available to him or her and other beneficiaries at a
later stage of life. These financial assets would be difficult for
creditors to attack and, at the same time, they would be protected
against premature disposition because the entrepreneur himself or
herself wanted to use the funds for something else, like another startup
or a trip to the DR or a new car…

The financial assets would probably not be invested aggressively in
‘Petrogold’ penny stocks on the VSE, say. This is supposed to be the
third or fourth ‘silo’ of personal investing, namely:

1. The first silo might be the matrimonial home which, at least in
Canada, is likely to be owned directly by the spouse with the lowest
risk profile. When it is sold, a principal residence in Canada is not
subject to capital gains tax. Also, in most divorces, the matrimonial
home is a shared asset so the value of the home (or a share in it) is
not likely to run away from the entrepreneur.
2. The second silo is other real estate owned or controlled by the
entrepreneur: perhaps a multi-residential dwelling and an office
building that is rented to the operating company. This real estate is
usually owned by a PHC, Personal Holding Company.
3. The third silo is the operating company where the entrepreneur
expects significant returns on equity and where they have perhaps the
most risk. The operating company is also likely to be owned by the PHC.
This structure allows the controlling mind to move money from eligible
Canadian Corporations (say the real estate company or the operating
firm) to the PHC tax free using inter-corporate dividends. Funds are
also moving from the operating company to the real estate company in the
form of a fair market value rent. Real estate also generates CCA,
Capital Cost Allowance, which creates a capital dividend account which
can be divdended out to individual shareholders, tax free. Finally, the
shareholders of the PHC (typically, the entrepreneur and his or her
family) can be paid by the PHC or receive dividends from the PHC so as
to minimize taxes overall. This is an efficient tax structure, creates
diversity in the asset mix and works well operationally.
4. The fourth silo is the Trust we discussed above and it is obviously not owned by the PHC but by the Trustee(s).

These days, if you could see 5% to 6% returns over the long haul from
your principal residence, 8% to 12% from your other real estate
holdings, 18% to 22% ROE in your operating company and 3% to 5% from
your Trust, that would be a realistic and satisfactory result for most
of us.

Here is more information provided by Mark and Susan:

Prof Bruce

Prof Bruce @ 2:37 pm

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9 Comments

Check Check Check

Posted on
Tuesday 20 July 2010

My Dad, the late Professor OJ Firestone, and I tried to
determine which three things were the most important skills for an
entrepreneur to master:

– SALES SALES SALES (moi)
– CHECK CHECK CHECK (my Dad).

As I have grown older, I have come to realize they are equally
critical: without sales, all organizations will eventually disappear
and, without attention to detail, they will fail to execute and just
wither away.

Here is a Venn Diagram for Dad:

If it’s important, make sure you remember it: CHECK CHECK CHECK everything.

Prof Bruce

Postscript: Parents have been passing on this advice to children for
generations if you can rely on the film ‘The Godfather (Part 1)’ as a
guide. Near the end of the film, Vito Corleone goes over and over again
possible scenarios with his son, Michael, on how he (Michael) will be
able to recognize the traitor in the family and avoid the trap his
enemies are preparing to spring on him. The Don gives Michael a lecture
on being careful and checking everything, advice that will soon save his
life. When I saw that, it had the ring of truth, at least to me.

Prof Bruce @ 7:33 pm

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