Feeds:
Posts
Comments

This weekend I attended a panel discussion at Pinchot University alumni day, where a series of grads talked about how they’ve actually funded their businesses to-date.  There were some common themes but it was a wide range of sources, that I’ll organize in circles of personal connection.

First and foremost is your own pocket. A common theme is being able to run the business without paying yourself, so most entrepreneurs had supportive spouses with secure jobs. For those who need to get paid and so need to start with funding, the funding starts at home, for example, one entrepreneur was able to launch after receiving a small inheritance.  Two other sources that did not come up are home equity and retirement equity.   Home equity loans were a common business funding source before the meltdown, I’m not sure how common those are now.  More recently I’ve heard from one or two entrepreneurs who have tapped their retirement funds. If you take the money directly out, you’ll have to pay big penalties for early withdrawal. An alternative is to find a self-directed IRA fund and then invest in your own business.

At the next ring out is getting money from other people who want to support you. One entrepreneur got their startup funds in unsecured loans from friends and family, at 10% interest to reflect the risk of such loans as family saw it. Community Development Finance Institutions or CDFIs were cited by several entrepreneurs. These are very much like bank loans in cost and terms:  all the loans discussed in group required collateral and for large loans borrowers had to make personal guarantees. The advantage of a CDFI loan is they’ll lend to businesses that banks wont – for example banks will usually require a stronger track record of profitability.

Financial support can come in ways that aren’t cash infusions: favorable terms on rent or long repayment periods on supply purchases were ways these early entrepreneurs found support.  Specific loans for equipment or supplies can be less risky for lenders and so easier to obtain because repayment can be tied to a specific revenue stream, or collateralized by a specific item.  For example, a couple businesses were able to get loans to purchase supplies in larger lot sizes to get a price break, and then repay that loan as the supplies were consumed, and then repeat again for the next order. Several cited equipment loans.  The folks making these loans were community members met through networking or just through business operations who wanted to be supportive.  One business’s supplier let them have 5 months to pay the invoice.  These opportunities are built through personal relationships, and to some extent have an informal personal guarantee.  A loan against a purchasing contract from a potential customer can be another way to fund supplies and give security to a would-be lender with a less personal relationship.

At least two of the businesses had been through local business accelerator programs, and one of the entrepreneurs pointed out the importance of making sure those programs also provide access to capital!  Both program graduates did get some grant funding as a result of participation in different programs, and one got access to ongoing borrowing opportunities.

The best source of funding for a business is of course, revenue. However one entrepreneur cast this in an interesting light – they’re still focused on their original business idea and think it can become self-sustaining but that it’s a long road.  So they started a different, but related, line of business that will be profitable more quickly and that can cover fixed costs that support both businesses.  I thought that particularly for social entrepreneurs, bootstrapping with a more mainstream business while you work on your cutting-edge idea is a path worth pointing out.

 

It’s a common frustration for small business owners that banks seem only willing to finance companies that don’t need it. It’s pretty standard that to get a bank loan a business has to have multiple consecutive quarters of profitability. That seemed pretty conservative to me, but after a couple years of working with bootstrap small businesses I’m beginning to see why that might be necessary protection.
Bootstrapped startup and young businesses are wonderfully creative in their ability to make-do. As a business grows and generates more resources, it doesn’t become profitable right away. Those early years of business growth end up steadily funding capacity building. As a business has more resources, those resources go not only into growth through marketing, or asset building with equipment and facilities, but professionalization where previously there’s been make-do.
Obvious and common sources of “hidden funding” are underpayment or non-payment of founders or early staff. Understaffing and working folks long but unsustainable hours is common. Family members might work in the business for free. When building financial models, staffing is one category where educated guesses can be made about what it should be to support a target level of business, and so this one is less hidden, but still difficult to assess.
Making do with word-of-mouth advertising can work when a business is small, but to grow into a fundable company it will need to move beyond personal social networks and be able to develop a clientele based on its marketing & sales reach. That costs more money and changes margins on sales. Upgrades of equipment and facilities are likely in search of more efficient process, or lower risk.
Professionalization where there is currently make-do is a more subtle version that requires more attention. Bookkeeping needs to be done by a bookkeeper, not Aunt Jane. Software and technology needs to be legally purchased with regular investments for backups, replacements and upgrades. Office furniture and facilities, if cobbled together from craigslist, is a very likely expenditure as a company becomes able to afford it. Rent may be subsidized by a supportive launching business or relative.
How much growing funds are dedicated to upgrades and improvements before they’re ready to be peeled off to fund additional financing is going to vary a little bit from company to company. Does this CEO feel pinched by their 2nd hand desk or do they take pride in their own thriftiness? Is their affordable tech support person a local gem or are they having to wait for more profitability to afford better service? It does seem impossible as an outsider to assess what remains as not-yet-funded internal capacity in any given company. Instead, insisting that a company generate cashflow for a sustained period is a very tangible measure of its ability, and that CEO’s willingness, to operate at a given internal capacity level.

When It Rains, It Pours

I’ve been working with some family going through difficulties and it’s interesting to see how the adage “when it rains it pours” becomes true. I’ve observed a couple different subsets of that, and I think there can be some interesting insights for companies.

  • The urgency bar for things to get addressed gets raised. When there’s a crisis, people’s attention gets focused on the crisis, and preventative maintenance on lower-urgency issues gets deferred or delayed, increasing the risk that they will themselves become crises. Even if they are already problems, the urgency level needed to break through and attract attention is now higher – so only other crises will get attention. For those making decisions it will seem that every decision is a crisis, and that’s because they’ve narrowed their scope of attention to only crises.
    One way to deal with this in a work situation might be to delegate crisis-handling to only a few people and try to keep the rest of the team out of crisis mode. In a family situation, having more members and friends to help is a source of resilience.
  • For those operating in crisis mode, it’s easy to be distracted or rushed when getting tasks done, making those tasks more prone to error. Because there’s already a lack of resilience, those errors can be derailing and feel more impactful. This is where meditation really helps, to constantly work to coming back to mindfulness and taking time to do it right. The simple example I encountered – changing lightbulbs in an unfamiliar basement on a stressful day. I didn’t have a proper stool so I was really reaching. I used my left hand on one, screwed it the wrong way and broke the bulb in the socket. There was a temptation to panic, but as a supporting family member I realized it was really important I not pass this stress on. So I took a breath, found a flashlight, pliers and the breaker panel, and fixed it, without ever telling the homeowner.
  • People’s decision making ability does actually suffer under stress. A lawyer warned me of this not too long ago and suggested that during difficulty I only make the decisions I absolutely have to and I postpone as many others as I can.   When making decisions, try to pick the simplest route and don’t get complicated by trying to optimize too much.

Sometimes I feel difficult situations are complicated further by pricing models on things like airline tickets that penalize short-term decision-making. But I’ll take a moment to be grateful for people and organizations who do pitch in to help with responsive services and kind gestures.

Opportunity Shift

I recently saw Arthur Miller’s “A View from the Bridge” at a local playhouse. It was a fascinating play, the core of it revolves around relationships, loyalty and belonging. Wikipedia has a nice synopsis if you want more detail. It is set in the 1950s. A key part of the supporting context is two Italian day-workers who come into the US illegally and are staying with the family. From the discussion in the play, it seems this is common among this neighborhood – they’re cousins of the household. They work on the docks, and there are many references to how they’ll have to work off their passage and that’s when it will become difficult to get work. I found that so interesting, this idea (presumably based in reality) that the union or other association of dockworkers would essentially sponsor protected passage of illegal workers as an investment payback through their future wages. There must have been plenty of work to go around.

It captured my attention as yet another example of how it used to be those with capital took more risk, especially around employment. It seems to me to be akin to how employers used to hire employees and train them, whereas now it seems much more common that smart young people pay to go to various school and certification programs in hopes of getting a job. Now, if you don’t have capital, or friendly people who will front it for you on the basis of personal relationship, you don’t have opportunity. Even illegal immigration seems to be that way from what I read in the papers, that immigrants pay guides to get them across the border and it’s pay up front, no guarantees.

The personal example that brings this home for me is a young couple I know that came to Seattle for him to go to commercial dive school. They seem like the American dream – smart, good looking, hard working. But they still needed a lot of support from family to be able to go to school. Then they moved across the country where he could work, and he was as successful as he could be, but the economy and job opportunity market shifted. His opportunity for advancement dried up and he was unable to make it pay off. She had been putting herself through school but they were really stuck and in debt and it took more help from family to help them move back home to where job opportunities were better.

It’s disappointing to me to watch our economy shift to emphasize who you know over what you know. As Piketty says, we are shifting from an economy where people could do well through labor to an economy where you will only be able to do well through inheritance. Further, he suggests that such is the historical norm, and the bulk of the 1900s when it was otherwise in this country is the exception. If we want to be a country of opportunity, it will take dedicated work to get there.

Buddhism at Work

I started listening to “Falling into Grace”, by Adyashanti (available from Sounds True, or from Seattle Public Library via Overdrive!) a book recommended by a friend of mine. So far I’m liking it, it’s sensible basic Buddhist advice. He starts off emphasizing that the simple basics are more important than the complex subtle so-called advanced meditation or thinking. I was listening as roomie & I were cooking and right as dinner was ready he was going through several explanations about how people suffer fundamentally because they believe their own thoughts.

I have come to believe the truth of that statement, but it still triggers a reaction for me to hear it stated. Of course I believe my own thoughts, how else am I to function? It helps a little when he says “you don’t automatically believe someone else’s thoughts when they state them.” Ok, but I don’t necessarily have the experience of built trust with that person that I have with myself. Still, there are people in my life I know well and respect and so yeah, why should I automatically hold the value of my own thoughts above theirs?

Thinking from that perspective, my mind flashed to an article from Strategic Finance magazine that I’d been meaning to photocopy for my business friends. It was about why we make poor business decisions. It basically also says that the problem is A) we believe our own thoughts because B) we believe we can have the whole truth of a situation, so ergo our thoughts are correct. The SF article was about specific ways in which we usually DON’T have the whole truth, in hopes of helping us design a “Professional Judgement Process” to get better results as teams.

Examples of why we don’t have the whole truth:
We are subject to Groupthink – the tendency to suppress divergent views. We are subject to Anchoring – a preference for not moving far from an initial numerical value. We are subject to Overconfidence – the tendency for confidence to grow more rapidly than competence as we gain experience. We are subject to Availability – the tendency to only consider easily accessible information and ignore other relevant information.

Hopefully you find those concrete, specific examples helpful in understanding the Buddhist notion that you should not automatically believe your own thoughts. Another phrase I like is “Pain is inevitable, Suffering is optional.” In this case, Pain will be when you inevitably (because you are human) make one of the above mistakes. Suffering will be if you beat yourself up about it, perhaps because you read this blog or that Strategic Finance article. Awareness of the mistake you made, graceful acceptance of your humanity (one way to describe Equanimity), and then calmly making the best correction you can will have you on your way to enlightenment!

I’m blogging about listening to Piketty’s Capital on audiobook, page numbers refer to the hardcopy.

This week I listened to chapter 14 on the Progressive income tax – how it came about, what role it plays in preserving equality.

The progressive income tax is an important part of supporting the Social State – we need that much tax and if it’s regressive then Piketty contends that people will find the system unjust and be unwilling to participate. The Social State does require substantial funding, it got close to 50% of total national income at its peak. Folks were willing to move up to that point in the 50s & 60s because everyone was doing well. Further, it was implemented very progressively. “All told, over the period 1932-1980, nearly half a century, the top federal income tax rate in the United States averaged 81 percent.” (p 507) It actually peaked at 88% in 1942, with surtaxes that created a high of 94% in 1944, before falling to the 70% some of us remember. Piketty calls that kind of rate “confiscatory”, and suggests it’s motivated to address “incomes deemed to be indecent (and economically useless)”. (p 473)

Progressive income taxes were introduced right around World War I, and took hold in part because of the huge debts governments ran up in the war and had no other way to pay off. The Bolshevik Revolution of 1917 and worker strikes are also suggested as a factor.   The United States actually introduced higher tax rates than in Europe, and Piketty attributes that to a reaction against “the hyperinegalitarian societies of Europe” as well as a response to the Great Depression. (p 506)

In the 1980s the US and Great Britain with Thatcher and Regan began to significantly cut top tax rates. My sense from this chapter is that part of the argument was that Germany and Japan were catching up to us technologically and we needed to get more competitive. That strikes me as a misguided argument now after earlier chapters talked about economic growth as being towards the current “technological frontier”. Rapid growth in the last near-century has been more about recovery from the two world wars than from technological advance and the catch-up of Germany and Japan was inevitable. The fear that they might slingshot past was misguided. Anyhoo, we did cut tax rates.

Piketty describes it thus: “After experiencing a great passion for equality from the 1930s through the 1970s, the United States and Britain veered off with equal enthusiasm in the opposite direction.” (p 508) One consequence? The explosion of CEO salaries. “If we look at all the developed countries, we find that the size of the decrease in the top marginal income tax rate between 1980 and the present is closely related to the size of the increase in the top centile’s share of national income over the same period…. Conversely, the countries that did not reduce their top tax rates very much saw much more moderate increases in the top earners’ share of national income.”

Why? “In the 1950s and 1960s, executives in British and US firms had little reason to fight for such raises, and other interested parties were less inclined to accept them, because 80-90 percent of the increase would in any case go directly to the government. After 1980, the game was utterly transformed…” (p 510)

Piketty continues “there is no statistically significant relationship between the decrease in top marginal tax rates and the rate of productivity growth…” so there’s no evidence that the rise of top salaries is justified.   In an earlier chapter he goes into greater depth about the difficulty of rationalizing high CEO salaries, or correlating them in any way with performance when compared with similar companies and similar demonstrable economic performance. It’s all about negotiation. After comparing CEO salary variations across countries he concludes “only dissuasive taxation of the sort applied in the United States and Britain before 1980 can do the job” of reigning in high salaries, not corporate governance reform. (p512).

This section particularly catches my attention because in my own experience as an investor reward is the intersection between luck and motivation to negotiate, more than skill or merit. I have long believed that the only way to keep people from gaming the system is to reduce their incentives to do so.  Sounds like Piketty concludes the same thing based on data.

Adventures in Small Biz

I’ve been deep in a small local biz (revenues < 500K annually) and it has given me a good view on some specifics of why small business is so difficult. I’ll put high on the list the challenge of not being able to afford full-time people. Instead, small business is a cobbling-together of part-time and volunteer labor. Volunteer labor is particularly important, I have yet to encounter a small business or startup that does not in some way utilize it: the founder working for no or low pay for starters! Usually a family member or good friend will pitch in, and frequently dedicated customers as well. I have yet to see any studies on this, and I was saddened to see KIRO try to make a fuss over the use of volunteer labor in a local NW business.  That business was able to go back and pay everyone minimum wage, but most businesses would not be able to. It’s part of what makes a local business connected to and accountable to the community.

The part-time labor is also a challenge. Coordinating tasks and turning things around get more complicated when the designer only works on Mondays and the Project Manager for a particular project only works on Tuesdays. There’s pretty much a minimum one-week turnaround to get anything done because it takes that long for all the relevant staff members to cycle through! Need to contact a small business? Try to have a little patience when they’re not online 24/7, and realize they probably don’t have all your info and transaction history in a database at their fingertips. We’ve been trained to expect that by larger companies.

Both an upside and a downside is that jobs really are about individuals and not pure roles. In this manufacturing business, labeling is not a bottleneck because of Josh, he’s a champ. However nobody else can label as fast as he can, so should we budget for a labeling machine or should we budget for a food processor? Credit is very personal at this level as well – a startup doesn’t have the history or credit for formal bank lending. Credit is the personal credit of the founder – in a formalized way through personal guarantees or personal assets, and in an informal way by getting favors from other vendors based on personal relationship – being able to delay a payment, or borrowing equipment, or negotiating a lease.

I’m really noticing how growing a business is about steadily reducing risks – growing to hire people full time so they’re more likely to be there for you when you need them; having buffer room in the budget so unexpected expenses hit the balance sheet and not the owner’s pocket; being able to experiment more on product or placement innovation; being able to sign more contracts and get preferred pricing. Those are the efficiencies of scale – it’s about negotiating power more than just about volume, and about focused attention and commitment from stakeholders & partners that reduces frictional costs.

One way to get past many of these things quickly is to raise a bunch of equity and start operating at a higher level, but food businesses tend to be low-margin and can’t promise a return on significant equity. The steady risk-mitigation of organic growth seems to be a necessary path.   Luni of the Fledge Accelerator refers to these as “earners” vs “burners”. Earners being the organic growth path, and burners being the quick equity and try to scale quickly path. A frustrating trend we’re starting to notice is that high-risk money is coming into the food/ag sector where the business models can’t justify it. In the 3-5 years it’s going to take to lose enough money that risk-takers stop flooding it in, those “burners” that get funded will distract partners and resources from the “earners” that could actually sustain and thereby starve them in the short term.   It’s yet another example of how our capital funding system is broken.