Many entrepreneurs go into business to "do it themselves" and consequently don't want to have to answer to anyone, especially to the bank or to outside investors! A common refrain heard of many entrepreneurs is: "I want to control my company completely, so I won't need any outside financing!"

Yet, despite their optimism, entrepreneurs often end up having to find some kind of outside financing. The subsequent myths in this chapter deal with how to go about raising the money you may need. This myth is the first in this chapter because it explores the reasons why a startup company often needs to raise outside financing by selling equity in the company or by taking on debt, and how to keep both of these to a minimum.

The central question inherent in this myth: Is it possible to start and grow a company today without any outside financing? If so, why give up any control of the business? And if not, why not?

This leads to a common misperception about the circumstances under which companies need to get outside financing. In this myth, we learn that there are two times when a company needs money: 1) when it is not doing well or has no sales, and 2) when it is doing extremely well. Keeping this in mind, we will look at different ways of getting the additional money for your company - with or without raising equity financing.

In the old days, it was often possible to start a company from scratch by borrowing a little money and then growing the company successfully over a number of years. The money borrowed could be paid back from profits, and the profits created wealth for the company owner. The entrepreneur(s) owned 100% of the company.

In looking at financing in today's startup environment, the first question we want to examine is the following: Is it still possible to completely finance a company's growth on a shoestring?

Let's take an example of a company I know well: Brainstorm Technologies. When I started Brainstorm with my college roommate, Mitch, we had very little money (having just graduated from college, we hadn't been in the working world long enough to accumulate any savings!). We borrowed $5,000 from Mitch's parents as our startup capital. That seemed like an easy enough solution, and we thought we were off to a good start.

Lucky for us, we started in an industry that is well known for its low initial investment: the software industry. The argument in the software industry goes like this: "The only thing you need to start a software company is brainpower... You don't need to make big investments in equipment, office space, or anything... you just need a PC and your brains ... It's the perfect company to start in a garage ...or dorm room. "

Of course, those of us who've lived in the East Coast realize that it's not really practical to start a company in the garage - it gets quite cold in the winter. So we did the next best thing: we started it in our living room. We slaved day and night to build the first version of the product, keeping expenses extremely low. Within one month of product introduction, we had enough sales to pay back Mitch's parents, and we also realized that we were onto something!

So far so good... We started the company with little or no investment, and what money we needed, we borrowed and paid back out of cash flow. Just like the good ole days!

Soon it was time to move to an office space, time to start to grow the company. We couldn't possibly keep doing everything ourselves. So what did we do?

We raised $50,000 as an equity investment from family and friends to help with our cash flow. We didn't call it that - we didn't know anything about cash flow, we just thought that we could keep the 50K in the bank in case we needed it. And we needed it soon enough: we had new employees to pay.

Now, by high-tech start-up standards, $50,000 isn't a lot of money. But with the $50,000 that we raised in January, we were able to grow from two employees to twelve by the end of the year, and then ... we realized we needed a lot more money!

There's an old rule in engineering circles: a task will expand to fill all of the time that's available for its completion. There is a corollary in the startup world: A growth company that raises financing will expand to spend all of the money that it raises!

We convinced our Japanese distributor to invest another $50,000 in the company, which held us over until we could then go out to raise even more financing! This time, we sought out Venture Capitalists (an interesting experience that you will learn more about in the rest of this chapter) and so we raised $2 million.

Now, this story brings out two very important points about our central question.

The myth is that you can start a company without raising any financing. The reality behind this myth is that you can do that in the very early stages, but only if you want to (and are capable of) doing all the work by yourself (and don't want to get paid).

When we first started our company, we imagined that we would do everything ourselves. And we did. We got the first product out the door and made our first few sales without any significant outside help or money. In the startup world, this is referred to "sweat equity," because instead of giving up any share of your company (equity) to outsiders for money, you did it all by yourself, without pay.

This is not a trivial point by any means.

First, many entrepreneurs don't look at the question of how to get a company to generate sales as quickly as possible. Rather, they define a product that will take a year to build and requires x number of engineers, when they might have been able to build a scaled down version of the product in six months, by themselves, or with one or two engineers. Or, they define a business model that requires a massive amount of costly inventory before the first dollar of sales is generated.

Secondly, this approach doesn't work with a lot of other industries. To start a retail store, for example, you'll need to rent retail office space and stock your store full of merchandise. You'll still be doing it all yourself, but you'll probably need a little more start-up capital than we needed. For most industries, the startup costs are more than intellectual capital, and it's difficult, if not impossible, to start those companies without raising some kind of financing up front.

And what was the next thing we did as soon as we had sales? We needed more money or we felt we couldn't meet the demand.

In short, even in the industry that is best known for not requiring any outside financing, and even when we were doing really well, we couldn't have gotten by without raising some outside financing!

So why did we continuously need MORE money?

Were we opening new offices? No. Were we investing heavily in expensive new equipment? No. Were we investing in sales and marketing to carry our product to the public? No. Were we unprofitable? No - in fact, the first year we were extremely profitable - 30% pre-tax profits. That's almost unheard of in the first year of operation for a company like ours.

What was it then?

We needed it because 1) we wanted to stop doing the work ourselves (and wanted to start paying ourselves a salary), 2) we had big plans for growth - another product, etc., and 3) though we were making sales, we weren't controlling our receivables. This then brings us to the next Principle:

In our case, the product was selling rapidly, and we didn't have an infrastructure to handle the sales we were getting. We had no salespeople, no technical support or shipping and accounting people. And so we weren't collecting money from our customers as quickly as we should have.

Yet once we raised the financing, we had no problem "investing the money" to make the company bigger; it wasn't long before we needed even more financing.

The real reason we raised money was because we wanted to be BIG, and we wanted success to happen FAST. In the fray to grow very quickly, we needed a lot of money to hire ahead of our anticipated growth so that we could make appropriate investments in people, and build a solid infrastructure.

It's certainly possible to start a company today with little or no capital, as we did in our living room. In our case, if we had decided to stay at three, maybe four employees for the rest of the year, rather than expand to twelve, we could probably have gotten by without more outside financing.

The bottom line was this: We didn't want to be a four-person company; we wanted to grow into a 100-person company, and we wanted to do it quickly!

So, is it possible to successfully grow a company without outside financing?

Yes, but it all depends on your timeframe for growth. Some entrepreneurs want to sell their companies and cash out so they don't have to work another day in their lives. Other entrepreneurs want to run their business for the rest of their lives.

It's the first type of entrepreneur who is likely to try to grow very quickly, and he or she will end up giving up a lot of the company by raising outside financing. This first type of entrepreneur will also end up with less money after the company has been sold.

So the answer is not necessarily to keep your company small, but to grow it steadily, over time.

This principle does not mean that it's impossible to grow your company to be LARGE without giving up a significant portion of it. It just means that you should take your time. There's another benefit to taking your time: you usually build a higher quality company, because you have time to insure quality at each stage of growth. Many companies try to grow too rapidly and raise their expenses too quickly, eventually imploding.

Let's look at an example of a very successful company that was able to grow rapidly without imploding on itself or raising outside financing. Let me say that this company, Sapient Corporation, is quite unusual in the startup world for what it was able to accomplish very quickly. By examining what they did, we can gain some insight.

The founders of Sapient, one of the biggest entrepreneurial successes in Cambridge, Massachusetts, were able to start and grow with minimal outside investment. Sapient grew from 2 to 200 employees in 5 years, and went public at a $250 million valuation. The company is currently valued at over $400 million dollars, is highly profitable, and the two founders, Jerry Greenberg and Stuart Moore, still own most of the company (that means that they're both worth in excess of $100 million dollars; not bad for 5 years of work!)

How did they do it?

Well, for starters, they put up their own money, and because they were a service firm, they were able to do the work initially by themselves. "Sweat Equity" was used to generate dollars into the firm right away. They were utilizing principle # 1.1; the way to keep equity in the company is by doing the work yourself until cash starts coming in the door.

But doing all the work by yourself just isn't practical as the company starts to grow. You have to hire consultants. Luckily, the costs are more or less variable in this scenario: you only need as many consultants as you have business. As you hire consultants, you can bill them out to clients and make money right away! Correct?

Not exactly. Even though the costs of a services firm are variable (you only need as many consultants as you have projects to put them on), there is a ramp up time for each consultant. They must be hired and trained before they can be put on a project that generates revenue for the company.

This means that even in a fully variable cost business, you will need cash to increase those variable costs before they can be put on a project and produce revenue for your company.

So ... how did they do it?

The answer is to get the money you need from another source. Namely, your customers...

Sapient used their customers to finance them. Sapient had a unique fixed price methodology for their consulting projects. This was also in the days before too many of their competitors were doing the same thing. In exchange for this no-risk feature for their clients, Sapient required that customers pay half of the amount of the entire project up-front. This cash could then be used to fulfill the costs of each project.

Now, there are many customers who are not willing to pay half of the costs of the project up front. If you want your customers to finance you, and they are not willing to pay up front, then you have to be willing to walk away from the business.

I have yet to meet an entrepreneur who is comfortable walking away from any type of business. But if you really don't want to raise outside financing, then you have to be able to say NO to business that you can't afford. And you have to be able to hold your ground when negotiating with potential customers.

For most of us, we will be selling products and/or providing services for which we won't get paid right away. We have to invoice our customers, who will then turn around the invoice and pay us in anywhere from 30 to 90 days after submitting the invoice.

This is the crux of the cash flow problem for many successful companies. Even if the company is profitable on paper (i.e. selling more than you are spending), the collection cycle can cause your company to run out of money quickly.

Cash flow crunches have led to the untimely deaths of many unsuspecting small companies. "Why don't we have any money? " screams the entrepreneur. "We're selling more products than we were last month!" The answer is that although you're selling you're product or services, the customer are taking their sweet time to pay you the cash they owe you.

The best way to solve this particular problem is to get a working line of credit from your local bank. Most banks will give you a loan on up to 80% of your outstanding invoices. However, you have to show a history of getting your invoices paid so that the bank will be comfortable that they will be readily collectible.

The other way is, of course, to raise outside financing from investors by selling them a portion of your company.

But be careful with the bank, because an accounts receivable-based line of credit IS NOT the same as getting outside money from investors and should be treated differently. In the case of the outside investor, you are getting money that you can invest in any area you like, and you don't have to pay the money back!

In the case of the bank working line of credit, you are getting money loaned to you that you have to pay back. More importantly, this money is to account for money you have already spent on performing the services or creating the product that you have sent to your customers and invoiced them for.

Now, I shouldn't have to tell you that getting reimbursed for money you have already spent is different from getting new money that you don't have to pay back.

Even more importantly, a bank line of credit will come with a set of financial convenants that you have to maintain. This will mean that your company has to stay on a financial plan that they have approved, and has to maintain certain financial measurements.

An example of a financial covenant is: Your profit next quarter has to be more than $X. These covenants are generally very restrictive, and you may actually lose more flexibility by borrowing from the bank than from selling a part of your company to investors.

If you don't meet the covenants, then the bank can pull the line of credit, meaning you have to pay them back immediately. When a bank pulls the line, they don't request it from you; the bank has access to your checking and savings account, so they can easily take all the money from you without asking! So, it's a good idea to pay close attention to their financial covenants.

Finally, a bank will often ask an entrepreneur to personally guarantee the line of credit. This means that if the company can't pay back the amount borrowed, then you are personally liable. Usually this means securing it with your house or some other asset.

Securing the company's line of credit with your house can be a harsh pill for many entrepreneurs (and their spouses!) to swallow. Most banks will lift this restriction after the company has achieved some level of profitability, or if other investors put in a certain amount of equity financing (for a $1 million line of credit, the number is usually at least $1 million), or if the company goes public.

So it is possible to use a bank line of credit to help you grow your business without raising outside financing, but only if you remember what the money is for and can live with the bank restrictions.

Remember: borrowing money from the bank is a great way to finance your customers, but it doesn't mean that you won't have to raise outside equity financing, and it certainly doesn't mean that you will have more control of the company.

In conclusion, the origin of this myth is that many entrepreneurs think they can grow their companies without raising any financing.

This can be done, but only by being extremely creative in finding ways to get cash in the door before it goes out the door. Furthermore, it often requires slowing down very aggressive growth plans, and convincing either (or both) customers or the bank to "lend" you money.

All of these add up to some financing strategy that you will have to put together. It's not that you can start and grow the company without any financing; it's just that you have to be very creative in your financing strategy.

To recap the principles we learn from this myth:

Principle #1.2: There are two times when you will need money: when you're doing really poorly (and are out of money), and when you're doing really well and want to continue to grow rapidly.