Leonard Lee (Darren Brown, OBJ).

Building a business with little or no outside capital can be an inexpensive way of financing a new venture that gives entrepreneurs the freedom to pursue their business without having to answer to shareholders or other lenders.

Lee Valley Tools founder Leonard Lee increased the mortgage on his family's home to fund his newly-formed company in 1978, an experience he has described as "pretty scary."

However, Mr. Lee told the OBJ last week that bootstrapping remains a viable financing option for businesses of a certain scale in certain markets, provided entrepreneurs set limits and keep an eye on their cash flow.

OBJ: In your case of starting up Lee Valley in 1978, what was it that led you down the bootstrapping route?

LEE: I didn't think anybody else would lend me money. I think that was pretty straightforward. And the banks proved that. They required you to put on deposit more than they were willing to lend you. Banks have improved somewhat, but they should not be relied upon in general for a new business.

It was out of perceived necessity. And as business grew, we had people come to us that wanted to invest. But by that time, we were cash flow positive and so we did not take any outside investors.

OBJ: What were the advantages of self-financing?

LEE: There are always advantages when you don't have to report to shareholders. There are some disadvantages in that if you don't have to report to shareholders, you better clarify your own thinking. It is always useful to explain your business to somebody else. And by the time you've finished explaining it to them so they could understand it, you realize that there are elements of it you didn't appreciate yourself. You always learn from telling somebody else in detail what you do and why you do it. Somebody out there will point out that, just possibly, there is marginal improvement available.

OBJ: How did your approach to seeking out financing change when you launched Algrove Publishing and (medical equipment maker) Canica Design?

LEE: This was a case where the financial requirements were beyond our personal ability and there were investors who hoped I wasn't a one-trick pony. The difference there is one of scale. I'm not at all interested in selling Lee Valley and yet that is where most of the increase in assets is, in Lee Valley. You don't go and loot a successful firm in order to finance a startup.

OBJ: So is it that bootstrapping is an appropriate form of financing for starting a business of a certain scale?

LEE: I think so. But if you are thinking of bootstrapping, you have to decide how much of your accumulated wealth you are willing to part with. I was willing to mortgage everything, but not to the extent that I would lose it. So that if something happened, I might've had to dispose of one or two assets, but never the house. It's a question of how far you want to go.

And the critical factor, more critical than the amount of money you have, is whether or not the business will show an early cash flow. If it will show an early cash flow, then the risk is substantially reduced.

Far more important than profit is managing your cash and you have to have a positive cash flow even if you are not profitable. You have to have that cash flow in order to survive. I think the cardinal sin in a new business is letting it run out of money.

OBJ: How has the climate changed for bootstrapping since you founded Lee Valley?

LEE: The appetite for risk among the average investor has gone up appreciably. Among other things, there are venture capital firms who will look at these businesses.

Banks aren't generally a good source for a new business. Most of them are not qualified to judge a new business, or maybe they are so qualified that they would never touch one.

But in general, I think the appetite for risk is greater, where people have money that they don't want to just get an annual interest rate on and they are going to invest in something and they will probably tend to invest in something where they at least know the owner ... (or) they at least know something about the business and about the management.

But that is the old danger of borrowing from family and friends to start the business. In the end, you could be left without any friends but you still have to live with that family, which is not very pleasant having lost all their money.

OBJ: What advice would you give business owners considering bootstrapping?

LEE: It depends on the complexity of the business you are going in. If you are going to go into the high tech business, you may or may not be able to raise enough money to achieve the mass that you need in the marketplace.

If you are thinking of going into a business that has a relatively low entry-level requirement for financing, such as if you are buying a currently operating restaurant and going to run that, then your risks are quite different. Your risks are whether or not you can convert it into a popular restaurant but not that you have to convince anybody to eat. So the risks are substantially different and I think you have to look at the risk/reward question. Usually where the risks are low, the rewards are low and where the risks are high, the rewards can be high or the risks can break you.

If you have developed a new approach in almost any field, there is not going to be a current customer base because this didn't exist before. Where you have to create a market, as opposed to entering an existing market, the capital requirements are usually beyond the bootstrapping abilities of any individual.

The experts say

If you seek external financing, it will take you hundreds of hours to talk to the right people, to put together all the business plans, to do all the kinds of things that an investor might want, that you might not need to run your company. If you were to take that same level of effort and apply it to commercializing and selling your product, in some cases you might be further ahead.

According to PricewaterhouseCoopers, 95 per cent of software founders plan that their company will be acquired someday. That is the result of a national survey among Canadian software CEOs. If you've got external financing, particularly for a software company, you usually give up a lot, especially if you are talking about institutional money, like angel money or institutional VCs. They are often taking a significant ownership part of the company, they are often talking about preferred shares ... so when it does come time for the company to be acquired – and acquisition isn't the end, it is usually just a major step - it generates not only a life of its own, but usually a life of its own that you could have never provided yourself. My advice to a company that has got a commercially-ready product would be to get some help from somebody who knows how to sell it, and get out there and start selling your product.

Bruce Lazenby, chairperson, Ottawa Software Cluster

It's been my experience that if you have a good idea, you can often find a way to finance it without going and getting a loan from the bank.

What you do with bootstrapping is start on a small scale and work up. You don't start at 10 employees, you start at one. It's a question of scale. It might take you two or three years to get up to the 10 employees instead of doing it in one swoop.

One of the advantages over taking a loan from the bank is that you don't have the overhead and you actually learn the business from the ground up. (At) my own business, we didn't take out any loans, we just simply developed the product, and kept it simple enough that we could bring it to market and start raising revenue streams. I can think of several small businesses that have done that. In one case, they are selling office products. When the company they were working for closed down, they had the client list and they went and sold the same products using the same sources. Did they put any huge amounts of funds in? No. You can bootstrap by getting money from your accounts receivable. I'm sure you could bootstrap by withholding your payments for 30 days although you wouldn't want to do that for too long.

If you are just starting up, usually the rationale is that you have six months worth of expenses in the bank before you go. I think that is always good advice.

Barry Bockus, president, Canadian Small Business Association