Bootstrapping Your Way to Business Growth

Bootstrapping Your Way to Business Growth

By reinvesting free cash flow back into the growth cycle of a business, bootstrapping helps contractors combat the recession

It's ugly out there. The recession has all but eliminated the credit markets as a funding option for new business growth. Contractors with existing lines of credit have found their limits slashed, and installment loans are being called in as banks seek to limit their exposure. With the freewheeling days of low-cost capital gone, what is an electrical contractor to do? Is it still possible to grow your business in the wake of this capital crunch?

Bootstrapping, an old growth concept, has made a revitalized appearance in today's marketplace. Bootstrapping is the reinvestment of free cash flow back into the growth cycle of any business. The cost of capital is free where the only downside is that owners must defer their personal compensation expectations for a future period. In this era, where external capital is, at best, an expensive alternative, doesn't it make sense to go back to the future?

Cash conservation

When the recession hit, the majority of electrical contractors followed the operating traditions of the past economic downturns and started working harder. After all, previous recessions were short in duration and could be overcome by working longer hours, spending more money on business development efforts, and sacrificing a small percentage of project profitability. Although it's a great strategy for a short-term downturn, this approach wreaked havoc when the recession moved from a momentary blip to a firmly entrenched long-term economic decline. Companies that followed this path for overcoming the recession watched as cash reserves were depleted and borrowing limits were exhausted. One small electrical contracting firm I've worked with is a good example.

Watching as the construction industry started its decline, the owner, a veteran of three previous recessions, knew the drill — longer hours, more intensive marketing, and meeting customer demands for lower prices. Cash outflows actually increased as overtime had to be paid, and the cost of sales nearly doubled in an effort to find more customers. In time, cash reserves dwindled. However, a quick call to his local banker provided ready access to his dormant line of credit. In his mind, any debt incurred would be short-term in nature — fully recoverable when the recession ended. Unfortunately, the owner's gamble didn't pay off. He was too slow in controlling his cash outflows. By the time he realized the recession was in place for the long haul, his cash position had completely eroded. His firm, which at one point had been valued at more than $1 million, now had a negative valuation — meaning that he would have to pay someone to buy his firm versus the preferred alternative.

For those of you who have not figured it out yet, this recession is not your father's recession. Unemployment rates continue to rise, and no industry has made any form of appreciable recovery. As an owner, this is the perfect storm. But there is a solution, a way to make this economic downturn work for you. The first step is to have a new appreciation for cash — to realize that free cash flow remains the very best investment source for your future growth.

When this recession hit, a small segment of contractors rediscovered the most basic of all operational mantras — conserve cash. With revenues dropping and receivable balances extending out, in some cases to more than 180 days, these contractors learned that conserving cash precluded their need to borrow or, alternatively, sell off portions of their empire. With cash conservation came the realization that they could be their own bankers — finding legitimate opportunities for acquisitions or other methods to accelerate growth.

For example, another electrical contracting firm established an internal goal of maintaining a cash balance equal to one year of operations sans any form of new customer revenue. For this firm, that amount came to $1 million. Throughout the course of the year, the owner took a hard look at both recurring and non-recurring expenses — making decisions as to the necessity of each cash outlay. The owner reduced his compensation level to a more reasonable (and certainly still livable) standard. By the end of the year, this $7 million firm had put away its $1 million cushion. Now, the firm is sitting on its own “gold mine.” Customer revenues have continued to roll in — albeit at a level that was less than two years ago. Through prudent operational planning, even though revenues have dropped, the overall profitability of the firm has remained positive, and the contractor continues to add to his own investment pool.

Cash conservation occurs when contractors test the necessity of each cash outlay. Overhead costs are trimmed, and non-productive employees are shown the door. Similarly, any capital outlay that does not have the ability to meet a payback period of less than 12 months is considered unacceptable. In the end, businesses reflect the old adages of the Great Depression: “Use it up, wear it out, do with it, or do without!”

Avoid the overzealous gardener syndrome

For many contractors, their first inclination after reading the last few paragraphs is to attack their expenses with a hatchet — cutting away swaths of costs in an effort to achieve immediate profitability. Just as there is a danger of not trimming away enough operational excess, a converse issue occurs when owners go overboard with their budget-cutting sword.

Another electrical contractor I've worked with serves as the perfect example. In an effort to immediately return to a positive bottom line, this firm started laying off employees — with a particular emphasis on the lower-level field staff. The owner's belief was that his longer-term employees represented his core staff, and, under an ethical obligation, allowed them to continue to receive a paycheck. Likewise, indirect personnel, such as a marketing manager and the controller, were also let go. In his mind, these indirect charges had no correlation to the firm's generation of revenue.

While his goal was admirable, his choices for termination sent the firm into a downward spiral. Lacking any junior field staff, the cost of operations soared as more senior employees were pushed back into the field — incurring a much higher cost than their junior counterparts. The marketing and accounting functions fell to the owner. At first, he relished being back in control of these indirect activities. However, he soon bored of the administrative tedium as work started piling up on his desk.

This owner had fallen prey to the overzealous gardener syndrome. As most effective green thumbs can tell you, gentle pruning of a bush or tree is necessary to achieve new growth. Wholesale destruction of the same plant puts too much strain on its constitution, resulting in its untimely death. The same philosophy holds true for a business. Trimming away non-productive personnel while keeping the established organizational structure standards in place ensures the remaining individuals will productively move your business forward. By chopping away necessary personnel, the business was doomed to become a shriveled, dead stick.

Slow and steady wins the race

The foundation of bootstrapping success is akin to the all-too-familiar race between the tortoise and the hare. In our industry, the hare is the recipient of external capital. In a market where low-cost money is available, dynamic companies can grow quickly with the infusion of external funds — often growing exponentially over a relatively short-term period. Like the hare, these companies jump forward quickly, settle, and need future infusions to remain viable entities — and those that lack such funds flash out of existence.

Contracting firms that grow predominately through acquisitions are the primary beneficiaries of “hare” funding. Rapid geographic expansion and a large diversity of offerings are characteristic of firms that have used external resources in a productive manner. However, with each acquisition, a careful analysis of indirect costs must be conducted to ensure multiple businesses don't lead to redundant non-chargeable activities. If done correctly, these firms prosper as diverse offerings combine with larger customer rosters, ideally creating a large, fully integrated single firm concept.

Unfortunately, the more common trait for these acquisition-hungry behemoths is to make the deal and leave the conquered firm to fend for itself — now as a profit center of the larger company. The expected benefits of joining a larger firm are usually not realized as former business owners now must not only operate their firms but also do so in the context of the acquiring firm's administrative constraints. Revenues may increase slightly as a reflection of a changed corporate name; however, the expected profits from the sale are almost never realized.

For instance, one large electrical contracting firm had a simple strategic objective: to find and acquire as many viable businesses as possible. A member of a national electrical contractors association, the primary owner of the firm confided that his only reason for attending association functions was to find potential acquisition candidates. This large firm sought out well-managed small businesses that could be added to the company's portfolio. When it was decided by the association to reduce its number of conference activities in the wake of the recession, the large firm opted not to renew its membership — its fishing pond had dried up.

In periods where there is abundant external capital, the “hare” growth model can flourish. Unfortunately, when access to capital becomes less available, these same businesses quickly jettison off unprofitable business segments, force remaining profit centers to “sign up” for difficult revenue targets, restructure their debt, and revert back to a smaller corporation that can wait until ready capital is once again in play.

Contrast that role with our version of the tortoise. Using only internally generated funds, the growth of the business is slower yet much more controlled. At the same time, no new debt is incurred, and the ownership structure remains closed — usually only distributed among working partners. In the end, these tortoise traits ensure long-term business viability and an attractive payday for departing owners.

For example, a small electrical contractor had the fortune of having two banner years in a row where revenues grew at more than 100% per year. The son of a retired electrical contractor, he knew that long-term success was predicated on his ability to control his growth — as well as protect his cash position. Although painful, he made the necessary tax payments on the monies that were generated by the business and left the majority of the monies in the business.

As he planned for the next year, he had several opportunities to reinvest his free cash flow into acquisitions, new technologies, and the hiring of new employees. Although he could envision another year with more than 100% growth, he was quick to realize that meteoric growth spurts were neither sustainable nor prudent, given the culture of his workforce. He worried about whether or not he could sustain the quality of the firm's work if he attempted to grow at such an exponential rate. In the end, he opted to suspend his rapid growth curve in favor of a slower rise that could ensure the quality of his end deliverables.

Bootstrapping is the slow and steady alternative. Neither flashy nor the prescription for exponential growth, bootstrapping keeps your business viable — protecting it from the clutches of outside “bankers” — the same entities that now have turned against your desire for continued growth.

The reinvestment answer

Holding cash for its own sake is not a prudent reinvestment strategy. The goal for any contractor is to find avenues to gain greater value through the investment of their idle cash. But in these recessionary times, where do you find viable investment options?

The good news is this is the very best time to acquire an existing business — especially if you have followed the hare growth philosophy. High levels of debt and tired owners put many businesses in an undervalued position. For those businesses that have amassed an internal investment portfolio, these quick (and inexpensive) acquisitions can have an almost immediate impact on business growth. But what are the best businesses to buy?

During recessionary periods, contractors should follow the practice of horizontal acquisition, which is the buying of complementary, non-competitive businesses that diversify the offerings portfolio and customer base. They are literally logical sideways extensions of your core business. Businesses acquired under this horizontal philosophy form a stronger, much more vibrant base that can be exploited now and when the recession ends.

For electrical contractors, horizontal acquisitions could entail the purchase of closed-circuit security firms or those that specialize in data center work — both logical extensions of your current activities. Alternatively, establishing a footprint in the maintenance of existing electrical systems (from both a “break and fix” and an overall efficiency perspective) represents another way for your firm to prosper. The key is to find businesses that complement your current activities and extend your value proposition to a more diverse customer base.

Finally, making acquisitions without clearly understanding the financial and operational impact of your decisions can have a devastating impact on your cash position. Although you might be intrigued by buying a friend's business, remember that a carefully calculated return on investment — as well as an operational strategy to integrate the acquired business into your fold — will gain you far more benefits. And don't forget business owners who have recently sold their businesses to you have lost a great deal of their competitive zeal — even when the buyout arrangement has out-year escalation clauses. Presume nothing, and move forward with the understanding that the success of the acquisition will rely predominately on your efforts — not the former owner's.

Chaos breeds opportunity

The current economy is in chaos. With traditional business structures failing and customer requirements changing, omissions in the marketplace have erupted. For the innovative and well-funded business owner, now is the time to strike. As a contractor, the decision is yours — follow the slow, steady approach to growth or burden your company with debt, hoping that access to low-cost capital is right around the corner.

Dawson is the managing director of LTV Dynamics, located in the suburbs of Washington, D.C. He can be reached at [email protected].

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