Bootstrapping is a trendy topic right now because early stage investment is hard to find, particularly for businesses that do not promise extraordinary growth potential. One of the bootstrap financing techniques often suggested is the trading of stock in the enterprise for products or services needed by the start-up. I have a strong opinion on this practice.
It's a terrible idea. Here's why...
As I have pointed out in other posts, equity is forever. Swapping shares in your company for one-time needs might be compared to paying for an oil change by giving the mechanic partial ownership of your car. Without the oil change, your car might eventually grind to a halt; but do you really want to enter into a long-term relationship with the mechanic?
Let's get specific. Suppose you offer an attorney a share of your company for preparing incorporation papers, and she accepts. Now, as a shareholder, the attorney has permanent access to your corporate records and the right to participate in all ownership activities. The dream, of course, is that the company is on a fast track to outside investment and on to liquidity. The lawyer will get to draw up all the financing documents and then the merger or IPO papers for a healthy fee; and the tiny share of ownership that you gave her will be insignificant to the fortune you will make when you sell the business.
Here's what really happens most of the time. The company, if it survives beyond its first year or two, grows nicely, but slowly. It doesn't need, or warrant, serious outside investment. The best way for you to make real money is not through a liquidity event, but through handsome personal compensation. You have occasional need for a lawyer, but you try hard to avoid those inflated fees whenever possible. They are, after all, money right out of your pocket. The lawyer now has a marginally profitable client relationship and a meaningless share of a company that will not be sold. BUT she also has all those pesky rights I mentioned earlier. If she gets grumpy, she is in a position to create some real pain. This is not a good deal for you, and its also not a good deal for the lawyer.
Now suppose, instead of trading for legal services, you trade for a salesperson, as proposed by more than one author. The dream this time is that the salesperson will be a huge success and a liquidity event will occur on schedule. The reality, more often than not, is that the salesperson has some early success, but not enough to foster venture capital or an early liquidity event. Then the company's growth settles in to the typical modest upward trend, and the commissions earned by your minority-shareholder-salesperson do not meet his financial needs or aspirations. The bloom is off the rose. You're unhappy with the results. He's unhappy with the results. You part ways. BUT he still owns a piece of your company and has all those pesky rights, including the right to assert that you are over-paying yourself to the detriment of minority shareholders. Does this still sound like a good deal?
Jim Flowers (that's me) has said this before:
Cash is the recommended medium for acquiring products and services that are not strategic to the business. Bestowing equity on any entity in lieu of cash payment amounts to paying forever for products or services that may not even remain relevant a short time into the future.
The use of equity in bootstrapping is sometimes very smart, and it is sometimes unavoidable. It is, however, always risky. I strongly recommend that it be employed only as a last resort and only for strategic requirements, not commodities.
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