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Bootstrapping without Sweat Equity or Venture Capital

I explore the options for creating a start up that can't accept venture capital and can't offer stock options, but in exchange for these limitations can offer a greater potential profit and influence on management to employees than normally possible.

William Leader, Blogger

April 21, 2010

5 Min Read

If you have been reading my previous blog posts, you'll know that I am in the middle of an attempt to build my own browser based MMO, and while some of the challenges I am facing are techincal, the further I progress, organizational challenges come more frequently. What I mean by organization challenges is the growing need for more people to be involved in my project. While I probably could continue to do things solo, the other concerns in my life such as my actual job and being a new father means that If I want to finish this and not have it take ten years, I need help. That means creating some kind of organization, most likely a company.

Given that neither I nor my family is rolling in fat stacks of cash my options are somewhat limited. This leaves me with two other possible choices for startup funding. One is a business loan from a comercial bank and the other is attracting venture capital. Both have problems that need to be dealt with.

Loans are problematic for a software startup because unlike business that deal in physical goods or operate out of a store front (such as restraunts) a software company that is doing business online uses little of its money to purchase assets that can be reclaimed by the lender if the business fails. There is no building or inventory to sell off. There might be some computer equipment, but the rate at which that depreciates is so fast banks won't even consider it, and banks don't want to deal with selling off the half finished intellectual property either since they rarely have the expertise to deal with it. To put it simply, startup loans to software companies are an extremely high risk to a bank which means even if you can get one, the interest rates on it can be crippling. I simply don't see loans as a possible funding path for me at this time.

Venture Capital (VC) faces the same problem of risk that a banker does, but VC is more accustomed to dealing in risk, and their compensation is for the greater risk is a greater potential reward. I can't imagine a situation were VC will settle for anything less than a share of the business ownership. I have personal ethical reasons to avoid having multiple business owners which I will detail below. This is an artificial limitation on funding sources that I may have to reconsider if my ideas on how to convert my game into a company prove to be a failure.

In the absence of Loan or VC based funding to start a company there is really one possibility left: Sweat Equity. Basically Sweat equity is when portions of the company are traded to employees instead of a salaray or wages. While normally this is an acceptable choice when funding is not available, it still has the problem of causing multiple owners, and if that is unacceptable in a VC situation, it must be unacceptable for sweat equity as well. 

Readers who are familiar with some basic accounting principles may have figured out that I am aiming to create a business with a single owner. The reason is a bit difficult to explain in a consice manner, but I'm going to try anyway. I would much rather work at a company that exists to make its employees wealthy than a company that exists to make its shareholders wealthy. 

VC makes other people wealthy so it doesn't work for my needs. Sweat equity does a good job of making the employees wealthy, but only the initial employees and at the cost of converting the initial employees into shareholders. This means that as soon as an employee is hired that is not also a shareholder, sweat equity as a method to enrich employees breaks down. In order to meet my goal of creating a company that makes its employees wealthy, I need to consider a non-traditional business structure. 

What I want to do is create a business where the owner(s) is contractually obligated to behave in a certain ways. The purpose of the restrictions is transfer as much of the profit motive and control as possible away from the owner to the employees. I haven't yet worked out all the details, but some of the key restrictions I would like to see are:

  • Prevent or restrict the payment of a dividend to the owner(s), to encourage directing a greater part of the profit generated back to the employees or used to grow the business. 

  • Force the owner(s) to only install executives that have been approved by the employees by a vote.

Now certainly when you start messing with the organizational structure like this there are bound to be some unintended consequences so a much more explicit system of company governace would have to be defined. I am imagining something like a corporate constitution that lays out the rules that govern the relationships between owners and employees.

Lets presume for the discussion that such a company was being formed, and you had the option to join it and influence the creation of its constitution. As a startup, the company would not be able to pay a wage or salary until it started recieving income. And because of the restrictions, and the company could not offer stock. The only compensation option is a contractual obligation to pay you when it does have income. What kinds of  limitations on ownership and assurances to you would you like to have before agreeing to join such a startup? What concerns would prevent you from joining?

I am very interested in recieving comments from anyone who has ever considered working for a startup company.

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