Frontiers of Entrepreneurship Research, 1995

Frontiers of Entrepreneurship Research
1995 Edition


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    FRONTIERS OF ENTREPRENEURSHIP RESEARCH 1995.


    WHO BANKROLLS SOFTWARE ENTREPRENEURS

    John Freear, University of New Hampshire

    Jeffrey E. Sohl, University of New Hampshire

    William. E. Wetzel, Jr., University of New Hampshire

    ABSTRACT

    The research makes a significant contribution to the understanding of the start-up, survival and growth of the next generation of software ventures. Software entrepreneurs actively employ bootstrapping and business alliances as part of their strategies for growth and survival. Dependence on personal sources of support is significant, and most ventures have earned a significant percentage of their revenues from business alliances. Knowledge of the industry and an ability to use contacts and networks has proved to be a critical part of the search for business allies.

    INTRODUCTION

    The general purpose of this research study is to extend and refine technology-based venture financing research by examining the financing strategies employed by successful entrepreneurs in computer software ventures. The research expands the definition of venture financing to include non-traditional techniques for gaining control over needed resources. It explores the roles played by "bootstrap" financing and by non-financial corporations as both direct investors and corporate partners. The research pays special attention to the frequency and characteristics of successful and unsuccessful financing strategies and partnerships.

    METHODOLOGY

    The survey instrument comprised fifty-two questions divided into five sections: Bootstrapping, Business Alliance, External Equity Financing, Characteristics of Private Investors, and Firm Characteristics. The Center for Venture Research mailed a letter introducing the nature and purpose of the research to 755 members of a state-wide computer software council. The research is supported by council itself, and by a large accounting firm and a large law firm. The letter was signed by representatives of the supporting organizations as well as by the Center. Shortly thereafter, the Center mailed the survey accompanied by a cover letter, also signed by the same group.

    At the time of writing, 77 responses have been returned, a response rate of 10.2 per cent. The Center plans to mail a follow-up letter to non-respondents, followed by a post card reminder and then a telephone call, with the intent of improving the response rate. A series of meetings between Center researchers and a group representing the software council, software entrepreneurs, private investors, venture capitalists, lawyers and accountants helped the Center to construct and refine the survey instrument. The sections on external equity financing, private investors and firm characteristics, in addition to providing contextual data for the survey, seek to validate existing research findings. The sections on bootstrapping and business alliances are the subject of this paper and represent the first attempt systematically to discover information about financing techniques that are extremely diverse and difficult to identify.

    BOOTSTRAPPING

    The survey instrument defined Bootstrapping as "highly creative ways of acquiring the use of resources without borrowing money or raising equity financing from traditional sources." The survey divided bootstrapping into two parts: one related to product development, and the other related to business development. The survey identified twelve possible product development techniques and twenty possible business development techniques that respondents were asked to evaluate in importance on a five point scale from (1) "critically important" to (5) "not important." They had the option, also, of checking a "never used" box, which was given a (6) rating. It is not always an easy task to draw a clear distinction between product development and business development, or indeed between bootstrapping and business alliances. Nevertheless, the attempt to make such valid distinctions adds an important dimension to the analysis of bootstrapping and alliances.

    Table 1 gives the responses to the six most important product development bootstrapping techniques, each with a median response of (2) on the five point scale. Existing relationships with customers or hardware suppliers accounted for five of the six techniques, namely: special deals for hardware access; prepaid licenses, royalties or advances from customers; customer funded R & D; free or subsidized access to hardware; and turning a consulting project into a commercial product. Between 28 (38%) and 32 (44%) of those responding regarded each of these techniques as critically important or important. The sixth technique regarded as critically important or important by 25 (35%) respondents, was the more traditional technique of working on product development on nights and weekends. It should be noted, however, that a substantial number of respondents, 18 to 30 (30% to 42%), reported that they "never used" these techniques that others had found critically important or important.

    > The two least important product development bootstrapping techniques were the commercialization of public domain or existing shareware products. As shown in Table 2, only 2 or 3 (3% to 4%) respondents regarded them as critically important or important. The techniques were "never used" by 51 to 54 (70% to 75%) respondents. Also among the less important techniques were research grants, the commercialization of university-based research, and porting fees to transfer software from one platform to another.

    The survey offered twenty bootstrapping techniques that might be used in the development of a business, using the scale described earlier. Table 3 portrays the seven most important techniques, identified as those with a median response of (1) or (2). Reduced compensation, forgone or delayed compensation, and the use of personal savings were the three most important techniques. Of those responding, 57 to 59 (77% to 80%) described them as critically important or important. The use of personal credit cards and home equity loans, was other business development bootstrapping techniques seen as important or critically important by 35 (47%) of those responding. Working out of the home 34 (46%), and the use of below market or very low rent space 37 (50%), were viewed as important, as were deals with professional service providers at below-competitive rates 26 (35%).

    Table 4 shows the three least important bootstrapping techniques in business development, that is, those with mean responses of over (3.5), medians of (4) or higher and modes of (5). SBA loan guarantees, severance and parachute payments, and shareware revenue streams were never used by 54 to 63 (64% to 85%) respondents. Other techniques seen as unimportant were SBIR awards, barter arrangements, and special terms with customers.

    Approximately 31 (44%) respondents reported that they had managed to survive in business for two to four years without resorting to bootstrapping for product or business development. Nine (13%) had managed to survive for ten years without bootstrapping. Five (7%) had engaged in bootstrapping from the start.

    BUSINESS ALLIANCES

    The survey instrument defined a "business alliance" as a "cooperative agreement with one or more firms to utilize complementary resources for mutual benefit." Respondents were asked to restrict their answers to those alliances formed during the start-up or early stages of their venture.

    Of the 77 respondents, 71 stated how many business alliances, if any, they had formed during the start-up and early stages of their business. In total, 55 respondents formed 219 alliances, an average of almost four per respondent (see Table 5). Twenty-five of the 55 (45%) had formed only one or two alliances, 20 (36%) had formed between three and five alliances, and 10 (18%) had formed between six and ten alliances during the start-up and early stages of growth of their business.

    Respondents reported that 101 of the 219 alliances had contributed significantly to the growth of their business, a "success" rate of about 46%. Table 5 shows the data. Twelve who reported one alliance had a success rate of 83%. Thirteen who reported two alliances had a success rate of 54%. Twenty who reported three to five alliances each had a 60% success rate. Sixteen respondents (23%) reported that they had entered into no business alliances during the start-up and early stages of the growth of their business. The data suggests that the entrepreneurs who had formed many business alliances generally experienced a lower success rate than those who had entered into fewer business alliances.

    The survey instrument asked respondents to answer questions about the single most material business alliance they had formed in the early growth stages, and in which they were the least established partner. Table 6 identifies the year in which these alliances were formed. Thirty-five (63%) were formed from 1989 onwards. The average life of the alliances that were still functioning was five years. Table 8. Twenty of the 77 respondents did not answer this question. The most common responses to the question were: market penetration, 39 (68%); sales/marketing channels, 36 (63%); building product credibility, 30 (53%); enhancing company status, 28 (49%); inadequate resources to go it alone, 27 (47%); and complementary products 27 (47%). Least common were customer request, 10 (18%); to gain business experience, 8 (14%); lack of expertise, 10 (18%); and to accelerate time to market, 11 (19%). Respondents were asked to select the single most important reason from the list. Forty-nine actually did so, and the results are given in Table 8. The three single most important reasons for the primary business alliance were market penetration, 9 responses (18%), and sales/marketing channels, 9 (18%), followed by inadequate resources to go it alone, 6 (12%).

    The survey asked respondents to identify the primary reason that caused their ally to enter the business alliance. There were fifty-three responses, including twenty multiple responses. Table 9 summarizes the data. The most common primary reasons given were complementary products, 16 (30%); lack of expertise, 14 (26%); market penetration, 13 (25%); inadequate resources to go it alone, 13 (25%); and to accelerate time to market, 12 (23%). The least common primary reasons were geographic expansion, 3 (6%); access to customer lists, 4 (8%); to take advantage of economies of scale, 4 (8%); and to gain business experience, 2 (4%). It is somewhat surprising to find that "inadequate resources to go it alone" was a common primary reason, given that the ally was defined as the more established business partner.

    The techniques for locating the primary business ally are shown in Table 10. The most effective were an active search based on knowledge of the industry, 14 (23%) and the related technique of using industry networks and contacts 14 (23%). In eight cases (13%), the future ally called the respondents. Other techniques were relatively insignificant. Indeed, more allies were found by "chance encounters" than through venture capitalists or investors, attorneys, accountants and bankers combined. The last three, attorneys, accountants and bankers, were of no help to the survey's respondents in locating allies.

    Most of the alliances were cemented by means of tight documentation, legal agreement or memorandum of understanding. Forty of the 55 respondents (73%) used one of these methods. Only four (7%) relied on an exchange of letters, and a surprising 11 (20%) had no documentation to support a verbal commitment. The average alliance "success" rate of this last group was 52%, a little higher than the overall mean of 46%.

    Most of the primary business alliances did not involve cash financing. Thirty-four of the 53 respondents (64%) reported that no cash financing was involved. Where cash financing was involved, in eight cases (15%), there were restrictions on the use of the funds, and in another eight cases, the funds were unrestricted.

    The survey attempted to elicit information on the importance, in revenue terms, of the alliance to the respondents. Table 11shows that of the 54 who responded to this question, 14 (26%) stated that the alliance accounted for over 50% of total revenues. Thirty-one (57%) stated that the alliance accounted for over 30% of revenues. Only three (6%) stated that the alliance accounted for none of the revenues. Overall, the primary business alliance appears to have been a significant element in the revenues of the venture. This is confirmed by the responses about the importance of the alliance to the respondent's overall initial success. As Table 12 shows, 37 (67%) of the 55 respondents stated that the alliance was very productive or productive. Only one respondent (2%) found the alliance very unproductive. The median response to this question was (2).

    The survey instrument asked respondents to indicate, if the primary alliance had been terminated, whether it had been ended by them, by their ally, or by mutual agreement. The small number of responses (10) prevents much useful analysis of the data, which is presented in Table 13. The mean life of terminated primary alliances was just over three years. For those terminated by the respondent, three of the ten cases, the average life was also about three years. For those terminated by mutual agreement, the mean was about 2.7 years. None of the respondents indicated that their ally had terminated the alliance unilaterally. The overall alliance success rate exhibited by these respondents was 71%, appreciably higher than the 46% average for the sample as a whole. This might mean that they maintained a closer control over their alliances than the average and took steps to end them as soon as they ceased to be functional.

    Table 14 shows the reasons given by respondents for the ending of the primary alliance. Strategic reasons predominated, notably product life cycle matured, divergence of business interests, objectives were not satisfied, and more profitable strategy available. There seemed, in general, to be no particular relationship between the reason and who terminated the alliance. The one exception was "Objectives not satisfied," which was checked only by the three respondents who had indicated that the alliance had been terminated by them rather than by mutual agreement.

    CONCLUSIONS

    The preliminary conclusions to be drawn from the survey data on bootstrapping and business alliances are that the software entrepreneurs who responded to the survey actively used a variety of techniques to further the growth of their business and product. Relationships with customers and suppliers (the extended value chain) were of considerable importance in product development. Personal resources, personal credit and personal sacrifice were substantial elements in business development bootstrapping.

    Respondents regarded about half of the business alliances entered into as successful. Most had been formed in the preceding five years, and had lasted, to date, for between two and five years. Respondents cited market and competitive reasons most often as the main motivation for an alliance, along with "inadequate resources to go it alone." This last was also given as a reason by the primary business ally, along with lack of expertise and market and competitive reasons.

    There is doubt that active search and industry networks and contacts were the most effective methods of finding a business ally, far outstripping the next most common method, "they called us." Other methods suggested in the survey instrument were relatively insignificant. Respondents had no success whatever in using attorneys, accountants and bankers to locate business allies.

    Nor is there any doubt that business alliances were important to the survey respondents. A majority of those answering the relevant question reported that the primary business alliance accounted for over 30% of their revenues. Over 25% reported that the alliance accounted for over 505 of their revenues. This importance is confirmed by the fact that 67% of respondents found the primary business alliance a very important or important factor in the initial success of their venture.


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