In 1999, Dan Hobin was living the dot-com dream. He was barely 30 years old and his digital-publishing startup, SmashCast, had just raised $7 million in venture capital.
Like so many other new enterprises in those bubbly days, SmashCast used a lot of the investment to lease prime office space in downtown San Francisco, throw lavish parties, and fill its cubicles with new employees.
Two and half years later, the party was over. Hobin had to shut down his company after he ran out of cash. It was a very expensive lesson.
“We raised the money before we even had a business plan,” he says. “It was like taking a little kid and pumping him full of steroids. It’s too much too soon for a company that hasn’t figured out where it’s going.”
When Hobin launched his next company in 2005, he took a different approach. He didn’t solicit outside capital. Instead, he wanted his new startup, G5 Search Marketing, to be completely bootstrapped.
So far, Hobin has stuck to his plan. G5 Search Marketing has $10 million in annual revenue and 56 employees. Better still, it’s almost entirely debt-free.
The Bend, Oregon, company offers search engine optimization and search engine marketing programs for small and mid-size businesses like self-storage spaces, senior living facilities, and apartment communities. It has about 160 customers representing 2,000 properties across the country.
The first thing Hobin did before launching G5 was to move out of San Francisco. He and his wife were looking for a slower pace. He also appreciated the fact that in Bend he can hire talented tech workers for about half of what they make in the Bay Area.
On the accounting side, he got into the habit of invoicing customers upfront, at the beginning of each month. A typical G5 customer pays about $500 a month to drive Web traffic to one of its properties or locations. G5 can justify the upfront payments because it uses part of that money to purchase advertisements on major search engines like Google and Yahoo! on behalf of clients.
Linda Keith, a certified public accountant and business credit specialists, applauds G5 for not being afraid to ask customers for payment in advance. “If you can articulate the value of charging upfront, most customers will be happy to oblige,” she says. “There are plenty of industries where this is standard operating procedure.”
At first, Hobin used a personal credit card to cover the lag time between when he had to pay Google and other search engines and when a customer paid him. He was regularly running a credit card balance upward of $50,000.
But after about a year in business, Google and the other search engines recognized that he was a steady and reliable customer. As a result, he was able to renegotiate credit terms with them and extend his payment horizon. Today, Hobin has a 75-day window from the time he invoices his clients at the beginning of the month to when the search companies require payment.
All told, the float adds up to a couple hundred thousand dollars a month in client payments to G5 that the company doesn’t have to forward on to Google for another month or two.
“This approach makes total sense,” Linda Keith says. “The only real danger I see is being disciplined enough to set that money aside and having it at the ready when it’s time to pay the ad expense. As a business owner, you always need a clear picture of your spendable cash balance versus how much needs to be set aside for upcoming expenses.”
Now that G5 has a strong footing, Hobin is gradually loosening credit terms with some of his best customers. Instead of billing at the beginning of the month, he’s extending payment terms up to 60 days.
“Some of our regular clients may have one or two properties that are having cash flow issues, so we might extend credit on those properties for a few months, just to let them catch up,” he says. “But we only do this on a limited basis.”
Hobin admits he doesn’t check credit reports on clients as frequently as he should. “It’s mostly because we’ve done business with them for a while, so we have a pretty good feeling they’re creditworthy.”
So far, he’s been able to collect from every customer. But experts like Keith recommend using a service like Dun & Bradstreet to monitor the financial health of customers and predict their payment habits, especially if you’re going to extend credit.
“Credit checks are critical,” she says. “But I can also understand the need to selectively offer better payment terms during a recession. When the economy improves, customers will remember vendors who took care of them and this will be a huge differentiating factor.”
For G5, running a profitable business also means being disciplined about how and when it spends money. “My partner and I have had many heated debates about whether we could afford to go to this trade show or that,” says Hobin. “But we both agreed from the beginning that we wanted to avoid debt and run this company from a position of cash flow positive.”
Hobin and his cofounder even devised a formula for hiring new staffers based on how many new customers the company signs and how much revenue it’s earning.
Keith is impressed that the business is able to distinguish between wants and needs. “Too many businesses hire new employees or go to trade shows without first stepping back and analyzing the financial benefit to the company,” she says.
After years of growing the business organically, Hobin is ready to take G5 to the next level and expand into new markets. That will require a substantial amount of working capital but, based on its track record and triple-digit annual revenue growth, the company could probably secure a million-dollar loan.
Hobin has other ideas. He’s now actively looking for venture capital. “We have a healthier business because we bootstrapped, which makes us more attractive to investors,” he says. “And this time we know exactly what to do with the money.”