My Favorite Bootstrapping Hack: Negative Working Capital

Some Housekeeping:

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At Gateway X, we launch "Bootstrapped Giants," but we "cheat" a little. I invest less than $250K in each business and it has to get cash flow positive within its first year or we'll kill it.

Notice how I didn't say profitable. I said “cash flow positive.” While for most of our businesses that means the same thing, it isn't always the case. That's especially true for our ecommerce brand Unbloat.

Brief backstory: after 10 years at Ampush helping others scale up D2C brands, I HAD to launch my own. I wanted to sell products with high margins and recurring revenue. To solve real problems in marketable niches. Long story short, we found people search "bloating" as often as "erectile dysfunction" and realized there was an underserved market.

We brought on a CEO, hired a Shopify dev, a writer, and a couple GrowthAssistants to get the business going. Unbloat has yet to be profitable, but within 6 months it was cash flow positive. How is this possible?

The Answer: Negative Working Capital

Now, I didn't invent this, it’s somewhat simple on the surface… Amazon famously used it to IPO with < $14M of venture funding! Here’s how they did it:

A customer goes to Amazon and buys a product.

Amazon takes the cash immediately and ships the product out. They pay their supplier 60 days after the product sells.

SO let’s say they do $100k in sales on $60k worth of product in month one. They collect $100k immediately and pay their supplier nothing (that’s $100k in cash flow).

Then two months later, they pay the $60k they owed 2 months ago to their supplier. But at this point they’ve grown and do $200k in sales on $120k worth of product.

Remember, they pay that $120k two months later, so they have $200k in cash that they can use to pay the $60k bill from two months ago. They have $140k in cash flow.

As they grow, they GENERATE more cash. It is absolutely incredible.

So how does negative cash conversion work for Unbloat?

Mostly the same.

Let’s say in January ‘22, Unbloat did $100k in sales. Inventory costs $30k. Media spend costs $50k. And other overhead is $30k. That's $110k in costs or a $10k loss.

But media spend is mostly Facebook and we have that on net 30 financing (or on a credit card with flexible terms.)

Inventory is also on net 30. 1/3 of our overhead is vendors who we can pay net 30. The rest we cannot finance.

But it gets better:

We work with a financing partner (in our case, we love Settle). They pay the bill for us after 30 days and then we have 60 days to pay them.

So this is what it looks like:

In January we did $100k in sales, paid out $20k in overhead and so generated $80k in cash.

By April, January's bills are due. We had $152k in revenue (cash in) and had to pay January’s bills of $30k + $50k + $10k = $90k. We had around $31k in overhead expenses, so we ended the month generating about $31k in cash.

AS LONG AS WE KEEP GROWING, WE WILL CONTINUE TO GENERATE CASH FLOW AND GROW OUR BALANCE SHEET.

Now for the accountants in the audience, of course the balance sheet must stay balanced… so yes, we ARE also accruing debt to our vendors/financing partner. So this is what the balance sheet starts to look like:

Ok ok, I hear everyone: "Jesse this is a neat trick but it sounds risky and dangerous…"

This is a bit like playing with fire. It can be very helpful to keep you warm but if you let it get out of hand it can burn you badly or even kill you.

If you look closely at the balance sheet above, you can see that even though we’re consistently increasing our cash reserves, our shareholder equity is getting more and more negative. That’s scary if you don’t have a plan to get net profitable.

So here are a few important considerations to keep in mind when using this strategy:

1. Make sure not to do a PG (Personal Guarantee) - I don't care how sure you are you have the next Dollar Shave Club. Don't guarantee debt personally at large scales.

2. REALLY understand cash flow and your balance sheet. Said differently, have detailed forecasts on a weekly basis. Understand cash obligations as you borrow to ensure you don't squeeze yourself. Model out "worst case" scenarios and see how resilient things are. If you’re interested in a course where I walk you through cash flow and other MUST KNOW financial concepts for entrepreneurs, fill out the survey here.

3. Have a GREAT relationship with your lender. Send them projections, and beat those. Make sure you keep them updated and are super transparent. Send them customers. Make sure you know any limitations they may have.

4. MOST importantly, GET YOUR BIZ PROFITABLE. This extends your window but accruing cash and debt is not the way to grow a business. It’s still important in ecommerce to strive for first order profitability and limit overhead to generate real profits. Then you can start paying off your debts.

I’m going to say it again because it is so important to emphasize: this trick is like playing with fire.

It shouldn’t be used to fund your operating losses or expenses, but rather your working capital (ie COGS, media spend, etc). If you know you owe money 90 days from now for expenses that you incur today, you better know you have enough cash to pay it back in 90 days: whether that’s through revenue growth or payback via additional sales to existing customers.

Here’s an illustrative example:

Say your company has a $70 AOV, $65 CAC, $15 cost of goods, and $10 in overhead expenses per order. You’re losing $20 on every order.

But let’s say you know that 50% of customers order for a second time 60 days from now. That means in 60 days, your average revenue per customer = $105, and your average cost per customer = $97.50. You generated $105 revenue - $97.50 cost = $7.50 in profit per order after 60 days. This is the perfect use case for working with a financing partner.

However, if your CAC was $75, you’re screwed. This means that (on average) you borrowed $107.50 to generate $105 in revenue - you lost $2.50 on EVERY customer. If your revenue isn’t growing, you won’t have the cash to pay back your financing partner 90 days from now. So please listen to me when I say this: BE CAUTIOUS with this strategy. And don’t borrow money to fund operating expenses like headcount. It can be a dangerous game.

As long as you're at least break even during your financing period (including overhead costs), you should be good.

But again, it’s worth noting that first order profitability should be the goal for any ecommerce business. It’s hard to count on future orders to make the math work - especially when you’re just starting out.

Well, that's my quick playbook. Bootstrapping isn't always pretty but it can work.

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Jesse