Starting a Business in a Down Economy

Starting Up in a Down Economy
Nobody loves a recession*. But many successful entrepreneurs say that, in retrospect, they were lucky to have launched their businesses in tough times.
By: Ryan McCarthy, Nadine Heintz, Bo Burlingham
Published May 2008

Case Study No. 1: How Method Weathered the Dot-com Bust
* A recession is commonly defined as two consecutive quarters during which the country's gross domestic product shrinks. It is too soon to say whether the economy is in a recession now.
When they look back on the early days of their start-up, Adam Lowry and Eric Ryan remember that a lot of potential investors laughed at them. The Bay Area, where they were living, was awash in Internet start-ups. Each week in 2000 brought another glitzy launch party or news that the scantest of business plans had attracted venture capital. Even office landlords were demanding equity from their dot-com tenants. Lowry and Ryan, who wanted to start a company to make -- of all things -- humdrum household products, were decidedly out of step with the times. "You had the sense that there was this real historical thing going on in the region, even if it was not going to end well," says Ryan.

Still, Ryan and Lowry felt they had a good idea. Method, their start-up, wouldn't sell just any household products. Its soap and cleaning supplies would be made from environmentally friendly ingredients and would come in chic packaging. Compared with the products of giants like Procter & Gamble (NYSE:PG) and Clorox (NYSE:CLX), Method's merchandise would be hip. So the partners passed on interesting and potentially lucrative job offers and pooled $100,000 in personal savings to get started.

You know what happened next: The go-go New Economy abruptly ran out of steam. Dot-coms ran out of money, layoffs were rampant, and the entire city of San Francisco seemed to suffer from an economic hangover. People started to worry openly about a recession.
Like most business owners facing hard times, Lowry and Ryan focused on their costs. They were expert bootstrappers, mixing cleaning solution in a bathtub, bottling it themselves, and driving around town to restock shelves. They would accost any store manager who would listen to their spiel. They returned to some stores three and four times before they got an order, and little by little their sales pitch improved. And the partners noticed something else: Compared with the situation a year before, when there seemed to be five start-ups for every idea for a business, the competition was relatively muted. "Starting a business in a recession is like vacationing in the off-season," says Ryan. "It's a little less crowded, and everything starts going on sale."
By spring of 2001, Lowry and Ryan had gotten small-batch production on track and had hired a CEO named Alastair Dorward. But Method's debt stood at $300,000, split among the three men's personal credit cards. Payments to their vendors were three or four months past due, and at one point Lowry and Ryan had just $16 left in the bank. "We had to appeal to the inner entrepreneur of each of our vendors," says Lowry. "We had to sell them on the fact that Eric and I could do something that had never been done before."

Lowry and Ryan also tried again to raise money, and with VCs falling out of love with dot-coms, they found that there was more interest in their idea. In early September 2001, the partners received a term sheet for $1 million -- a sum that would allow Method to get current on its bills and then begin to expand. They were set to close the round on September 11. Needless to say, the deal didn't go through right away; the partners finally closed in November. And there were some serious strings attached. Lowry and Ryan would receive $550,000 up front. Of that money, the legal fees associated with the transaction would eat up $110,000, and $300,000 would go to pay outstanding vendors' bills. That left Method with $140,000 in capital. To get their hands on the remaining $450,000, Lowry and Ryan were obliged to meet a key milestone: They would have to add distribution to 800 stores by March, which was just five months away.
The tenuous nature of Method's financial situation was underscored at the dinner Lowry, Ryan, and Dorward hosted to celebrate the deal. The partners gathered their investors plus their lawyers and accountants at an expensive restaurant in San Francisco. When the bill came, Lowry's credit card was declined. Then Ryan's card was declined. And Dorward's. Their backup cards were declined, too. "It's a good thing Eric knew the owner of the restaurant," says Lowry. "We convinced him we were good for it -- that that guy over there was about to give us a million bucks."

Method did make it into 800 stores by March -- though just barely. When Lowry and Ryan got the remainder of their Series A funding, they paid off old accounts and then jumped right back into fundraising mode. With the recession in full swing, venture capitalists were being very picky when it came to making new investments. But Method, which had been ignored barely 18 months earlier, was suddenly a Bay Area darling. "It was really interesting," says Lowry. "We used to be completely off investors' radar screen, but when the bubble burst, people were clamoring for us. Our business plan wasn't some sort of ad-based or online thing that was hard to understand. Our model was, 'Hey, we're going to make this cool product, and if you think we can sell a lot of it, then it's a good investment."

Being able to raise money in 2001 undoubtedly put Method on the growth path. By 2006, the company had $71 million in sales, and today the founders are pushing to reach $100 million. But Lowry and Ryan look at the period before they raised money, when they struggled and nearly drowned, as pivotal. In retrospect, the fact that they had to hone their pitch in countless meetings with store managers and vendors was fortuitous. They were practiced enough that by the time their big break came -- pitching Target for national distribution -- they didn't blow it. Which raises the question: Did the recession actually make Method better? The founders think so. As Ryan puts it, "The hungriest wolves hunt best."