I have long been a proponent of venture bootstrapping. I still am. Some of its benefits include control, caution, customer focus, responsibility and freedom. The irony is that for each one of those benefits there are downsides. Bootstrapping comes with a set of disadvantages that must be seriously considered especially if such business funding route is planned and taken by choice despite funding availability.
Key assets that constitute the foundation of any business require capital. One of such assets that I find many startup founders compromise is team. Hiring bad talent is every entrepreneur’s closest door to entering the startup historic failure rate. Lack of capital not only includes the initial investment to get the business up and running, that is, build a useful solution that can generate enough revenue for reinvestment, but also in miscalculating operating expenses for 12-18 months ahead.
Product And Organic Development
Not all business ventures can be bootstrapped. Labs, manufacturing equipment, key hires and other resources may be imperative to the initiation of a business venture. Finding an alternative to these resources may be another door to the startup historic failure rate let alone if the product is in a market with high barriers to entry and highly competitive. Additionally, take the example of Quora or WhatsApp. These two companies combined raised hundreds of millions of dollars before generating the first dollar. Their business model mandates high volume of content and users before any revenue model can be applied.
Even though a team with the needed skills and sufficient initial capital can successfully bootstrap their way up, some models are better off in the long run if larger amounts of capital is available since the beginning.
Startup X is backed by VC or Angel Y. There’s a lot more meaning to the word backing than just the dollar amount invested. Especially in a B2B setting, most clients will value trust, safety and commitment a lot more than product pricing and unless startups have proof of concept and years in business, nothing is more assuring than being backed by a venture capital firm or an angel investor with connection and expertise in the chosen industry. I remember meeting with a senior VP at one of the local chambers of commerce thinking that my main job is to prove the value my product and how pricing is built on performance. For 30 minutes, the only discussion we had is how the product will be available and grow for many years ahead. Self-funding in some cases can highlight startups’ lack of resources which can be a deal breaker for some clients. Startups backed by well-respected investors simply have a less non-linear path to success.
Business Potential And Valuation
Only 0.91 and 0.05 percent of startups are funded by angel and venture capital investors, respectively, according to data compiled by Fundable. Funding thus signals uniqueness, potential and entrepreneurs’ real intentions in building a successful business given the effort it takes to obtain funding. This logic has been studied and is proven through academic research as well (Elitzur and Gavious, 2003). Furthermore, funding, especially by reputable and respectable Angel and VC firms, puts a number on the worth of the startup which can make further raising and potential acquisitions relatively easier, more transparent, and at the highest possible valuation given investors’ main objective of exiting at the highest multiple. Bootstrapped startups forgo these benefits.
Leaving Money On The Table
Its’ simple. There’s two ways to building a growth startup; growing slow and organically by reinvesting gains and expanding the initial targeted tribe one step at a time or growing fast through investments by serving larger groups of buyers within multiple tribes (customer segments). Under the earlier, you may invest $50,000 to acquire 200 users and generate $80,000 in revenue, and from the latter, your investment can be 10 times higher and as a result the return is also a lot higher (say $800,000). The question becomes, do I want to build a $200,000 company owning 100% or a million dollar company owning 80%? From a return stand point, for instance in our example, do I want to generate $30,000 owing 100% or $300,000 owning 80%? The latter is a more attractive offer both from a valuation and revenue stand points. This is of course conditioned on the viability of the solution and keeping other variables such has operating expenses and taxes constant. Bootstrapped startups can leave money on the table.
Continued bootstrapping can inhibit growth. There is an obvious limit to what reinvestments of gains can contribute to startups’ growth. Unless the introduced product, concept or model revolutionizes an industry or market, and unless the team is not seeking exponential growth in the first place, startups are pressured to generate enough revenue to sustain or speed growth. Exponential growth is certainly not for every company. Jason Fried, founder and CEO of Basecamp, is a fan of slow and consistent growth. He argues that it is the healthiest way to grow. Ryan Smith, CEO and co-founder of Qualtrics, is also an advocate of slow and sustainable growth. Growth must be in the agenda when choosing which startup development route to take.
The advantage of being small, nimble and customer centric can later turn into a disadvantage when it comes to fighting for key contracts, deals, partnerships and trust. There are many ways bootstrapped startups can compete with funded rivals, nonetheless, it is mostly an unfair battle and one of the most important points every startup must consider before entering the space. Better, faster, cheaper products are not viable for all industries. Startups’ competitive advantage is of utmost importance.
The Right Way To Bootstrapping
Nowadays, tell an investor I’m seeking X amount to turn an idea with a lot of potential into reality and the door will be slammed. The right proven way to bootstrapping is not one that aims for infinite self-funding but rather for the right time to get funded. Lessons from companies such as Apple, Microsoft, Disney, Qualtrics, Basecamp and others highlight the importance of the product as the initial and ultimate focus of founders. These founders found their own ways to build simple versions of their products to validate the need for their solutions, reinvest their gains, build a brand and then receive funding to build billion dollar companies. The right way to bootstrapping is thus one that aims to get startups to the funding inflection point.
For some bootstrapping is an option, for others it’s the only option. Whether it is an option or a must, it’s not always the best startup development financing strategy.
First, growth undercapitalization can be tolerated whereas compromising needed resources for core product development upon validation cannot.
Second, in bootstrapping a startup, founders rely heavily on customers’ money for sustainability and growth. Because some business models cannot be monetized quickly, founders are likely run out of cash and lose enthusiasm eventually. Bootstrapping is disadvantageous in this case.
Third, startups backed by well-respected investors are generally more recognized and trusted. Bootstrapped startups, at least initially, lose the credibility gained from investors’ association.
Fourth, funding signals startups’ potential and entrepreneurs’ intentions in building successful businesses. Furthermore, funding, especially by respected backers, builds value, increases chances of acquisitions given investors’ network and connections, and makes future funding relatively easier. Bootstrapped startups forgo these benefits.
Fifth, bootstrapped startups can leave money on the table by restricting business potential to the available reinvestment amount.
Sixth, bootstrapped startups can rarely achieve exponential growth by reinvesting retained earnings. Fast growth is certainly not always the best option, nonetheless, funding can speed up growth.
Seventh, in a competitive space, bootstrapped startups can end up fighting for sustainability and survival. Most of the time, funded rivals have an unfair advantage.
Finally, lessons learned from billion dollar companies suggest that the right way to bootstrapping is not one that goes forever, instead it is about building enough value before funding can take the company to another level.
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