Today were going to explore the various pros and cons of “bootstrapping”, and in doing so, I’ll explain why I chose the bootstrap path for my current projects.
Let’s do this.
What is bootstrapping.
Bootstrapping is, quite simply, starting a business without outside funding, and minimal self-investment.
With bootstrapping, you grow your business by reinvesting profits from the business, which usually demands an early focus on revenue, profitability, and lean operations.
Bootstrapping is usually considered in contrast with the “venture-backed” startup path, which is characterized by investment rounds (Angel, VC, etc…), hyper-growth, big valuations, and big exits (aquisitions, IPO, etc…).
Both paths have their advantages and disadvantages. Let’s explore the pros and cons for each, and then I’ll explain why, for our current projects (and, I’d argue, for most first-time entrepreneurs), bootstrapping is the obvious choice.
Part 1: Options
Does $1 million excite you?
That was a question we were faced with early on, and it’s the first great filter for whether or not the venture backed path is right for you. You see, for most people, first-time founders included, $1 million is a life-changing amount of money.
Here’s what I mean:
In a bootstrap business, as we explored in an earlier post, a million-dollar outcome is actually very attainable.
And in a bootstrap business, the founders are able to shoot for that million-dollar outcome, work towards it, and reap the benefits when it is attained.
In a venture backed business, the million-dollar outcome is taken off the table, because when you take outside funding, the Angels or VCs that back you demand multimillion dollar returns, usually tens or hundreds of millions of dollars returned.
So when you take outside funding, the people who have invested in you will not let you settle for single-digit million outcomes:
Say you get a buyout offer for $5 Million that will give you personally $2 Million. As great as that might be for you, most outside investors would exercise their power to veto such a deal, forcing you to keep all the chips on the table and keep playing your hands in pursuit of an even bigger payout.
To be sure, I’m not saying that there’s anything wrong with this level of ambition, just that you should be clear going into your business, whether or not your financial interest would be aligned with such ambitions.
For us, for our first businesses, such humble single-digit million dollar outcomes would be a success that we’d be happy to reap, so our financial interests wouldn’t be aligned with those of most outside investors.
Part 2: Financial Discipline
Another advantage that bootstrapping offers is that of financial discipline.
Again, when you bootstrap, you have to have a very strong focus on your own revenue, profitability, and lean operations (keeping a close eye on your spending).
Because you can only spend what you earn, bootstrapping demands a level of discipline, efficiency, and frugality that can easily be lost if you take on outside funding.
When you raise capital, often times you actually have to show that you’re spending the money to keep your investors happy.
Investors want to see that you are putting their money to work, not just having it sit in a bank account.
So, unless you have a really clear area to invest the money for growth (something we’ll discuss later), for a lot of early stage companies, raising outside money early on can actually instill a level of financial carelessness that will be baked into the companies DNA from an early age.
Part 3: Focus
Fundraising itself can be a full-time job. By that, I mean it can be a massive distraction from the other important things in any start up, namely building and selling.
A lot of first-time founders get so caught up in the act and glamor of fundraising, that they forget that fundraising itself is just a means to facilitate the real business: building something that people want, and marketing it.
And then, after you raised your round, the money in the bank can be another distraction.
Once you’ve raised, again, you usually increase your spending. As your monthly spending, also known as your monthly “burn rate”, increases, you put your business in a ticking time-bomb situation.
Imagine you raise a seed round of $500,000.
You hire a few people, and with all salaries and expenses totaled, your monthly burn rate comes out to around $50,000. You now have 10 months (called your “runway”), before you burn through your entire bank account.
Inside that 10 months, you either have to raise another round of capital (extending your runway), or become profitable to the point where your business can sustain itself at the increased burn rate (the airplane lifting off).
That limited runway scenario can be stressful and a massive distraction for first time founders who could otherwise just have focused on building and selling with a tight, lean, team, and becoming profitable without the pressure of outside capital.
Part 4: Control
When you raise outside capital, you’re normally selling equity in your business in exchange for cash.
Equity is ownership, and that means that when you sell equity, you actually selling control of your company.
This is why, if you watch Shark Tank or The Profit, equity is such a hotly valued commodity.
It signifies not only a payout percentage should the business sell, but also the percentage of control that you have when it comes to making important decisions about the business.
If you’ve ever wondered why you hear some stories about founders getting fired from their own businesses by their board or investors, it’s because they’ve sold control of their business to outside investors in exchange for their cash.
Again, there are times when it makes a lot of sense to raise outside capital, but usually for first-time founders building products or businesses that haven’t been proven in the market yet, outside capital comes at great expense – meaning more equity and more control given to the outside investors in exchange for their cash.
It’s easy to imagine that this also introduces a lot of complexity.
When it’s just a small team of founders in control of the company, decisions can be made really quickly and easily.
You can choose to make key expenditures, or key hires, or key strategic moves without assembling a board and managing a voting process or anything.
That makes it easier to move quickly and adapt to market learnings swiftly: two of the key advantages small startups enjoy in the first place.
The Downsides to Bootstrapping
Bootstrapping is not without its disadvantages to raising outside capital.
Indeed, as mentioned before, some businesses and markets lend themselves more ideally to venture capital.
The first advantage of raising capital is, quite obviously, the potential for faster growth when you raise outside funding.
With outside capital, you have more resources. you can spend more on hiring, advertising, product development, and other areas that can affect your growth directly.
These additional resources can make it possible to grow businesses faster, as long as you invest the money wisely.
(It’s for this reason that fundraising makes a ton of sense in the right circumstances. More on that later.)
In the business world, investors tend to be highly networked and connected people.
They often have connections and relationships with a lot of key people who can help your business on its path to success.
Angel investor Ron Conway used the analogy of a software startup being like a car speeding navigating its way through a city, and that as an investor, he can sometimes help make the connections that help make sure as many of the traffic lights as possible turn green before the speeding car reaches them.
Whether it’s key partnerships, access to potential customers, distributors, suppliers, or even eventual acquirers, investors usually come to the table with more to offer than just cash.
And when they have a stake in the success of your company, you can usually count on investors to do what they can to help you succeed.
Business models that depend on scale
Finally, it’s worth noting that there are some business models that depend on scale, meaning that the bigger they get, the better they get.
For example, marketplace businesses, businesses with strong network effects like social networking apps, and hardware businesses – these all become more useful or more efficient the bigger they get.
Marketplaces, like AirBnB or Uber for example, become more valuable when more people are posting homes or offering rides, and when more people are searching for home-stays or requesting rides.
Social networking tools also become more valuable to users when more people are on them. Instagram, Snapchat, and Facebook are all more useful when you have hundreds of friends using them instead of a dozen or so.
Because such businesses depend on scale, they need to invest in growth in order to be valuable for their users, and also to defend against competition.
With marketplaces and social networking tools, big user bases are the best way to defend against competition, because once you’re cemented in place with a critical mass of users, it can be very hard for a competitor to displace you (see Uber vs Lyft).
Alternative to marketplaces and social apps, hardware and other physical-product businesses all benefit from “economies of scale”, which basically means that the more product they can order, the cheaper they can get it for, so they can see more profit per sale.
They also have higher startup costs – it’s much more expensive to develop a hardware product like a watch or a smartphone dock than it is to develop software – so raising capital up front in the hardware business is usually a much more necessary gateway to cross.
In these scenarios, bootstrapping is less ideal, and raising outside capital becomes the reasonable (or in some cases, necessary) option.
Are we against raising money?
I get this question a lot when I talk about raising venture capital vs. bootstrapping, and the answer is no, I’m not against raising money.
First, as we discussed in last section, there are situations in times when raising money is necessary.
But for us, funding just wasn’t necessary to get our B2B SaaS products off the ground.
That said, there can absolutely come a time when it makes perfect sense for us to raise money with our businesses: once we proven product market fit, and know that we built something that the market actually wants.
Additionally, once we got a growth channel dialed in, one with a clear ROI, then investing everything we can get our hands on makes a lot of sense.
For example, if we do some experiments and find that with a particular advertising channel we can earn $2 for every $1 we invest in ads, it makes sense for us to get as much capital as we can to invest in the channel.
In these situations – product market fit dialed in, and a clear ROI proven on a particular growth channel – it will make sense for us to raise money.
Here’s the kicker: because our business is already profitable, we’re making more money then we’re spending every month, meaning we have an infinite runway. No ticking time-bomb.
When we have an infinite runway, clear product market fit, and a clear ROI on a growth channel defined, we have way more leverage when it comes to raising money.
This means that, when we go to raise under these circumstances, we’re a much safer and more attractive investment, and will be way more valuable, so we’ll have to give up less control and less equity: we can raise at much more favorable terms then if we raised money when we were still a speculative investment.
It’s cheaper, with less risk and more control, to wait to raise money until after you’ve proven product-market fit and are sustainably profitable as a business.
That’s bootstrapping. It’s not the end all, be all. It’s not the only path. It’s just one of several options available to you as a founder.
But for its merits, bootstrapping was an obvious choice for us, and the one that I normally encourage first-time entrepreneurs to consider first.
So think about. Think about everything. Thing about life, and the trees, and the animals. Think about the children. And, think about checking back in later this week for my next post that I have to make, lest I need to donate to Donald Trump’s 2016 presidential fund 🙂