Introduction
You’ve built a product, and now it’s time to fund the thing. Most entrepreneurs don’t think about the difference between bootstrapping and fundraising before they launch, but one of the very first major decisions you’ll make as an entrepreneur is how to fund your startup. This choice will determine the ownership percentage of founders, the growth pace and vision of the company. What’s the “right” answer here? There isn’t one. Startup funding options can vary widely depending on the startup’s model, market, and circumstances.
Some founders choose to bootstrap for 7 years or more, and some founders jump into the arms of investors pre-product / pre-revenue. And for most founders, there is a middle ground after which they make certain strategic decisions about how to grow their company. By understanding the advantages and disadvantages to each approach, founders can make the best decisions for their startup.
What Is Bootstrapping in Startups?
Bootstrapping in start-ups, is financing a start-up from the founder(s) own savings or early profit of the start-up under construction. This means there are no dividends to pay to external investors. The start-up is being Startup’d from the founder(s) own pocket.
One thing that all bootstrapped companies have in common is FULL OWNERSHIP. Yes, 100% ownership. No investors diluting ownership, pressure for an early exit, pressure for growth, interference with your strategy, a seat on the board, or monthly financial reports. You build your business the way you want, at the pace you want, with the focus you want.
While many startups build revenue before securing seed funding (the new normal!), there are also a healthy number of Bootstrap startups in the list. The 222 companies make up a diverse set of successful, scalable businesses – many that have reached multi-million dollar annual revenues, while others are growing e-commerce businesses, professional services, B2B software, and everything in between. The vast majority of the Bootstrap companies come from industries and contexts where the cost to go from 0 to the first customers is minimal, but once validated product/market fit, they’ve scaled up quickly to become large, successful businesses. The important insight for these Bootstrap companies is that it didn’t take $10 million in sales to validate core assumptions of their businesses.
What Is Fundraising?
Fundraising is the process for a company to collect investment dollars from an investor for shares of the company. The capital a company raises at a given time can come from various sources depending on the stage and/or type of company. Startups can look to raise money from angel investors (individual investors looking to invest in early stage companies for both financial return as well as mentoring and knowledge transfer) and venture capital firms (vc’s) which invest institutional funds on behalf of their partners/limited partners. There are also micro-VCs who focus on seed stage investments and strategic investors who are larger corporations looking to invest for both commercial and financial return.
Fundraising involves dilution. There’s the obvious dilution of equity as cash comes in to support growth. But there’s also the subtle (or not-so-subtle) dilution of ownership as you take on investors at various stages along the way. A pre-seed investor might have a similar founders % as other early investors, while seed investors fight for a decreasing % as time goes on. By the time you reach a Series A, investors are happily taking ~30% for $20m (which ramps up in later As). When do you “take the hit” of dilution of ownership for the benefits of fundraising? Done correctly, fundraising can be a powerful growth accelerant, provide a strong network, transfer operational expertise to your team, and cast a positive light on your company.
Startups have increasingly turned to outside fundraising to bring in checks from VCs, but that’s not the only way to line your coffers these days. Some big investment dollars have poured into crowdfunding, revenue-based models for startup investing and alternate forms of start-up capital based off of Islamic Finance models (such as mudarabah based investments). How does all of this change the game for founders?
Advantages of Bootstrapping a Startup
Complete Ownership
We don't involve any equity investors in the business which means you do not dilute any ownership of the company, and 100% of the value created is yours at exit (IPO or sale). This makes a great alternative to bringing Venture Capital in for early growth funding, that usually will dilute your share of the company's value through multiple rounds of funding, only to end up with a load of largely illiquable diluted equity at exit. A great option for founders seeking long term returns and exit for maximum value.
No Investor Pressure
Investors on the cap table often have a negative impact on founders’ ability to make decisions in the best interests of their business. Removing investors on the cap table removes the pressure to make decisions to suit the return profile of a fund. No stressful quarterly board meetings, no harrowing updates on progress towards some mythical user growth velocity ‘tipping point’, and no pressure to take dilutive capital to hit arbitrary growth targets. Instead you can think and act for the long-term and make big bets on alternative strategies and directions that could be valuable to your business, even if they’re not in the short-term interests of a VC firm.
Sustainable Growth
One of the advantages of a bootstrapped startup is that since you have no external capital, you have a healthy financial discipline. Since there is no external capital, revenue becomes the lifeblood of the company and every dollar you make is much more valuable. As a result, you become a capital efficient company and with time, you can be a lot more profitable even though your growth may be slow in the initial years.
Disadvantages of Bootstrapping
Bootstrapping has real limits which are gradually eroded over time as the market presses for increased velocity/scale that self-funding cannot deliver.
Growth tends to slow down on smaller annual revenues, when there is no injection of capital, hiring is delayed, product and service innovation is driven by revenue and marketing budgets are low.
In fast growing markets with a small window of opportunity to become the leader, slow growth is not a minor hindrance, but a strategic risk.
Cash flow is a persistent and insidious problem for most startups. Bootstrapped founders in particular operate their business in a tight circle of cash timing: receiving money on time from customers, negotiating the best possible terms with suppliers, and making any number of spending decisions with the company’s cash balance top of mind. Cash flow should be a marginal consideration for such companies, one that is secondary to strategy and competitive advantage.
Scaling is hard with real money but even harder without external capital. Expanding to new geographies, building a sales team, or buying hardware and software before revenue comes in all requires capital which a bootstrapped business does not have. Now, with funding, your competitors can move faster, spend more on customer acquisition, and outspend you on product.
This is so important that I have to repeat it. Given the challenges in the market today, and some of the challenges that startups have in general, bootstrapping vs funding is not a decision that a founder can afford to get wrong. The margin for error is small, and losing a few months or years may be too costly to recover from.
Advantages of Fundraising
Speed is a major advantage of external investment, as it allows you to hire and build faster than revenue can support. In competitive industries, an early strong position is essential, and it creates significant barriers to entry through network effects, brand effects, and switching costs.
It is also worth remembering that fundraising can bring a whole range of other resources to your business beyond the actual check itself. Experienced investors bring follow-on investment, customers, networks of other potential customers, and operational/technical advisors that it is hard to find through bootstrapping alone. A great angel or VC firm with a relevant portfolio can bring connections and credibility that can open doors in months that would take years by themselves.
There is also a credibility effect. It’s useful to have the backing of a well-known investor or venture capital fund as it shows customers, prospective employees and partners that other people who have done venture capital professionally have looked at the business and decided to back it. In fast moving markets where it is hard to establish credibility quickly, this can have considerable value.
Disadvantages of Fundraising
One of the main costs of fundraising is equity dilution. Every investment round results in a decrease of founders’ equity percentages which compound over multiple rounds. Founders who have managed to secure four or five rounds of investment, often struggle to believe that they are minority shareholders of the businesses they founded and successfully grew. The love of having money and growing their businesses blind them to this early cost of building a successful startup.
The change in dynamics of running the company comes from the investor perspective. This changes the way you experience Board meetings, the reporting you need to do to them, and the time horizon in which you expect to get a return for the investors within the life cycle of the fund. Some founders enjoy this, others are constrained by it and how it affects their decision making and culture at the company.
In addition to the potential downsides of fundraising, the process itself can be incredibly time consuming for founders. Typically three to six months from the first meetings with potential investors to a closed round, this time could be better spent on building, integrating feedback from customers and developing the team. As a founder, your time is a company’s most precious asset, particularly at the early stages of a startup.
Also read:
- How to Create a Winning Pitch Deck for Investors
- Top 5 Startup Fundraising Mistakes & How to Avoid Them
How Musaffa Helps Startups Choose the Right Funding Strategy
One of the most difficult questions for startups to answer is the bootstrapping vs fundraising one; a question that often gets answered with un-informed advice from well-meaning mentors who have not even briefly looked at the startup. Musaffa brings an honest and experienced perspective to the table in understanding the current state of a startup and providing guidance on realistic options at that stage, for that market and with that team.
If you’re working out which path is right for your startup and want a clear-eyed assessment, our fundraising advisory services are the right place to start.
Final Thoughts
Bootstrap or fund? This is not a decision you make once at founding. As your company grows, the answer will change as the market and competitive landscape changes. Some companies bootstrap until very late in the game, while others require funding from day one in order to be competitive. Most companies fall somewhere in between and the answer will evolve as the evidence base gets updated.
Ultimately it is up to you to make that decision as informed as possible. Don’t mistake your wishful hopes for reality, and don’t mistake your hype for real value. There are many people who can spit out formulas for startups, but successful founders rarely do well by following a recipe. They think deeply about what they are building, and then make the best possible decisions about what their startup needs in terms of funding to reach its potential.
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Nusrat Ahmed