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Startup Bootstrapping – Understanding the Pros and Cons

 

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Putting revenue ahead of fundraising is risky, but it can help you control your destiny

Andrew Beebe, a venture capitalist at Obvious Ventures, was impressed by the tiny startup that recently pitched his firm. Its founders were seeking investment so they could start hiring and build out their idea. But already they were selling product and earning revenue through a rudimentary e-commerce site they’d built quickly.

“That’s very different than someone coming in at the seed stage with a business plan, a deck and an interesting team,” Beebe says. “I might fund them, too. But this other company is getting a much bigger valuation because there’s much less risk.” The founders had braved the market before stepping out in search of early stage funding — and were rewarded with more favorable deal terms.

As a founder, do you immediately start raising money, which in turn will allow you to begin building your team and invest in your idea? Or do you put off raising venture dollars and bootstrap — financing yourself through sales, for as long as you can, perhaps after securing some cash from friends and family — before you look to sell off a piece of your company in exchange for venture capital?

Bootstrapping is hard. “Whatever you think your pain threshold, you should double it,” says Beebe, who co-founded a pair of tech startups before becoming a VC.

And sometimes entrepreneurs have no choice: They need to seek venture funding because they can’t afford to go months without a paycheck. Or maybe their idea is one that requires a large upfront investment to get off the ground.

But if you can manage it, there are advantages to bootstrapping your enterprise, at least until you have a prototype or a proof-of-concept to show potential investors. And lest you think the approach works only for small, niche businesses, consider this partial list of companies that have taken some version of the bootstrapping route on their way to mega-success: Atlassian, Github, Wayfair, Squarespace, Spanx and Patagonia.

If you are thinking bootstrapping, here are some factors to consider.

Retaining more of your company

The earlier you raise money in your startup’s life, the more that money will cost you in equity and dilution. So if you manage to rely on bootstrap funding even for a short while, you’ll likely hold on to a larger share of your company when you bring in investors.

“If you can, put off raising venture money – that lets you raise money on more attractive terms,” says Scott Dettmer, a lawyer at Gunderson Dettmer, who has been advising founders of tech startups in Silicon Valley since the 1980s.

A company with no revenue might be valued at a few million dollars while a similar one showing early traction might be valued at closer to $10 million — which could translate into a larger infusion of money and the founders holding on to a bigger piece of their company, if not both.

“Even a few months can make a huge difference,” Beebe says. “In later stages, the difference between $100 million and $110 in revenue might not be a big deal. But early stages, the difference between no revenues and even a few hundred thousand dollars in revenues, can be enormous.” And since any early dilution of your equity will get magnified in later financing rounds, the difference when your company finally exits will be substantial.

Expanding fundraising options and improving deal terms

Waiting to get some traction and revenue has another tangible benefit: it will expand the universe of investors who may be interested in backing your startup. “If someone is trying to raise $200,000 as two founders and a napkin, we might not fund them,” Beebe says. “But if they get to a place where they could and should raise $2 million and they’re starting to get meat on the bone, that’s our sweet spot and the sweet spot for a lot of other firms out there.”

Bootstrapping also might mean better deal terms beyond pricing. How many board seats must you give up in exchange for funding? Who holds the upper hand in negotiating the term sheet that dictates things such as liquidation preference and conversion mechanics if there is an exit?

“If you can bootstrap, you can negotiate better terms from a position of strength,” Dettmer says.

Raising too early could hurt your business

Capital can keep a business afloat. But it’s a means to an end, not an end in and of itself.

“The way venture is portrayed in the popular press and on TV shows like Shark Tank, it seems like the biggest challenge confronting you as an entrepreneur is raising money, when the real challenge of entrepreneurship is creating a product that people want to buy and use,” says Michael Wolfe, a serial entrepreneur who has been a founder or early employee at five startups. 

Four of those companies had exits, either through an IPO or an acquisition. The fifth failed, Wolfe believes, in part because it raised a $3.5 million A round prematurely.

“We were hiring people and pushing out product and looking for traction when in retrospect our focus should have been on experimentation and validation for the product and other foundational work before moving into the next phase,” says Wolfe.

The downsides of startup bootstrapping

For all its advantages, startup bootstrapping isn’t always the right choice for everyone. “If you’re bootstrapping, it’s hard to hire great people,” says Joe Beninato, a serial entrepreneur who has founded or co-founded four startups and worked for four others. “Let’s say I’m trying to hire this great person to help me build a company. But they’ve got a mortgage or a kid in private school or whatever. It’s hard to get someone to come work for you for equity and zero salary when they’re making $200,000 to $400,000 a year.”

What’s more, the backing of a professional investor comes along with validation. “Raising capital can be a stamp of approval and give you legitimacy,” says Beninato, who sold his most recent company to Google and now works at X, the “moonshot” unit of Google’s parent, Alphabet.

Investor validation can be especially important if you are selling to business customers, he says. “Saying firm XYZ has funded us says that at least we were credible people — that someone had vetted us and confirmed that we know what we’re talking about.”

Those selling to businesses might also feel more pressure to take money earlier, Wolfe says. “With B-to-Bs, you always need more upfront investment to build the product,” Wolfe says. “It’s not like you can build a demo and put it out there. A product a large enterprise wants to use needs scalability and a lot more features.”

However, Wolfe notes, some SaaS companies have managed to bootstrap by tapping small-and medium-sized businesses first and then moving up to bigger and bigger customers.

The takeaway – bootstrapping can put you in a better long term position

If you can and it makes sense for your company, bootstrapping your business through its earliest days can put you in a position to raise more money, receive a higher valuation, and retain more control of your company. But it isn’t easy.

“If you think you can do it for three months, put in your three months and only then start looking for money, which is going to take some time,” Beebe says.

For most founders, the first round of VC investment provides not only startup cash but also a validation of their entrepreneurial dreams. But that doesn’t mean seeking VC funding right off the bat is always the best path forward.

Entrepreneurs who are able to bootstrap their startup, financing it through early product sales, will find themselves in a much stronger position when they do decide to go after professional investors. They’re likely to end up with more choices, better terms and more equity.

– DeMarcus

Visit Startup Insights for more on what you need to know at each stage of your startup’s early life:

Getting Started

Startup Incorporation

Startup Finances

Startup Metrics

Startup Accelerators

Equity Dilution

Gaining Momentum

Startup Bootstrapping

Investor Emails

Cap Tables

Burn Rates

Ready to Raise

Friends & Family

Angel Investors

VC Funding

VC Choices

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. You should obtain relevant and specific professional advice before making any investment or other decision. Silicon Valley Bank is not responsible for any cost, claim or loss associated with your use of this material.

About the Author

Based in our Santa Monica office, DeMarcus Williams is the Director of SVB’s Early Stage Practice, joining by way of Zealot Networks, where he served as Vice President of Business Strategy. DeMarcus’s work at Zealot, including strategic planning, corporate development, and business development, is directly relevant to his current role at SVB, where he is focused on fostering collaboration within LA’s early stage technology/innovation ecosystem and leveraging SVB’s brand to add value to early stage entrepreneurs. Prior to joining Zealot Networks, DeMarcus was a financial advisor with Merrill Lynch’s Private Bank and Investment Group, where he focused on cultivating relationships with entertainment and technology communities.

A scholar-athlete, DeMarcus played basketball at the University of Washington. His playing days were unexpectedly cut short by a career-ending injury, which ultimately led DeMarcus to transfer and complete his bachelor’s degree at the University of California, Irvine. His experience as a student athlete gave him first-hand insight into the importance of securing a future beyond sports, initiating his curiosity with technology and finance.

Passionate about charitable causes, DeMarcus has been recognized by the Los Angeles Mayor’s Office for his contributions to the community and, since 2006, has served as an Athlete Ambassador and Steering Committee Member at Cedars-Sinai’s Sports Spectacular. In addition, he has worked with the Challengers Boys and Girls Club, the Brotherhood Crusade and numerous schools in underserved communities.

Currently residing in Los Angeles with his family, DeMarcus is a loyal Philadelphia Eagles fan and student of Capoeira, the Brazilian martial arts form. With his passion for startup life, DeMarcus is also actively engaged with a sports technology startup ranked by Fast Company as one of the “Most Innovative Companies of 2016.”

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