Bootstrap or Raise Money?

By | February 21, 2017

Many entrepreneurs think that the only route to startup success is raising funds. But there is a another way of building a company. Financing it with your own savings and cash flow from the business: bootstrapping.

Bootstrapping is not as glamorous though. Raising money, especially if you do it from well-known VCs, gives you instant status among fellow entrepreneurs. You will probably also be asked to give talks on conferences, get coverage on tech blogs and receive other ego-enhancing benefits. Although bootstrapping does not look spectacular to the outside world and has it´s own set of challenges, it also has a number of advantages.

I set up the partner network in EMEA for a software company that raised tens of millions Euros and have bootstrapped my own company to profitability. The experience has given me a basic understanding of the benefits and challenges with both methods. This post is an overview.

Advantages of bootstrapping

The upside is yours. When you start to make lots of money, or your company is bought, the proceeds are yours to keep. Outside investors, even when they only own a limited part of the shares, can potentially take a disproportionately large part of any upside because of liquidation preferences and similar clauses.

Focus on your business. Raising money takes time and lots of effort. Every minute you spend raising money is time that you are not building the business. Ask anyone who has been through the process, raising money will take a lot of your time. Pitching investors, creating reports, answering questions and negotiating an agreement will keep you very busy.

Test and try anything you want. The business is yours. You can rebrand, pivot, add features, hire, change prices, or become a digital nomad. You make the rules. There is no need to ask for approval or give explanations to anyone. Having investors is not the same as having a boss, but it does place more constraints on what you can and cannot do.

No time-consuming reporting obligations. You did not start a business to start reporting to someone again. When the business is yours, you do not have to give explanations to anyone or create any reports that you feel are unnecessary.

Spending discipline. You have to earn each Euro before you can spend it, or it is coming from your own savings. Both help ensure that you think a lot before you spend. You will also bargain when you do spend to make sure you have a good deal.

Creative problem solving. When you have a bag of money it is tempting to solve problems by spending money and hire, for instance, consultants for things you don´t know how to do. When it is your own hard-earned cash you are spending, you think about it more carefully. Perhaps you do not have the money required to solve a problem in the most obvious way, and you will have to come up with something more creative or elegant.

Potential conflict of interests. Most investors want an exit in less than ten years. This can create a conflict of interest when your focus is on doing what is best for the company in the long-term, whereas investors could be willing to trade-off potential future problems for a direct increase in revenue or profit.

Can it be better to raise capital instead?

It might be. Venture capital has a number of advantages over bootstrapping:

Scale fast. You can use the additional capital to accelerate growth by investing in engineers, marketing, sales, or whatever you think will make your company grow faster.

Spread the risk. Not all money on the line will be yours. “Don´t put all your eggs in one basket” is the first lesson when you learn about investing. Diversification can be a good thing to ensure you will still have some savings if your startup fails.

Discipline. Your investors will want to be kept up to date about results, KPIs and other relevant information. Having to do outside reporting does ensure that you stay on top of all metrics and analyse them so you can explain each detail to investors. When you do not have to report to someone external, you might prioritize other things.

Capital requirements. Some businesses, such as biotech, are impossible to start without significant funding.

Salary from day one. Even if your firm does not generate revenue, yo will get a salary. This can be important, even critical, when you have a family to feed.

Stability. Many startups die prematurely because of founder conflicts. VCs will insist on having contracts and agreements between founders in place that will allow a clean breakup. This can ensure that a conflict between founders will not blow up the company.

Exposure. A significant finance round will put you on the radar really fast and get you media exposure. Moreover, many well-known tech blogs cover almost only VC backed startups.

Network. VCs are usually well-connected and can introduce you to potential customers, partners, employees and other entrepreneurs for advice.

Credibility. Being backed by well-known VCs and having significant funding will increase your credibility towards potential employees and clients. Depending on the industry you are in, significant backing might even be a requirement for clients to start working with you.

Expertise. VCs tend to have a lot of experience in growing businesses successfully. Having them onboard means that  you will be benefit from this experience. You can sort of replicate this when bootstrapping by getting advisors in exchange for equity, but it is not as good a solution as advisors will likely be far less involved than a VC.

To raise, or not to raise.

Both financing methods have different advantages. It might also be possible to combine both. Start your business bootstrapping and raise money later on. This is not a bad way to do it, because having a track record will make it easier to convince investors and will also get you a better valuation resulting in less dilution.

When it is impossible to start a business without outside funding the decision is easy. Most founders, however, have a choice. And there is only one right answer to the question: whatever works best for you.