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The Funding Dilemma: Bootstrap or VC?

3298287657_a296897cba_bFinding the funding to launch and grow a startup keeps many an entrepreneur awake at night: do you bootstrap or do you attract external investors? The path you choose has a big impact on the kind of business you will build.

Many choose the self-financing approach, using savings and generating cash flow on the side by selling services or other products. Earn during the day, develop at night. It is a lot of work, and it takes monster project management skills to keep on track.

The other option is to go “fat” by seeking and closing venture capital rounds as early as possible. Cash in the bank gives you the runway to more fully explore your market potential and build out more of your product.

The advantage of the bootstrap approach is that your limited resources require you to run smart. You need to become very good at validating assumptions before acting. Bootstrapping forces you to listen closely to the market and build only what your customers are willing to pay for, now. You can freely iterate or pivot as you discover bigger and better opportunities. This is the essence of the Lean Startup approach.

Running Lean allows you to gain real traction in your market as evidenced by recurring cash flow. This is the essence of being in business. Bootstrapping also prepares you to avoid much of the “Death Valley” syndrome where funding is necessarily scarce. Jason Fried of 37Signals (Basecamp, “Rework“) is a big proponent of bootstrapping.

There are a couple of traps hidden in the bootstrap approach:

– Transitioning from a service business to a product business: If you generate most of your income from services and develop a product at night on the side, it is very difficult to pivot your business or your team to become mainly a product business. You may be locked into a long-term (and lucrative) consulting gig. The mindset and team culture needed to succeed in a product business is different than that of a service business.

– Undercapitalization: A bootstrapped business rarely has reserves to take full advantage of a sudden opportunity, or to survive economic hiccups. The longer you bootstrap, the harder it is to raise substantial capital when you need to scale, because VCs like to get in early, before the business has a significant validation.

– Trying to do it all alone: Bootstrapped entrepreneurs don’t have the same access to outside mentoring. You absolutely need to invest time, effort and money to get a mentor-coach and establish an advisory committee. This ensures you are seeing all options around you as you otherwise bury your head in the day-to-day of keeping your business afloat.

Professional money has a lot of advantages, too. The biggest is that the money comes with a support system of experienced mentors to help you focus on the big picture. They have been there, done that, and can steer you around the potholes before you see them.

The downside is that getting outside capital is expensive. Expect to spend 10% to 20% of the capital you want to raise. Expenses include the roadshow and the professional legal, accounting and marketing help you’ll need to be successful.

Professional capital makes your startup less agile, so the more market validation work you accomplish before the investment, the better.

There are other options appearing also. Consider crowdfunding (product or equity, if available) to get cash and gain valuable market insight before moving to the production stage. Angel capital can help at the validation stage, but is less able to help you as you grow because the angels get priced out of subsequent funding rounds.

One approach is not better or worse than the other – it always depends on your particular situation, the maturity of your idea and your offer, your market and your goals. Whatever path you choose, it is a good idea to always be visible to investors, in order to build relationships, validate your idea and demonstrate your ability to perform. In this way, you can quickly shift strategies to access the appropriate financial resources at the right time.

But remember, whatever your financing strategy, the ultimate goal remains the same: get customers who recognize the value you offer them, and who are willing to pay you more than it costs you to make your product. A healthy profit margin is always the best source of cash.

 

For more information

“Rework” by Jason Fried: https://37signals.com/rework/

“The Bootstrappers Manifesto” by Seth Godin:  http://www.sethgodin.com/sg/docs/bootstrap.pdf

“Bootstrap Finance” by Amar Bhide  https://hbr.org/1992/11/bootstrap-finance-the-art-of-start-ups/ar/1
– A 1992 article in Harvard Business Review which is still highly relevant, and explores this topic even deeper

Image credit: Thomas Hawk via Flickr.
Direct link: https://flic.kr/p/62sA1z
Used under Creative Commons

Article adapted from an original text on my French-language blog:
http://blogue.davender.com/2012/01/le-dilemme-du-financement-bootstrapping-ou-vc/

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