We’ve never taken outside capital at Software Advice, and that decision is central to the type of company we’ve become. So I wanted to cover the topic of funding a start-up organically, which is also known as “bootstrapping.” I put Holly Regan, one of our Managing Editors, on the task. She talked to my friend, Greg Goldfarb, who is an investment professional at Summit Partners. The following is what came of their conversation. –Don
If you’re an entrepreneur thinking of starting a business, there are a lot of questions you’re probably asking yourself. One question in particular tops the list: Should you bootstrap your business, or seek funding for your company from venture capital investors?
To answer this question, I spoke with Greg Goldfarb, a Managing Director at Summit Partners, a growth equity firm that has invested in more than 380 companies over 30 years. Interestingly, most of those companies started off bootstrapped and experienced commercial success prior to taking on outside capital.
Bootstrapping—starting a company with little or no outside funding, and usually some of the founders’ own personal capital—may be a daunting path to consider. But according to Goldfarb, if you’re in a position to do so, it’s best to bootstrap your company first, and seek venture capital funding later.
Why Should You Bootstrap Your Business?
Goldfarb is a strong advocate of bootstrapping early in the life of a new business. There are several reasons behind this:
- Bootstrapping creates a directed and disciplined company. When you don’t have a lot of money to work with, you are more disciplined about how you deploy it as a result. You pay close attention to where every dollar is going. Sometimes, having a lot of money allows entrepreneurs to try things that are artificial and unsustainable; when every dollar counts, you must focus on what’s realistic and what’s really working. And when a company gets bloated with capital early on, it’s very difficult to roll that back later: the whole system is built on assumptions of excess and spending. This almost always means a less profitable company down the road.
- Bootstrapping creates a culture that’s focused on customer pain. A lot of extra funding may lead entrepreneurs to work towards a theoretical “perfect product,” instead of paying attention to what the customer actually needs. When you’re bootstrapped, you don’t have the luxury of operating based on the theoretical. You must keep your finger on the pulse of the customer and stay closely attuned to their most urgent needs: the ones they’ll pay to solve.
- Raising capital is distracting. A focus on fundraising early in the life of your business can distract you from your primary goal of producing a great product and selling it to customers. And while the right investor can add a lot of value to your company, not all investors are great–and some can even lead you down the wrong path. By staying focused on the customer and your product, you can actually test your ideas in the marketplace, instead of spending valuable business cycles worrying about raising money. You’ll learn about yourself and how you want to shape your business–which will help you decide what type of investor will be your best fit.
In addition to these points, there’s a major side benefit of bootstrapping: As the entrepreneur, you can maintain a larger ownership stake in your company by putting off the decision to raise capital until your company’s value has grown, through commercial success.
Exceptions to the Bootstrapping Rule
There are a few exceptions to the general rule of bootstrapping early in the life of a business. These include:
- A “winner takes all” market. In some markets, the leading company holds as much as 90 percent of the market share, leaving little for its competitors (think eBay in the online-auction market in the late 1990s). In these scenarios, your company may need the help of an outside investor to gain a foothold in the market more quickly than it could by bootstrapping.
- A capital-intensive business model. Some companies are, by their very nature, capital-intensive: for example, you can’t really start a biotech company or a communications satellite network by bootstrapping. If your business requires this sort of initial capital intensity, you’ll probably need to seek external funding. The good news is, most companies today require less capital to get off the ground. Low-cost, efficient cloud resources and software development tools have reduced start-up costs and time-to-market for many software and internet businesses.
When Should You Seek Venture Capital for Your Company?
Even if you’ve started off bootstrapped and done it successfully, Goldfarb says, there may come a time when you want to consider raising capital. Here are a few such scenarios:
- When you’re feeling things start to work–and you have the data to tell you why. Early in the life of a company, there are some other fundamental questions you must ask yourself as an entrepreneur, such as:
- How does my product resonate with customers?
- What are the most efficient ways to create leads?
- What sales tactics will work, and how long will the sales cycle run?
- What will it cost to acquire a customer?
- What new products are my customers consistently requesting?
The best time to raise capital is when you have enough data to answer these types of questions with reasonable confidence, but you want the opportunity to perfect those answers—and fast. Seek investors when you’re feeling things start to work, and you have identified the key areas of your business to which, if you applied capital and the knowledge of a well-aligned business partner, you could achieve success in the marketplace more quickly.
- When you need help executing on an opportunity. Another good time to seek venture capital is when you see an opportunity that feels foreign, or where you know you could leverage someone else’s experience to increase the odds or speed of success. Say you’re trying to build out a new product, or go international. You could take on that opportunity by yourself, but it might take six to 12 months, and you might not have the resources or team members to execute on it properly. However, if you brought on board the additional capital, expertise and advice of others who have helped companies solve this same problem, you can often solve it more quickly—and at much lower risk.
- When you need to show staying power, or be prepared for future opportunities. When your market is changing quickly or you foresee opportunities where you want to be ready to move swiftly, a strong balance sheet and a well-aligned partner can make a big difference. You need to show customers you’re there to stay. You might want to pursue an acquisition. Or maybe you just want to be ready for the next big thing. Regardless, it’s always better to raise money before you need it than when you need it.
- When you need a second opinion. Entrepreneurship can be lonely. Often, a patient, aligned and experienced board member can help guide you through the tough decisions, hard times and existential crises that unfold—while giving you the confidence to move swiftly when times are good. Having someone to call for a candid, open conversation can be a critical outlet that makes the endurance race of building a company manageable.
- When you want to take some wealth out of the business, but want to keep building for the long term. Entrepreneurs tend to think about liquidity events as “all or nothing”: sell everything and give up control, or sell nothing and risk having your whole life’s work in a privately-held stock. However, there is a middle path if you’ve built a business that is growing and has real value. You can sell a minority stake and put some wealth aside, while still keeping control of the company. It’s the best of both worlds—and can relieve a lot of the pressure, letting you make more patient decisions. It lets you focus on the core business instead of worrying about the eventual outcome. And if investment suitors approach, it allows you to maintain a calm, disciplined response to their inquiries.
There is one important element underlying all these points: For many bootstrapped entrepreneurs, the decision to seek funding is as much a hiring decision as it is a capital decision. While all money is the same shade of green, there is an incredibly wide disparity in the value you can get from a particular investor. Entrepreneurs tend to get the most value from raising capital when they find a proven, culturally-aligned and respectful investor, who appreciates what it’s like to bootstrap a company and has experience in relevant areas—in other words, a true partner. Thus, taking venture capital is as much about hiring the board member you want to work with as it is about money.
Advice for Budding Entrepreneurs
There are a few things those striking out on their entrepreneurial journeys should keep in mind:
- Stay focused on the customer’s pain. Make sure you never lose sight of what the customer needs. Deciding what you’re not going to do—in terms of the product you’re going to develop and the initial steps in serving your market–is as important as deciding what you are going to do. If you try to do everything at once, you’ll likely fail. Maintain a cycle of quick, ongoing communication with the target customer, as well: Don’t retreat into a cave for three months in the hope of unveiling a “wow” product when you’re done.
- Don’t just hire for skills—hire for values. It’s true of any business, but making the wrong hiring decision when your company is small can be especially devastating. Many entrepreneurs think of candidates as a “skills fit” first, and a “values fit” second (or not at all). Reverse that priority. If you hire someone with the right core values, but the wrong skills, it won’t affect company culture—and you’ll likely find a different, more effective role for that person. If the person’s values are wrong, the results can be destructive. Have a clear, written view of the core values you expect team members to demonstrate, and assess candidates in light of those values.
While not every business can be bootstrapped, the vast majority of them can be. If it’s possible to do so, you’ll get a lot of value out of bootstrapping your business now—and seeking venture capital later.