Why You Should Strongly Consider Bootstrapping Your Startup
What do 37Signals, GoPro and 99Designs have in common? They all started up with minimal financial resources and without external, institutional capital but now, they are valued at hundreds of millions of dollars. The three of them bootstrapped their way to success.
Bootstrapping means starting up (an Internet-based business or other enterprise) with minimal financial resources and without external, institutional capital. This is a reality thousands of businesses face every year, but most of them do it unwillingly, forced by the fundraising market.
According to Mattermark, in 2014 only 1250-1500 US startups were able to raise seed capital from institutional investors. This means that the odds are you won’t be able to raise money.
With that said, let’s discuss why making a conscious decision to bootstrap and not raise money might actually be a good thing.
Focus on profitability and long-term viability.
When you are bootstrapping there is only way to survive: get to profitability before you run out of cash. This means you won’t have the comfort that money in the bank provides.
At first, this may seem counterproductive but actually, this uncertainty will give your team extra fuel and put them in the right mindset.
What’s the right mindset? Before performing any task, they should ask themselves: ‘is this getting us closer to profitability?’. Is the answer is yes, then do it. If it’s no, then don’t.
Let’s take a look at a simple formula that will guide your startup’s future:
runway = revenue + savings – personal cash burn – startup cash burn
Let’s see how that plays out in 3, completely different scenarios:
As you see in the table above, your goal should be to get to Point B (Break Even) as fast as possible, or before running out of money.
When savings start burning, the only way to keep the business afloat is revenue. This ‘forced’ focus is what will help you build your startup 2x faster than the rest.
Focusing on product and not raising money
When money is not available, the biggest resource you can leverage to grow is your time. The problem with fundraising, if and when done right, is it’s extremely time-consuming.
For those who decide to raise money from institutional investors, as a founding CEO, at least 50% of their time will be devoted to this task. Some (but not all) of the things they’ll need to focus on are:
- Research which angels/VCs play in your space and might be interested in early stage deals.
- Reach out to them (preferably via someone they know and trust) to set up an initial meeting even before you start the actual fundraising.
- Follow-up if needed.
- Send weekly investor updates to keep everyone on the loop and show them your team can execute.
- Prepare the materials needed (deck, executive summary, hiring plan, financial forecasts, etc).
- When the time is right, you’ll need to reach out again and set up another round of meetings.
- Present to the entire VC firm if needed.
- If successful, talk to lawyers, revise term sheets, etc.
As I mentioned before, that’s extremely exhausting and time consuming, especially when you’ll also need to launch a product, acquire users, and prevent them from churning.
If fundraising is not in your mind because you decided to bootstrap, then you’ll have twice the hours and mental stamina to invest in growing your product and business.
The possibility of turning it into a lifestyle business / distribute profit before a liquidity event.
When you raise money, investors want you to grow. Fast. This means burning cash and re-investing all earnings back into the company. They have a point: they just invested at least $500,000 and they want to see a return. It’s their job. This impacts your business in two different ways:
First, you can’t distribute profits at the end of the year. Founder’s liquidity only comes after an acquisition. All earnings will be re-invested back into the startup.
Second, if your business generates enough money to support itself and a few employees, but isn’t growing fast enough to raise another round or push for an acquisition, then you are dead. You are in the startup limbo.
If you are not 100% OK with this, then you should avoid venture capital at all costs. Having hundreds of thousands of dollars to accelerate growth is nice, but it comes with a few rules.
You won’t lose control
In the early stages, no one knows what a company would look like in the future but you, as a founder, have a vision in your mind for what you want the company to look like. Investors will also have one of their own, and there is a chance both visions conflict.
Maybe you want a distributed team and they want you to stay in the Bay Area. Maybe you believe the right thing is to expand to new niches instead of adding more features. Maybe they want to hire an external CEO because you ‘aren’t ready for an executive position’.
When you raise money, you have to answer for major decisions you make to external shareholders, and they may not agree with those answers. Bootstrapping will prevent this from happening because you’ll be the one on the driver’s seat.
It’s easier for founders to get f’ you money.
At first, a lot of money and giving a tiny piece of your company might look like a smart move, but raising money at astronomical valuations might be counter-productive.
Let me explain: as your valuation increases, your chances of an acquisition that will pocket you millions of dollars decrease exponentially.
This is because you are the pool of companies that can acquire you is getting smaller and smaller – many companies can do a $10M acquisition, but only the Big Ones can afford $150M.
Let’s do some math.
You bootstrap your startup to $100k in MRR. If someone decides to pay 12x ARR, that’s a $14.4M acquisition that can happen fairly quickly (12-18 months with the right team). If you had an equal partner, you’ll pocket roughly $7.2M each.
Let’s say that, instead of bootstrapping, you raised $1M at a $4M pre. After cutting a 10% option pool for key employees, you and your co-founder now own roughly 32.5% of the business. This means that to pocket $7.2M each, you’ll need to sell the business for a little over $22M.
What happens if you go straight to A and raised $4M at a $16M pre (same founder ownership)? To start with, you should know that a $14.4M acquisition is off-the table. Heck, even a $30M acquisition isn’t possible.
Most VCs need to return their funds, and to do that, they need to get at least 2-3x their money back. You’ll need to get your startup to a $40M acquisition. Yes, you’ll pocket $13.5M, but it will take you at least twice as longer and the possibility of failing increase exponentially.
Let’s see how that scenario plays out in numbers:
Please note: this is rough math, not taking into account more complex terms like participation preferred.
Raising Money From A Better Position
Bootstrapping your startup isn’t a synonym with ‘not raising money, ever’. Most old-school bootstrappers claim that VC money is evil, and that they want to retain control, but there is a time in which bringing external capital may make sense. Maybe you want to accelerate growth and shoot for a bigger acquisition. Or a competitor raised cash and they are getting close.
Raising money for a bootstrapped, profitable startup is a completely different game than doing it for a pre-revenue startup with no critical traction.
This proves your business model works and your team is the real deal. You just need to prove that the market is big enough and that you are capable of scaling and growing the organization.
More importantly, you don’t need the money. The business is profitable and able to run indefinitely without jeopardizing your financial stability. This affords you the luxury of picking the right investors to partner with and at the right valuation.
You can walk away. When you need external money to keep the lights on, you may end up with the wrong partner.
A great example is Baremetrics, a startup providing SaaS analytics for Stripe from a single dashboard. Josh Pigford, the founder, bootstrapped it to $30K in MRR and 30% growth month over month, while neglecting investor interest.
Eventually he come around, but only after he found the perfect partner (Stripe/General Catalyst) who was inline with his interests and willing to offer the right terms, at the right valuation.
Bootstrapping it’s very hard and it takes a long time, but it’s worth it. If you are interested in running your startup this way, you should start by figuring out your runway.
Find out how many months you can live before having to take another job. Experience say the ‘magic number’ is 12 months, but 18 is a safer bet. That should give you enough time to build a product, get it out there and start iterating until you get to break even. Remember:
runway = revenue + savings – personal cash burn – startup cash burn
Finally, work every week to get to profitability. Ask yourself: ‘is this going to help me increase monthly revenue?’.