Alternative Financing Strategies For Bootstrapping Startups — Borrow.ai
Bootstrapping a Startup
Bootstrapping, from the idiom “to pull oneself up by the bootstraps,” is when founders start companies with little or very little initial funding. Generally speaking, a bootstrapping entrepreneur will launch his underdeveloped product onto the market in order to gain a customer base and initial traction. Then, after refining his product in accordance to the product’s performance, he will attempt to scale the company. It is this stage that can be the most defining for a startup’s success or failure. Aside from the small amount of capital and guidance a company may receive early on from incubators or angel investors, a founder might think to raise capital through venture capital (VC) or though corporate banks — in other words, through VC equity or through interest incurring debt-based loans. However, debt-based loans are often insufficient and bootstrapping founders don’t often qualify for them in the first place. Therefore, the obvious starting point for many such founders is VC.
While VC might be suitable for the rare “unicorn” startup with the potential for neck-break growth (Microsoft, Amazon, etc…), it is not suitable for the vast majority of companies. This has to do with the nature of venture capital firms’ investment strategy. The New York Times wrote an article on this and why entrepreneurs are starting to avoid VCs.Their strategy is essentially “go big or go home,” in that they invest in a lot of startups and treat them all like “unicorn” companies; they force them to grow at a tremendous rate without much regard for the individual companies’ ability to do so. As a consequence, the majority fail, but the VC firm gets its return on investment because a minority achieve staggering success. According to the National Venture Capital Association, only 25–30% of venture-backed companies succeed (not just bootstrapped ones). So it’s no wonder that for VC firms, a 10x return on investment is the benchmark for success. Not to mention that by working with VC, a founder sacrifices a significant amount of equity, making the cost of capital quite high if the company is successful. So what can a bootstrapping founder do if he can’t secure sufficient bank loans and doesn’t want to lose control or equity in his company? Don’t worry, there are plenty of viable alternatives.
Alternatives to VC
Suppose a company has decided that it doesn’t want anything to do with VC. What are its options? Well, one option is to self-finance. This could amount to using pre-existing capital from one’s personal savings, or to raising capital from friends and family. In the long-run, the company would aim to scale through its own revenues. Carolin Nothof goes through the economics of such an endeavor in her article, “ How to scale a tech company without investors.” Believe it or not, there are many companies that make it without taking a dime from investors. One example is the Indian multinational Zoho, which boasts annual revenues of over $500 million. Another notable company that self-funded is Tableau Software, a data visualization company worth over $100 million. But they started during the dot-com boom when the stock market was at a low-point. While scaling through growth is far slower, it might be an option to consider for entrepreneurs who want to take a slow and steady route and have no interest in scaling at a rate that exceeds their growth. There are countless examples of companies that were able to achieve this, but the process requires a lot of patience and time.
But what if one doesn’t want to put in perhaps decades before seeing their company take off? Are there any other viable ways to raise capital? Yes, there is one model that stands as a solid alternative to VC: revenue-based financing (RBF). For those who want to learn more about the mechanics of RBF, we wrote a detailed guide to the investment instrument. To summarize the basics, RBF is a financing model where the investor lends a founder a certain amount of capital that is payed back incrementally as a percentage of monthly revenue until the return cap is paid off. The caveat is the return cap, which is given as a multiple of the initial investment. For example, if the investor provides $3 million at a return cap of 2x, the founder must eventually pay the investor $6 million. There is no deadline to repaying an RBF loan and they are easier to get than bank loans, but companies still need to meet a number of requirements to be eligible. Chiefly, a company should have a consistent stream of monthly revenue. For this reason, RBF is particularly apt for SaaS tech companies who run on a subscription-based business model. Luckily for founders, there exists a variety of RBF funds to accommodate the unique funding needs of startups across the board. As we discussed in our previous article, RBF has yet to really catch on outside of the U.S., so American founders may want to take advantage of that.
While not ideal for every business model, crowdfunding may be worth considering. As somewhat of an analogue to IPO, a crowdfunding campaign raises a small amount of capital from a large amount of enthusiastic investors. In many cases, the funders have little or no control over the business, which affords far greater flexibility than through other methods. For most, platforms like Kickstarter come to mind; but there are actually a variety of platforms which aim to accommodate serious entrepreneurs. For instance, Wefunder allows investors to purchase equity shares in the early stages of a company. There is also iFundWoman which aims to help female entrepreneurs crowdfund in the early stages of bootstrapping. Forbes recommends having roughly 25% of your needed capital raised before launching a campaign.
I didn’t mention angel investors much because they focus mainly on buying equity. But for bootstrapping startups lacking other options, angel investors can be a godsend. Of course the founder(s) are going to sacrifice equity at an early stage, but with the right angel investor, founders may get access to priceless advice and management skills in addition to the funds that they desperately need to secure. Therefore, angel investors cannot be discounted. I just don’t know if they quite fit the profile of “bootstrapping.”
The Advantage of Bootstrapping
It seems like bootstrapping is just a poor man’s way of starting a company. But there are actually a number of virtues in bootstrapping as opposed to raising capital through equity. For one, a smaller team lends itself to greater potential for innovation. There is something to be said about the flexibility of bootstrapping in the early stages of a startup. Things are constantly changing and one needs to hone in on a clear and effective vision for the company. The financial burden might be alleviated by recruiting trusted colleagues, allowing one to also selectively hire trusted and competent partners/employees. Another virtue of bootstrapping is that one can dedicated all of the company’s efforts toward innovation and creation, rather than securing financing. Time is a valuable resource after all and bootstrapping allows dedicated founders to focus on their product. Another thing to mention is that with shifting expectations from investors, bootstrapping in order to further develop and prove the efficacy of their product, is a good segue into serious funding rounds.
Unfortunately there does often come a point where the company has a good product and a clear vision to scaling, but cannot do so in a reasonable amount of time through its revenues alone. This is where RBF comes in (unless VC is a wise option). Designed to help companies grow at a healthy pace, RBF still allows for a lot of the flexility afforded during the purely self-funded phases. Investors don’t force a change in management; they don’t force unsustainable growth; and the investing stages and due diligence are more streamlined and take less time. While it’s true that the cost of capital is quite high (in comparison to traditional debt-loans), it usually pails in comparison to the equity VC ends up taking. And if you prefer equity to be a factor (for insurance purposes), plenty of RBF funds offer an equity-based option, which we discussed in our prior article. So there are plenty of virtues to self-funded bootstrapping, there often comes a point where additional funding is needed to move things along. This is where RBF comes in for many startups as a more hands-off investor that won’t stifle the innovative startup spirit.
Challenges in Bootstrapping
The largest and most daunting challenge of bootstrapping without outside funding is risk. If the venture fails, the money and time put into it is only yours to lose. To this end, a bootstrapping entrepreneur should financially plan for failure and perhaps even make substantial lifestyle changes in order to accommodate dry periods early on. Due to the inherent risk, many work on the venture part-time. But this can also be really detrimental to the success of the company. However the option to work on it part-time (no obligations to investors) can also technically be a virtue. In any case, it is risky and unlike with many investment instruments, all of the money one puts into the company could quickly vanish into thin air and you’re the “investor.” Another challenge is finding the right people to work with. Bootstrapping is a tough but rewarding endeavor. Accordingly, you’re going to need competent people with grit and guts. Therefore one should choose his partners and employees wisely. You need people whom you can trust to both get the work done and to have your back. Bryan Flynn at FounderPartners.co emphasizes the importance of proper delegation, in that “There are a whole host of practical and legal aspects to starting a business that far exceed the skill set of the average engineer. And even if, in addition to being a brilliant tech guy currently embroiled in masterminding the disruption of the modern search engine, you are in fact also a canny operator who knows all about product-market fit and KPIs and IP law, chances are you haven’t got the time to handle all of that on your own. Your job is to build a product that fills a need in the marketplace so that it can start generating revenue as soon as possible. You should surround yourself with other people who are good at doing everything else. After all, the ability to delegate is one of the most important traits shared by all successful CEOs.” Sure, bringing less people in the early stages gives you more equity in the company, but the importance of delegation cannot be underscored enough. Focusing on developing the product is a lot more important than spending your nights reading up on corporate law. Values and character are also important, as you wouldn’t want key business partners to bail as soon as the going gets rough. The final hallmark challenge faced by bootstrapping startups is cutting costs and optimizing workflow. Entrepreneurs are typically not the managerial type, so when it comes to logistical challenges relating to workflow, it can be a struggle to optimize. But doing so is very important because all of your remaining revenues need to go back into scaling your product. So automate when you can and try and cut all extraneous costs.
Takeaway
For many startups, securing an external source of capital is not viable and the only possible form of financing is in “sweat equity.” But there are also plenty of reasons to bootstrap, even when early-stage financing is available. The freedom and creative potential afforded by doing everything yourself and on your own dime can’t be overstated, but eventually business startups come to a point where they need extra capital. Thankfully, newer financing options like RBF exist as alternatives to VC and do not impose nearly as much of a burden on companies during critical stages of growth. Many of the most successful companies got their start bootstrapping by utilizing the flexibility afforded early-on and making a superior product. Hopefully we’ve covered most of the common bootstrapping methods out there and sufficiently discussed the various topics surrounding bootstrapping. On our site, you can find more information related to RBF, which we hope compliments our discussion on bootstrapping and alternative financing strategies for startups.
Originally published at https://borrow.ai.
