Tired of Chasing Investors? Consider Bootstrapping Your Startup

While it is widely believed that startups need outside capital in order to grow and survive, many of the fastest growing new businesses in the country—60% of the companies on the Inc. 500 list in 2015—have been launched using “bootstrapping” techniques with less than $10,000 in capital.  In contrast, only 7% of the companies on the Inc. 500 list that year were fueled with funding from venture capitalists.  Joel Spolsky, writing in Inc. about his own experiences with bootstrapping, said that “our goal has always been to grow slowly, organically, steadily and profitably”.  This approach contrasts sharply to the “big bang” model that involves rapid growth fueled by significant amounts of capital from outside investors such as venture capitalists.

This article is adapted from material in Sources of Capital: A Guide for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Spolsky explained that companies that bootstrap correctly move slowly and four important pillars of organic growth—revenue, head count, public relations (“PR”) and quality—are always synchronized.  In other words, revenue grows only as fast as the company can hire and train skilled employees and awareness of the company’s products never gets ahead of the quality of the goods and services that the company is able to provide to customers.  When the only capital available comes from actual revenues from sales of products or services, as opposed to outside investors, the company must build its workforce slowly, which means there is more time to train new employees and make sure they understand and embrace the desired culture of the company.  Working on a shoestring also means there is no money for big advertising campaigns, which makes the company rely on natural growth of the marketplace and be selective about how it prospects for customers.  Product development is more simplistic for bootstrapped companies; however, while initial product offerings are limited in the scope of their features they generally are enough to convince customers that the company is able to offer quality and value.

Several problems can arise when raising large amounts of outside money causes the company to get out of synch with its pillars of organic growth:

  • When capital is used for advertising that produces a service in revenues from sales to customers, companies often struggle to keep up because they are unable to hire skilled employees and train them fast enough to keep up with the demands of existing customers and the intense interest of prospective customers. Employees become overworked and demoralized and the failure to keep up with prospects means they lose patience and move on to competitors—generally for good.
  • When the company hires employees faster than it can reasonably expect the quality of its product to improve the new employee won’t have a chance to learn and absorb the culture of the company because there simply are not enough experienced mentors available to conduct the necessary training. If this continues for too long, the quality of work and service will begin to decline as more and more of the workforce consists of inexperienced employees who haven’t had the time to learn about the business and their specific roles.
  • When the company uses the money collected from investors to jump start demand through PR campaigns, it often isn’t ready for the explosion of interest in the new product or service, which often still lacks all of the features that prospects believe they have been promised in the marketing blitz. The company may find itself handling more customers, but turning them into paying customers is difficult and they may ultimately decide that the product or service is too simple or lacks the necessary quality and never return, even when the company has substantially increased the quality of its offerings.  A related risk of misalignment is that the time frame for developing high quality technology-based products is generally quite long, which means that quality has a hard time keeping pace with interest generated from high spending on PR.

Spolsky argued that “raising too much money—whether it is venture capital or private equity or from a strategic investor—is often the key deciding factor in whether a company grows at a natural pace or gets misaligned”.  His advice was that sometimes it makes sense, however difficult, to say “no” to investors willing to fund a “great leap forward” if the founders know that it will likely become too difficult to manage growth and satisfy customers to the point where they will forge long-term relationships with the company.  Having too much money may also lead to waste and a lack of discipline about finding smart solutions to problems in the most efficient manner.

The flip side of the argument is that venture capitalists not only provide money that can be used to accelerate growth, they also provide expertise that can be tapped to improve the business model and connections that are not otherwise available to the founders that can be used to find talent for the business and forge key partnerships.  Money from venture capitalists can also be used to make investments ahead of revenues, such as hiring and training employees who are best suited to the particular business and conditioning the market through selective PR campaigns.  Venture capital is also seen as a “Good Housekeeping Seal of Approval” for the company, its management team and proposed business model.  Finally, founders with money in the bank can spend more time on building their product and business rather than continuously looking for and pitching new investors or assuaging the concerns of employees and/or vendors worried about whether they will be paid.  However, venture capitalists are under their own pressures to produce results for their investors and will want to see their invested funds deployed quickly in order to generate value that can be turned into an “exit event” (i.e., a sale of the company or initial public offering) within a relatively short period of time, say five to eight years.  Venture capitalists also want to be involved in the steering the business, something that many founders are not totally prepared for.  In some cases, investors demand that companies move their offices, install elaborate tracking and reporting processes and adhere to tight milestones to ensure that progress, as defined by the investors, is being made.

In an article in The Wall Street Journal, John Roa, the founder and CEO of ÄKTA, observed that bootstrapping wasn’t for everyone or every business and that the answers to the following three questions would provide a founder with insight on whether it makes sense for him or her:

  • How well do you know your business and industry? The founder needs to have a solid understanding of the proposed business and the applicable industry in order to determine the cost structure and price points for the proposed product or service. If launch is not possible without investing in substantial R&D, inventory, etc., the founder may have little choice but to bring in outside investors.  If it looks like the business can be launched without such an investment, the founder must nonetheless be prepared to operate “lean” and make sure that the key functions for the business can be operated and talent can be recruited without substantial cash outlays (e.g., by offering equity).
  • What’s your comfort level with different kinds of risks?  Bootstrapping is risky business and it is likely that the founder will find himself or herself on the edge of a cliff, with a declining bank balance and no reserves, more than once during the time it takes for the company to gain traction. If the founder is uncomfortable with this, and the accompanying stress, seeking a cushion from outside investors may be the preferred route.  Even if the founder is willing to take on such a risk, he or she must have a plan for dealing with unexpected downturns to make sure the business can survive rough patches.
  • Do you want the buck to stop with you?  Founders who want, and enjoy, have full control over the management of the business will be attracted to bootstrapping, since money from outside investors generally comes with demands for sharing in decision making. In many cases, however, founders will benefit from having others who have “skin in the game” and can serve as sounding boards and bring different perspectives and experiences to the table.

Only certain types of companies can realistically look to bootstrapping as a viable strategy: companies that can generate revenue from the very beginning, usually firms that can quickly find a market for their product or service among other businesses.  The inherent ability to generate revenues quickly tends to lower the risk for properly-synched bootstrapped companies and the chances of “success” are enhanced by not having to meet the ambitious valuation goals of outside investors and instead concentrate on methodically building a sustainable business with the right amount of growth and marketing to support building a loyal workforce and customer base impressed by the quality and service offered by the company.

The reality is that “bootstrapping” and “big bang” funding are not necessarily incompatible and the ideal may be to use the two strategies sequentially, an approach that is at the heart of the popular “lean startup” methodology.  This path begins with self-funding until the point where the business model has been validated and profitability has been achieved.  Once that milestone has been reached, outside funding can be used for “company building” and fueling a proven growth model without the founders having to absorb too much dilution to their ownership stake.

Sources: J. Spolsky, “The Four Pillars of Organic Growth: Revenue, head count, PR and quality—if one gets ahead of the others, you’re screwed”, INC. Magazine (January 2008), 69; C. Said, “Bootstrapped Startups go against the VC trend”, San Francisco Chronicle (August 10, 2015), D1; and J. Roa, Weekend Read: Getting Rid of Bootstrapping’s Bad Rap (April 3, 2015)

This article is adapted from material in Sources of Capital: A Guide for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedInTwitter and Facebook.

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