gswardman

Bootstrap Vs Funding: Which Is Better for Your Saas Startup?

By gswardman September 7, 2022

The failure rate for startups in the United States is 90%, with at least 10% of the failures happening in year one. This is according to CBInsights’s annual startup failure post-moterm reports. The same data shows that over 29% of failures happen because startups run out of funding or personal money. That said, bootstrapping and funding are two of the most common and viable ways for new startups to raise capital in the early days to survive. You’ll get to understand the implications of choosing either of these capital-raising options in this Bootstrap Vs Funding post.

What Is Startup Bootstrapping?

Startup bootstrapping is a capital-raising method where founders or entrepreneurs use their resources to fund their businesses in the early stages. Bootstrapping has become very common in recent years as few new startups can attract external funding to support their business in the nascent stages.

The typical VC firm receives over a thousand proposals per year. A look at data in the past two years shows a more than 40% decrease in VC funding rates in some “high-value” sectors like tech, mainly because of the economic downturn and stagflation brought about by the pandemic and other current economic factors.

Bootstrapping your startup means using the following sources to fund your business as you aim to become a viable investable entity:

Personal Savings

The most straightforward and logical funding option when bootstrapping is utilizing your savings or money you’ve set aside to fund your startup. Of course, this option has many risks and shortcomings, losing all your savings being the biggest one.

Many successful companies started technically started by bootstrapping until they became viable to attract investors. Think of companies with one or more founders working from their home garages and using their money to fund day-to-day operations and purchase inputs.

Personal Savings

The bootstrapping approach confines you to your resources for the better part of your seed and budding stage and may even go all the way to launch. It means you will not be preparing any Pro-forma financial statements with hypothetical data and assumptions to attract venture capitalists.

Using personal savings to bootstrap is typically ideal for early-stage startups with low capital needs. The size and amount of capital you are willing to commit may depend on your net worth, risk appetite and enthusiasm. As a rule of thumb, it’s always advisable not to commit over sixty per cent of your life savings to a business unless you have a guaranteed safety net such as assets, long-term investments like bonds and a sizable emergency fund.

Using personal savings is also advised if the amount is enough to cover all your business expenses to launch so that you don’t risk having to suspend or abandon your business midway because you ran out of money. As noted earlier, this is easier said than done because running out of personal funds causes over thirty per cent of startups to fail in the first year.

Another vital point to note regarding using private funding sources is the viability of your business. Before you commit your savings to launch a business, you should do all the necessary research and tests to ascertain that your idea is viable. A simple market survey, for instance, will show you whether your product or service provides the intended value to the customer or not.

Bootstrap with Contributions from Friends, Family and Well-Wishers

You can also opt to seek contributions from close friends, family and well-wishers to fund your early-stage startup. The key term here is contributions, not loans or investments that give this category of people’s equity in your company. The whole point behind bootstrapping is that you maintain complete control over your company.

Getting contributions also allows you to maintain sole ownership structure and nature of your company under the laws lest you are accused of running an illegal investment scheme. If private equity is to be promised or given at this point, due process should be followed, and contracts signed. However, ceding equity to this category of funders defeats the point of bootstrapping as they can, at any time, want to recover their investment or have voting rights.

Bootstrapping Using Ploughed Back Profit

The third and safest funding option for bootstrappers is to reinvest any revenue generated into your startup. You can do this if you have already gone past the seed phase and already making sales from your product. Given that this is the most attractive funding option for bootstrappers, there are a lot of proven strategies you can use to improve your chances of succeeding. Here are some of them:

Join A Startup Accelerator

Startup accelerator programs help new companies shorten their idea to launch time. To do this, they avail expertise and consultancy services to help you actualize your ideas and move quickly through the stages of idea validation, market research, product design, testing, product launch and marketing so you can start making sales and reinvesting revenue to grow your business.

Accelerator programs may be run by private companies, Non-Profits or governments and are usually location-based or industry based. For example, you can find a startup accelerator program in Amsterdam that is tailored to the needs of Fintech startups. Many of these accelerators are free but use a very competitive selection process.

Design A Minimum Viable Product

Design A Minimum Viable Product

A minimum viable product is a prototype with enough features to function as intended. Using an MVP allows you to start generating revenue as fast as possible.

Find Early Adopters

You can support your startup in some industries by finding early adopters who will buy your products before launch or make pre-orders. This approach is prevalent where emerging technologies like electrical motoring are involved.

What Is External Funding

In the simplest terms, getting external funds refers to where a founder allows an external investor, usually through a venture capital VC firm, to invest in their startups in exchange for equity. External funding is the most common startup capital raising method used today.

That said, VC funding is not the only external option open to you as an entrepreneur. The other funding options you can explore include:

Angel investor funding

An angel investor is a person who invests in new startups on a speculative basis allowing them access to capital that they could otherwise have had to borrow or raise from private sources. Sometimes they appear in the seed stage way before you need a VC funding round to scale your business.

Angel investors are picky about the kind of startups they invest in and usually do a lot of due diligence. Fans of shark tank will know and appreciate what angel investors do for startups. Their role usually goes beyond pure monetary injection as they can provide business advice, mentorship and introductions.

Venture Capital funding

The second and most common option for startups is VC funding which involves getting a capital injection from a private venture firm in exchange for equity. Unlike angel investors or traditional private equity, VC firms usually invest on behalf of a rich pool of investors who end up having a share of your company.

It’s important to note that VC funding is not for everyone for the following reasons:

Business viability

Very few startups attract VC funding, and the few usually have to jump many hoops to get the financing they need. Most VC firms employ very rigorous vetting methods to determine the business viability of a startup.

Because they receive so many funding requests yearly, most VC firms are hesitant when investing. They are more likely to provide funding to businesses with unique products or innovations and those who are already generating revenue by the time they are applying for capital.

Growth Stage

You’ll be able to command a better premium from a VC firm when your startup is at a relatively advanced growth stage with clear prospects, a solid competitive advantage and some revenue to your name as opposed to future projections in a Pro-forma financial statement. This means, in practical terms, you can get a higher amount of money for a smaller percentage of equity ceded to the VC firm when you are in this stage.

Size of Your Market or Niche

In some cases, it wouldn’t make sense to seek VC funding, significantly if the size of your target market or niche restricts your growth potential. For instance, VC firms generally avoid investing in startups serving a small niche market where growth potential is capped at a million dollars unless there is a franchising opportunity

Bootstrapping VS External Funding – Pros and Cons

Available Capital

Bootstrapping limits you to the capital you can raise from private sources such as savings and contributions from people close to you. It can be limiting, especially if you need money to grow your business and gain a sustainable competitive advantage in your niche. For instance, many entrepreneurs would find it rough to use personal savings to open a franchise when possible.

On the other hand, external funding sources give startups immediate access to ready capital. Most angel investors or VC firms invest in businesses with specific targets or goals. They are willing to provide funding until those targets are met. For example, most Silicon Valley VC firms inject enough capital into a startup to fund its operations until they launch an IPO so they can get a good return.

Go for external funding if you need an immediate capital injection to scale your business and cannot access it from private sources such as savings and contributions. For instance, you would approach a VC firm or angel investor if you are in the final stages of product development and ready to launch.

Choose to bootstrap if you can fund your business and have no immediate need for capital injection, like when you are still in the product design and testing phase. Not many VC firms or angel investors would be willing to splash money when they have no idea about your business model’s growth potential and viability. Of course, you can still attract their attention if you develop an innovative product with patents.

Founder’s Equity

Bootstrapping allows you to maintain a hundred per cent ownership of your business until you invite investors or decide to sell it. You get to enjoy the profits generated from your company as an entrepreneur and have the freedom to use it as you want. Most entrepreneurs prefer to reinvest early profits to grow their business, especially if they intend to scale it or expand to new markets.

Conversely, you’ll need to give up a portion of your founder’s equity to external investors if you choose the angel investor or VC firm route. External investors usually demand a sizable chunk of your business in exchange for money. They can do whatever they want with their equity as your business grows. For instance, some angel investors choose to hold their equity to the point where they can sell it to a VC firm.

Ideally, aim to have investors willing to stay with you for the long haul, which in the startup world means all the way to the IPO stage. Your angel investor or VC firm should be willing to fund your startup until you are ready to go public, which means injecting more capital as you go through the different stages of growth.

Ceding Control

One of the implications of getting external funding for your startup is ceding some control to the investor, with most of them requiring voting rights. Most VC firms usually appoint someone to oversee your operations from the inside and represent their interests. More often than not, it means that you have to keep the investor informed about your every move, and they usually have a say in crucial decisions.

Having a venture capitalist looking over your shoulder can be a good or bad thing, depending on the circumstances and nature of their involvement. In most cases, venture capitalists would want to see a good return on their investment and, therefore, appoint the best people to represent them. They will help you build the infrastructure you need to grow and even help you with strategy.

Ceding Control

However, there are instances where ceding control or having a VC firm supervise you can be harmful. For example, since they want to protect their investments, most VC firms are more inclined toward effecting risk-averse business strategies, which may not necessarily be in your best interests. They will, for example, want a say on the kind of assets you purchase or who you appoint to top management.

In the case of angel investors, you will likely have a close relationship with them or their representatives, who will also have a say on critical decisions. However, the ideal situation is to have an angel investor who also acts as a mentor and consultant to help you navigate your early days as an entrepreneur. Most angel investors are like this, although some only do it for the money and have a hands-off approach.

You may have seen, for instance, some contestants on the shark tank show choosing a specific shark even when there are better offers on the table because that particular person has more to offer in terms of mentorship, skills and networking opportunities. In the same spirit, you should be ready to look beyond money when choosing an external investor, especially in your early days as an entrepreneur.

These two funding methods are good so your choice comes down to your situation and what you are trying to achieve. Evaluate your status and business goals before you choose because the likelihood of ending at different destinations with either is very high. What do you think? Is bootstrapping the best choice, or would you get some external funding instead? Start your business today and reap the rewards of entrepreneurship!