Bootstrapping a New Venture

 

Successfully raising startup funding for a new venture calls for a celebration. The simple fact that a high net worth individual, corporation or institutional investor believes in the idea enough to invest is quite exhilarating. The idea was not too silly after all and the vision has been “validated”.

Third party capital enables the founders to invest further in product development, people, marketing and equipment. However, securing early stage capital does not guarantee success even if it does reduce the risk of failure. Many startups spend all the third party capital and still fail regardless of the potential exhibited. The dot com bubble era of the late 1990s is an example of what can happen when startups receive too much money too early.

Bootstrapping

Bootstrapping in the context of startups is a strategy that calls for survival without external financing. The startup funding is solely derived from the founders’ private assets, personal debt, and reinvested profits. The bootstrapping model requires extremely frugal or disciplined spending on carefully prioritized needs. The approach also gives entrepreneurs the leeway to build the product and business in line with their own vision rather than that of an external investor.

Personal Challenges

Entrepreneurs do not always require substantial capital to launch a basic version of their new products and service. The founder needs to conjure up a basic business plan that accurately reflects the desired bootstrapping intention. The future financial projections and forecasts should show that founders’ capital and customer revenues are both sufficient to grow the business.

Consequently, bootstrapping founders choose to make a significant sacrifice to launch the business. They commit their personal savings and wealth to the project, and decide not to bring in external investors in the short term. Such founders often downgrade their standard of living as a result.

Sell As Soon As Possible

The earlier the sample product or service is available to customers, the shorter the bootstrapping period and the higher the likelihood of success. Entrepreneurs should avoid unnecessarily delaying taking their product or service public. Such delays are usually ill-fated attempts to perfect the offering instead of getting invaluable customer feedback to improve specific aspects of the product. By a tragic twist of fate, scarce resources are wasted resources because the entrepreneurs spent more time in product development than in interacting with customers.

Even a limited launch or to a specific group of people would provide invaluable customer feedback which will prove to be vital to the overall success of the startup. It wouldn’t matter if the product doesn’t come in a shiny box or lacks the finishing touches. Many consumers are willing to participate in early trials and are helpful if they realize that the Company is willing to further improve the product to meet customer needs.

Raising Capital Only When the Time Is Right

The earlier you raise venture capital, the greater the percentage of equity you give up. This is because there is an inverse relationship between startup risk and company valuation. Bootstrapping philosophy therefore suggests that startups should target customers before capital. With a decent prototype in hand and an interested consumer base to cater to, the entrepreneurs can begin to generate small amount of sales.

Such sales help to validate the concept and enable the startup to achieve product-market fit. The perceived business risk is lower, and the financial projections would be more believable. Thus, the business’ valuation increases dramatically (if you’re a good negotiator). The entrepreneurs would have landed on the path to growth without having lost shareholder control by raising external capital too early.

Major Drivers of Startup Success

A new idea is hatched. The entrepreneur sets a new business venture in motion. There’s a ton of excitement and visions of the venture generating cash, wealth and fame. If a team is assembled, they are looking forward to riding a wave of success, or a rapidly growing paycheck (for the skeptical types). However, a few hiccups occur along the way….

Unproven Business Model

Many entrepreneurs focus too much on the business concept instead of designing and executing an appropriate business strategy. They believe a good product will stand out and sell itself. They build the product, open the store, and then realize that not enough people are rushing through the door. Progress is slow because pre-existing competitors spend lots of money on building awareness and marketing their products. It is foolhardy to assume a startup does not require some of the same. Market analysis and financial acumen are needed to figure out how to earn revenues and profits.

Startups must assess the needs and cost of acquiring different types of customers and carefully choose the target market. Unfortunately, even entrepreneurs with a “great” product fail because they spend all their money on building the product or setting up shop without figuring out what the customers want. It is like carefully cooking a plate of seasoned chicken to sell to vegetarians. It is critical to execute a well thought out strategy that is clearly focused on confirmed market needs.

Stronger Copycats

Most startup ventures are based on an idea that is believed to be unique. The founders expect the startup to grow rapidly and become a dominant player in the sector. Alas, it is guaranteed that every successful business venture will soon be copied. Other entrepreneurs and established companies in the same sector will develop similar offerings to sell to the market. Thus, the first mover must avoid being an unfortunate guinea pig. Otherwise, the second and third mover can side-step mistakes made by the first mover to become much more successful (think about AOL and Yahoo versus Google, or Myspace versus Facebook).

Idealism is great because it inspired the entrepreneur to initiate the venture. Realism, however, wins the day. The entrepreneur must figure out the specific offering and selling price that enable the startup to get the required level of customer revenues. After the initial launch, the first mover must keep innovating and raise growth capital for marketing its product and to strengthen its position. Flexible business plans and financial projections are required.

Partnership – Are Two Heads Really Better Than One?

Startups are often cash strapped because the founders do not have limitless financial or technical resources in the early days. After bootstrapping from the beginning, initial founders are eventually forced to partner with other co-founders that bring additional financial, technical or other resources. However, the world is littered with startups that failed because the partners did not have complementary visions, styles, or working relationship. One partner may want to sell $1,500 laptops throughout the US while the other partner wants to sell tablet devices specifically in the New York market only. Also, the bond between the partners must be strong enough to withstand lots of rejection and the dark days that almost every startup faces in the marketing and capital raising efforts. As a result, angel investors and venture capital firms keenly watch out for strong history and chemistry between startup management teams.

Startup funding: Navigating the issues

It’s been said that securing adequate funding is the most difficult aspect of launching a startup. However, most entrepreneurs are inherently confident of getting funded if they have a unique product and a strong business strategy. The latter view bubbles up because forums highlight the fact that wealthy individuals and institutional investors are constantly seeking opportunities to commit excess capital to attractive, fast-growing companies. Such investors wish to increase their wealth by taking equity stakes in “the next big thing”.

Who wouldn’t love to have been one of the early backers of Google, Apple, Coca-Cola or Goldman Sachs? Unfortunately, there are thousands of failed startups for each highly successful new venture. Perhaps rightfully, each entrepreneur needs to convince potential investors that financial returns will be high and major risks to the forecast have been mitigated.

Fortunately, modern society has come a long way from relying solely on funds from large corporations and wealthy individuals. The timeline and cost of launching a new business continues to decrease dramatically compared to a few decades ago. For example, one can easily go online to incorporate a new company from the home without needing to visit the registration agency. Reminder: two brilliant PhD students developed the original Google search engine project that has transformed into a $300 billion behemoth.

However a huge number of promising startups fail simply due to the entrepreneur’s resources drying up. Most entrepreneurs only have enough money to take the venture from being a brilliant idea to developing a basic product. Sales projections are always over-optimistic, and actual revenue is not enough to build the company. Much more capital is required to hire a team, generate brand awareness and grow the business. If the road gets tough enough, the founder abandons ship and goes back to the job market to earn a living.

Crowdfunding

Crowdfunding gives entrepreneurs and innovators a unique chance to present their startup ideas directly to the investing public. The best aspect of crowdfunding is the ability to easily reach a large number of people who either donate funds or invest in the startup on very favorable terms. There are over 400 crowdfunding platforms that offer various types of services to both the entrepreneur and the investors. However, the business founders need to get comfortable with any potential investors, and vice versa. While crowdfunding is a wonderful way for startups to survive the early periods of existence, there are various risks involved (such as lack of confidentiality and insufficient regulation).

Angel Investors

Angel investors (or “angels”) are wealthy private individuals that seek to invest in promising startup ventures in exchange for excess returns on equity. The ultimate goal of angels is to sell their stake in startups at several multiples of the entry valuation. These individuals are usually “accredited “investors – accredited by a government regulator in terms of possession of a minimum level of assets or income. These individuals are assumed to be capable of making informed decisions to buy into high risk startup companies that have a significant likelihood of failure.

Angels typically want entrepreneurs to have a product prototype, some sort of business plan (or investor presentation), and a successful track record. Extensive diligence is performed before the investment decision is made. The amount of capital provided to each startup by angels and angel investment groups ranges from $50,000 to $1 million.

However, it is imperative to tread carefully before agreeing to get funded by a particular angel. This is because it can be extremely difficult to separate from angels once they become investors in your company. Some angels are very demanding because they’ve put more cash into the company than the entrepreneur who just had an idea.

Venture Capitalists

Venture capital (VC) funding is one of the most popular forms of funding available to promising startups. VC firms provide significantly larger rounds of funding than angels, and therefore have even higher diligence standards and greater return expectations.

Although all VCs are not created equal, VC funding generally comes along with board membership, strategic guidance and follow on capital. Extensive media and public exposure also occurs. These are invaluable benefits that propel VC-funded startups to tremendous growth.

Even though VC funding offers significant rewards, there are some potential pitfalls. Like a marriage, VC investment also comes with strings attached and no holds barred. Getting venture capital too early can overvalue the startup with negative effects on later attempts to raise capital. For example, VC firms have a preset timeframe for selling their stake in investee companies. Missed financial projections and performance milestones can lead to a turbulent relationship, or worse, the initial founder getting completely sidelined.