Bootstrapping: When should startups seek to raise external funding?

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Startup stories seem to follow a time-honoured tradition: a brilliant idea bankrolled to success by investors. While many tech startups look up to this formula, some explore alternative routes, one of which is bootstrapping.

The etymology of ‘bootstrapping’ implies an impossible task: to pull oneself up by one’s bootstraps. It’s a fitting illustration when you consider the limitations of bootstrapping for startups. A bootstrapping entrepreneur is one said to launch a business with little or no outside cash or other support.

However, bootstrapping a business to a significant point in its life cycle is not impossible.

Craig Newmark started Craigslist, the classified ad site in 1995 as an email newsletter to update ten to twelve friends on interesting events around San Francisco. As it grew popular, people asked him to list items for sale and post jobs and by 1997 the site had hit a million page views per month.

Newmark didn’t take any outside money until 2004 when eBay paid $32 million for a stake in the company. However, this resulted in a lawsuit that ended in 2015 with a settlement and Newmark bought back the stake sold to eBay. Craigslist does not publish its figures, but in 2018 according to Florida-based research firm, AIM Group, the company made over $1 billion in revenue.

TeamApt, a fintech startup in Nigeria, bootstrapped to profitability within two years, before raising external funding, citing a need to evade the trap of investors’ influence that might put a cap on spontaneous innovation. The founders were instead focused on creating value as a first step before considering venture capital.

CEO Tosin Olorunda said: “Since people will jump on you when you have value, it’s better to prove that you have value first, then come back to place a demand on that value.”

By the time TeamApt raised its Series A funding earlier this year, it claimed 26 African banks as clients and $160 million in monthly transactions, with yearly revenue running into seven dollar figures.

Olawale Adebiyi, CEO of Wecyclers Corporation, a Lagos-based recycling company, also highlighted the curtailment that can come from venture capital: “Once you begin to raise capital from investors you have to work with the investor on understanding their goals and making sure that your vision is aligned with theirs.”

But despite the success stories of firms like TeamApt and Craigslist, seeking outside funding still remains the most efficient method for startups to raise funding.

Capital intensive ideas require more funding than most founders can afford by bootstrapping, leaving a gap that venture capital is ideal to fill. For TeamApt, they were able to close deals from the word go. “To start, we closed a deal with Computer Warehouse Group to build a payment solution for them and that’s how we started bootstrapping,” Olorunda said.

Craigslist’s capital efficiency is also implicit from its present estimated revenue compared to the number of employees; fifty, and the company’s bootstrapped status.

However, consider WellaHealth’s story; the founder’s projections at the outset had promised a smooth ride to profitability on his personal savings.

Ikpeme Neto, founder and CEO of digital health startup WellaHealth, told me: “When I started out as a founder, I didn’t really think of fundraising as an option. I didn’t know anyone who had done fundraising personally and besides, my financial projections told me I’d be printing money well before I touch up to half of my startup capital from my savings.”

“Of course business didn’t obey the spreadsheet formulas so I quickly found myself short of cash,” Dr Neto explained.

Lacking external funds to keep the business alive, he changed direction to launch a product targeted directly at consumers (B2C), instead of other businesses (B2B).

WellaHealth’s previous product had been capital intensive, and its only chance of survival was a large inflow of capital.

“With the B2B model, growth was definitely hindered by bootstrapping. We couldn’t hire the sales force to go sell until we had enough revenue to pay them. So we trudged along, creatively finding ways to stay alive,” Neto said.

Neto recommends bootstrapping at the initial stages, “or at least having a bootstrapped mindset until just before product-market fit, then raise money to grow rather than to figure out the market.”

From his perspective, bootstrapping teaches startups to listen to the market and move closer to product-market fit: “Not raising [external funds] meant product and sales were super important. I couldn’t spend money wantonly to attack any problems I had. Always had to go back and speak to a customer to understand them better.”

Ochuwa Akhigbe-Ogionwo, Operating Principal at African venture capital fund, Lateral Capital, explained that investors have varying preferences when it comes to what stage of a startup’s life to get involved.

“Angel investors typically look to idea-stage entrepreneurs seeking seed capital, while venture funds tend to look at startups that have achieved some level of product-market fit, and private equity investors come in much later,” Akhigbe-Ogionwo said.

Akhigbe-Ogionwo advises founders to bootstrap their startups for as long as they can afford it, as this prevents dilution early on. Dilution is what happens when a startup exchanges equity for funding from investors.

“But don’t wait until you are almost out of cash and desperate as investors can sense desperation,” she said.

Founders may give up more equity than is fair if in a weak bargaining position.

VCs do not consider all businesses a fit for their portfolio and they are interested in businesses with growth prospects. “There has to be a clear path to scalability for venture dollars to make sense, and a desire to have a partner involved in your business,” says Lexi Novitske, a Lagos-based VC investor who is Managing Partner at Acuity Venture Partners.

And when a startup does not fulfil its destiny of gigantic growth, in the event of a sale “founders and early investors in a preference stack will not be compensated for their blood, sweat, and tears,” she added.

Preference stack refers to the predetermined order in which the money that is made from the sale of a startup is distributed to its shareholders. VCs usually have priority over founders in this stack as a form of insulation against the high risk of startup investment.

Ultimately, the question of whether to bootstrap or not – and when to seek external funding – is at the founder’s discretion, with the business’ goals and circumstances as determinants.

Source – techcabal

Published in Startups

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