Bootstrapping Versus Fundraising

by Shaun R Smith on August 9, 2011

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When should you bootstrap versus raise money through loans or equity?  I was speaking with a business owner last week about this issue, and it is a critical decision that can make or break a company.

Bootstrapping means that you are growing your company from your company’s profits.  You are growing from your growth.  This constraint limits your rate of growth.  You can’t leverage other people’s money to speed your time to market or to scale.

When you fundraise, you get an infusion of cash which enables you to jump ahead in the growth of your business.  When I’m referring to fundraising here it could be a loan or an equity investment from friends and family, a line of credit or loan from a bank, or an investment by professional investors (along with a bunch of other options – like vendor financing, customer financing, etc.).

In some business, bootstrapping is hard or impossible.  For example, when I opened my restaurant, I needed an infusion of cash to sign the lease, hire and train the team, and purchase the initial equipment and inventory.  Any capital intensive business needs money to start or to grow.

Many technology companies choose to fundraise to enable them to execute faster.  In some cases, the initial investment in the software development requires more resources than the founders have.   Some fundraise to buy customers to speed their growth.

When you have a choice, which should you pursue?  There are pros and cons to each.

If you get an infusion of cash, like we saw during the dot-com years, when you haven’t yet found your market, haven’t figure out your product or service, and haven’t developed your business processes, you can waste a lot of capital.  During the bubble, money poured into businesses that didn’t have a customer base or even a market for their goods or services.  And yet, the money was spent.

Many of these young companies didn’t have the expertise to build a profitable company.  In fact, the frenzy was fed by the notion that profitability is an old fashioned yard stick – and clicks are more important now in measuring a company’s success.  (Now, over 10 years later, the technology heavy NASDAQ still hasn’t reached its pre-bubble level.)

If your justification for fundraising is that you need more money to get to profitability, be careful.  In the service sector, this is almost never the case.  And in manufacturing or technology, make sure you’ve got enough affirmation from the market that they value your goods and services enough to pay what you need to generate to be profitable.

Call me old fashioned and conservative, but I actually like to see that a company that can make money before it starts leveraging other people’s money.  In addition, when you grow organically, chances are your mistakes will be smaller and relatively less expensive.  In addition, you don’t lose control of your company.

It’s an interesting time in the tech start-up space.   At the venture capital round, the money is starting to flow very freely again.  And valuations are being based on fiction.  Have we learned our lesson from 10 years ago, or is it Groundhog Day all over again?

 

Photo by: Jamie Welsh

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