🦄 vol. 48
claude chats about bootstrapping vs external funding 💸
bootstrapping vs external funding 💸
When it comes to getting a business off the ground, there always comes the age-old question: whether to bootstrap your company, or try and raise external funding?
This decision is not to be taken lightly. It has implications for how you structure your business and ultimately can determine the success or failure of a business.
Let's go through the terminology. 📖
Bootstrapping, also called self-funding, refers to the situation in which an entrepreneur starts a company with relatively little capital and relying on money other than outside investments. They build a company from personal finances or the operating revenues of the new company.
In contrast, external financing involves raising capital through bank loans, angel investors, venture capital firms, etc.
Like with most things, there are advantages and disadvantages between the two approaches.
Full ownership: When you bootstrap your business, you and your co-founders will remain the sole owners of your company, your team receives 100% of the 💰.
More control: Without investors who you have to appease, you have better control over the direction you take your company in.
Financial risk: Putting your own money into a company means that you directly are impacted by any failures of the business.
Less credibility: It can be harder to find the requisite resources to build up a brand and prototype a product without the backing of established investors.
Slower growth: It can be difficult for a bootstrapped company to achieve exponential growth. A more constrained budget means less money for marketing channels, less money to hire more resources to build out functionality faster.
There are a lot of examples of big companies today that successfully bootstrapped themselves…
Meta (formerly Facebook): In 2004, Mark Zuckerberg launched “The Facebook”, a social media website he had built in order to connect Harvard students with one another.
Nike: While it was still called “Blue Ribbon Sports”, founder Phil Knight funded his sneaker business through bank guarantees for years before pivoting from the low-margin importing of shoes to producing (in-house) high quality products.
External Financing 💸
Accelerated growth: External financing allows companies to fund growth projects that their regular cash flow would not allow. For example, new factory space and machinery to increase output to meet growing demand.
Advice and expertise: Good external sources of funding usually offer more than just finance. Established VCs, for example, have connections with many resources of expert advice, be it legal, technological, financial etc. Upon securing funding they are (typically) invested in the success of the business.
Ownership: Some sources of external financing require an entrepreneur to give up part ownership of the company in exchange for the funding. This is often accompanied by loss of control. For example; an investor would have a say on company direction.
Interest: External funding sources require a return on their investment. Banks require interest on loans, investors require a rate of return.
When to use each approach ⌚
Choosing a means of funding is heavily dependent on the stage the business currently finds itself in.
Tim Berry talks about a sweet spot at which it is appropriate to seek out funding. This point exists between inflection points. Inflection points are points where a business’ value changes significantly within a short amount of time (see two dotted lines above).
Valuation in the context of the graph refers to an agreed upon exchange rate of equity vs money. The higher the valuation, the less equity an investor would get for the same amount of money relative to earlier in the business’ lifetime.
After the first inflection point, there is reduced risk to potential investors because the need has been validated by meeting some initial milestones, such as developing a minimal viable product (MVP), onboarding users, registering intellectual property, satisfying regulatory constraints etc.. This translates into the value of the business increasing. The business has proved its utility.
It is after this point that external funding can be put to good use as the company has a clear idea of where to apply the extra capital and the investors have a good idea of the viability of the company based on real data.
The extra capital can help:
Fuel the exponential growth seen after the second inflection point based on a proven concept.
Can de-risk continued growth of a business whose core product might be easy to imitate through other (better funded) competitors.
Some key takeaways to keep in mind:
Never take on investment capital unless it is really needed: There is a high price tag attached to accepting funding. Diluting too early leaves founders with lesser equity and lesser control for future fundraising needs.
Investors should have more to offer than just money: Good investors should ideally be able to offer access to otherwise hard to obtain resources, such as other founders and individuals with expert knowledge that can help propel the business further.
It’s often a question of when: Even if they started off by bootstrapping, most large companies end up taking funding at a certain point in their lifetime to fuel their growth. (e.g. Nike, Facebook).
“Bootstrapping is a way to do something about the problems you have without letting someone else give you the permission to do them.” - Tom Werner
matt enjoyed this pod, that covered everything from scaling businesses to dopamine detoxes