Having a brilliant business idea is only the first step in building a startup. The next most crucial decisions involve bootstrapping vs. seeking external funding. Entrepreneurs need money to get their new companies off the ground. The question arises–where to get it?
Founders can either invest their personal savings and earnings into the venture. Or use credit cards and open lines of credit where they are personally liable. Alternatively, they can acquire that funding from external sources. These sources can include crowdfunding, incubators, venture capitalists, accelerators, bank loans, or angel investors, to name a few.
Each funding source comes with its set of pros and cons. Before working out the best option, it’s advisable to make comparisons and consider all the relevant aspects. These criteria may include the product niche you intend to develop, existing brands, target market, and competition. Also, factor in the industry where you’ll work and personal and business objectives.
The Ultimate Guide To Pitch Decks
Statistics indicate that close to 500,000 new businesses open in the US each month, with just 6,000 attracting angel investment. Banks may lend support with SBA-guaranteed loans to less than 100,000 businesses each year but also require collateral. As for venture capitalists, they may invest in around 500 startups.
On the other hand, 78% of startups are established using the founders’ personal savings. Attracting external investment is a lot more challenging. However, you should weigh bootstrapping vs. seeking external funding carefully before making the final decision. Read ahead to understand in detail how.
Understanding How Bootstrapping Works
The art of bootstrapping a startup is using personal savings and income to set up the business. Entrepreneurs may use cheap or free-to-use resources to economize on the initial costs. They also rely on home premises and reinvest the early revenues to scale the business.
Getting customers to prepay for their products and social media for free advertising are other strategies you can use. Also, consider using free WordPress templates for setting up your website and partnering with a co-founder to share resources and manpower.
Offering free beta versions and discounted pricing works well to attract customers. You can use their feedback and reviews to improve the product design before selling at full price in the open market.
Savvy founders preferring to maintain control over the company’s operations may try crowdfunding strategies and repay loans with products.
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Understanding How Early-Stage Startup Funding Works
The difference between bootstrapping vs. seeking external funding is that you’ll approach investors for money to set up the business. Several sources of financing are now available to entrepreneurs.
Aside from actual liquidity to build the venture, they may also offer resources like industry-specific expertise, mentoring, professional advisors, workshops, and more. Depending on the investors you work with, you could also access networking opportunities, staff assistance, labs, and other tools.
Some of the most successful startups that were acquired by industry giants include Zappo, Dollar Shave Club, Slack, and Instagram.
Here are some of the best sources of external funding you can tap into:
- Venture capitalists
- Angel investors
- Bank loans
- Crowdfunding platforms
- Friends and family
- Government grants
- Pitching competitions
- Personal funding
- Institutional investors
Getting funding from third-party investors typically comes with strings and several downsides. Losing control over the startups’ decision-making processes and being accountable every step of the way are only two of them.
If you do choose to acquire external funding, three options are available:
- Equity financing: Entrepreneurs offer equity in the company in exchange for funding. This means that investors retain part ownership of the startup and get compensation when it starts earning revenues.
- Debt financing: Founders borrow money from investors and pay it back at a pre-determined time with interest,
- Convertible notes: Investors have the option to convert their debt into equity or stock when the startup becomes successful.
Comparative Analysis – Bootstrapping Vs. Seeking External Funding
Availability of Resources
Considering that funding is the lifeblood of any startup, the lack of resources can be a serious snag in setting up and scaling your company. Limited resources will mean that you’ll cut corners when hiring the best talent.
Whether it is investing in updated technology and equipment or aggressive marketing, a lack of funding could make it harder to overtake the competition. When it comes to scaling the company, you may have to rethink decisions until it starts generating revenues. Only then can you reinvest the earnings and grow.
Additional resources enable founders to take more risks and experiment with new product designs that could be challenging otherwise. Most importantly, the money adds flexibility to the business model enabling pivoting to suit changing commercial spaces as needed.
On the flip side, working with limited funding ensures that you won’t take unnecessary risks and curb spending unless absolutely essential. The company will be leaner and have a stronger foundation, with a founder who practices efficiency when using available resources.
Control Over the Company
One of the primary concerns entrepreneurs have when considering bootstrapping vs. seeking external funding is the possibility of ceding control. Acquiring funding typically comes with accountability. Investors may require a seat on the board of directors or insist on overseeing any critical business decisions you make.
Getting approvals from investors can be a time-consuming process. When you need to make quick decisions to suit evolving market conditions, delays can be costly. Having stakeholders on board can make also lead to conflicts that can interfere with the company’s growth.
At the same time, having experts on board ensures that you make prudent decisions after considering all the relevant aspects.
Pitching to Investors is Challenging
Getting funding for a new business idea is a long, brutal, and complicated process. Entrepreneurs must often wait for 6 to 9 months before they can find the right investor who could be interested in their concepts.
When you have a groundbreaking product design, you’ll want to launch into the market as soon as the problem is identified. Sometimes products are time-sensitive, and you cannot wait that long before the competition catches on. For example, an innovative application or device.
Even if you can acquire seed funding, reaching your next fundable milestone could take anywhere from 12 to 18 months. This is why it is more advisable to rely on bootstrapping or friends, family, and colleagues for low-cost microloans.
On the other hand, certain products and markets need a high initial investment. And the only way to get the money is to work with investors who can not only provide the funding but also assist you with the expertise and networking opportunities you need.
Keep in mind that in fundraising, storytelling is everything. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
Access to Expertise and Mentoring
Setting up and running a successful company involves several other aspects, such as legal, technical, marketing, administrative, human resource management, and more. Every founder cannot be proficient in every aspect, which is why they need expert assistance.
Signing up with an incubator or accelerator program or partnering with a venture capitalist can get them industry-specific expertise. This expertise and advice can be invaluable when transforming a business idea into a Minimum Viable Product.
Incubators and accelerators provide workshops and premises equipped with the latest equipment and tools for research and development. You’ll get the opportunity to interact with other founders and toss around ideas. These interactions can form the basis of successful partnerships down the line.
An added advantage is access to their investor networks. Startup owners can make valuable connections and hone their networking skills. As the program comes to an end, they train in creating a pitch deck and presenting it to an audience. Pulling this off successfully means that they can walk away with seed funding for the new company.
On the flip side, a successful pitch does not always guarantee that you’ll get the asking amount. Investors conduct due diligence when valuing the company and may consider it worth less than the funding you’re looking for.
Validation for the Business Idea
Ideating a brilliant concept is easy, but entrepreneurs often lack the experience to know if it is worth exploring. Investing your personal finances could result in losses if the idea doesn’t have potential. Pitching to investors provides validation that it is viable enough to attract funding.
Getting that first investor to fund the project is often enough to get the ball rolling. When you’re ready for further rounds, your credibility and reputation will make the process easier.
Dilution and Taking on Debt
When weighing your options between bootstrapping vs. seeking external funding, a critical concern is the debt you’ll take on. Getting investment from external sources involves ceding equity of the new startup. You’ll give up part ownership, which means diluting the founder’s stake in the company.
Another downside is the funding terms and conditions. Investors lay down conditions that will protect their investment, and you’ll deal with a lot of documentation and paperwork. Further, the restrictions may get in the way of being flexible with the business model, which could prevent it from staying agile.
Founders should also be mindful of the cost of that investment and the interest rates they’ll pay. Relying on bootstrapping can mean saving on that interest and the equity, which could ultimately result in running the business more economically.
On the upside, getting external funding reduces your personal risk. Instead of sinking personal savings and paychecks into the venture, you’ll rely on venture capital and investor funding. When you can’t be sure the company will generate profits, risking credit card bills or bank loans isn’t advisable.
Pressure to Scale Quickly
Since investors are looking for returns and interest on their loans, founders start to feel the pressure to perform. You could try to scale the company before it is stable enough just to maintain revenues and financial projections. This factor could be a downside to the sustainability of the company.
Entrepreneurs could end up making hurried decisions that have negative impacts. With bootstrapping, they can take their time without worrying about meeting financial targets. Maintaining the company culture and keeping its mission intact can be challenging with external investment.
Are you looking for more detailed information about how to raise startup capital for your business? Check out this video where I have explained in detail your options and how to access them.
In A Nutshell
Bootstrapping vs. seeking external funding–the ultimate decision is critical and can influence the company’s future growth trajectory. Several criteria come into play here. You’ll determine if the product is unique and needs a high amount of funding to develop the prototype.
Some founders are not confident of the concept and unwilling to risk external funding. Or preferring to scale the startup a little before bringing in investors.
Then again, you might have an established customer base with the option to grow the business with the revenues you earn.
If this is you, bootstrapping may be the way to go. But, if you’re developing high-value products with high initial capital investment, getting external funding could become essential. Certain products also need an experienced team to build and market.
If the startup needs partners and expertise to get off the ground, go for external funding and ensure its long-term growth and success.
Make the final decision after weighing the pros and cons carefully!
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