6 Reasons Why You Shouldn’t Raise Funding Bootstrap Instead

Raising a round of funding is often seen as the ultimate stamp of approval for a startup — it’s widely covered in the media and can turn a bunch of average Joe’s in their dorm rooms or garages into perceived visionaries.

But while I was doing some reporting on entrepreneurs in Rhode Island, I found that many in the Ocean State ultimately choose to bootstrap. They start a company with very limited resources and no outside capital.

Unlike the two major venture capital hubs that Rhode Island sits between — Boston and New York City — the Ocean State has very few funding outlets, only about five or six venture capital firms.

Those that I heard from said they ultimately found the process of not raising funding to be extraordinarily helpful in their journey.

Recent data laid out by Mark Suster, an investor at UpfrontVC, also supports the argument that bootstrapping is on the rise. Suster’s data showed that seed investments less than $1 million and between $1 and $5 million were down by all measures in 2018.

Additionally, according to Suster’s research, funding round sizes of more than $100 million now account for 47 percent of all VC dollars, meaning while there may be more total capital out there, it is going to less companies.

Why this matters: There’s an uptick in early-stage startups choosing to bootstrap, not raising a round of funding. It’s not as headline-grabbing, but here’s why this is a really smart approach for founders.

1. Market validation is better than VC validation

Venture capital can give founders an inflated sense of validation. The market, however, never lies. If a product works, the market rewards it. The market can also be cruel, rejecting startups that most thought could never fail.

By hitting the market with limited resources, startup founders can discover very quickly — and with genuine feedback — whether they have a good idea or model. This way, they can also test their idea without putting everything on the line.

The other aspect that has made market validation almost a necessity is the way VCs now operate and how they evaluate startups. Ten or 20 years ago, there were more VCs that would give out money based on an idea or concept that didn’t have a lot of development behind it.

These days, most VCs want to see some traction — a prototype, some revenue or repeatable users — because seed rounds have gotten larger, making investments riskier.

So, even if a startup or founder intends to pursue VC funding, they will likely be forced into bootstrapping (e.g., Kickstarter) for a while to even get to a point where they can raise funding.

Along the way, the company may start to make sales, attract subscribers and build a strong social media presence. Those metrics alone may signal to the founder that they don’t need to go raise funding.

2. VCs require equity; bootstrapping does not

Raising funding is a tremendous accomplishment, but it also comes at a price, namely in the form of equity — most VCs are taking 20 to 30 percent of the business in the seed round.

A significant equity stake like that means giving up some control of decisions. But once you’ve gotten some traction on your own, the signals you are seeing from the market might give you strong indications about the direction of your business that not all VCs will agree with.

And if you have to go against your intuition, it may not be a good partnership.

Just ask Ben Chestnut, the co-founder and CEO of Mailchimp, which has never raised funding and always bootstrapped.

“Every time we sat down with potential investors, they never seemed to understand small business,” he told the New York Times, adding that VCs always wanted the email marketing company to serve large enterprise companies with thousands of employees.

“Everybody we talked to said, ‘You’re sitting on a gold mine, and if you pivot to enterprise, you could be huge,’” added Chestnut. “But something in our gut always said that didn’t feel right.”

With $700 million in annual revenues, I think it is safe to say that Chestnut made the right decision.

3. You don’t need venture capital to start a sophisticated business today

The fact that more investors want to see traction today makes it more appealing to bootstrap because it is cheaper to launch a business than ever before.

Abdo Riani, an expert on bootstrapping, reported that while it used to cost $5 million to launch a startup in the year 2000, it now costs less than $5,000 today thanks to open source software and cloud-based tools.

Additionally, the time to reach 100 million users has also decreased tremendously from 72 months in 2003 to a little over 2 years today, according to Riani.

Coffee shops, co-working spaces and the work-from-home trend has made office space very affordable or simply unnecessary, and digital tools such as Slack, Zoom, Trello or email marketing platforms like MailChimp, Hubspot, ConvertKit and GetResponse have made digital marketing and user acquisition much easier as well.

4. The time you spend fundraising is time you’re not closing sales

Take a look at the VC fund Launch Capital’s 2018 year in review:

The company started with 434 active leads and ultimately made 17 investments, which is less than a 4 percent investment rate.

That means a lot of startups are getting rejected and pitching can be a very timely process.

Think about all of the different steps involved in the fundraising process, which Forbes adequately lays out:

Gather your data on achievements and forecasting your financial needs

Prepare your pitch deck

Start reaching out to potential investors with your ask

Attend investor meetings

Field term sheets and proposals

Survive the due diligence process

Execute final documents and get money wired in

I couldn’t find any studies or articles on how long it actually takes to close a round from start to finish, as there is wide variation, but most articles I read and others I have spoken to say raising a seed round usually takes months and sometimes years.

Every pitch and meeting with your lawyers is time you are not dedicating to growing your company, so there are certainly tough choices to make when it comes to whether or not to seek funding.

5. VC funding does not bode well for startups with longer sales cycles

“Raising a round is not a milestone, it just means it’s time to work even harder because then the timer starts,” Sharran Deora, a Principal at San Francisco-based Digital Finance Group, told GoingVC.

Deora, who previously ran his own startup, is right because while raising funding often seems like a big deal, it also puts a lot more pressure on the startup and accelerates the big test of whether or not they will succeed.

After closing a round of funding, a startup has to hit targets, be it in sales, user acquisition or revenue before the money they raised is depleted.

If they don’t hit their goals, then raising that next round of funding or moving to the next level of growth is going to be extremely difficult and the startup could find itself in limbo.

These prospects often don’t bode well for startups with long sales cycles.

Take the fintech industry. There are a lot of startups in this sector that build their products and try to sell them to financial institutions like community banks and credit unions.

But the issue right now is that fintechs often build their technology in real time, while the backend systems of most community banks are built on technology developed in the 1970s and 1980s, making integration very complex for the banks.

This also makes banks weary to work with fintechs and the sales process all the more difficult.

Do you really want to start a timer knowing it could be a few years before you make any sales?

Don’t get me wrong, a lot of fintech companies selling to banks still raise money, but I’m sure this issue has stifled innovation at the early stage in this sector.

An entrepreneur I spoke with in Rhode Island named Annette Tonti confirmed this to me as well. Tonti runs The Innovation Scout, a platform that matches startups with corporations by using artificial intelligence.

“We are in a market opening the doors at the largest corporations like Mondelez, General Dynamics and Dupont,” Tonti told Rhode Island Inno. “These sales processes take some time so it wasn’t apparent that venture folks would be interested until we actually get to some level of repeatable monthly income. I’m not ruling out investors by any stretch — we have to get the signals that it will be worth their time, though.”

6. It trains startups to be lean

Having to be lean may sound bad at first, but entrepreneurs are actually realizing how great being on a budget is.

If you have lots of money, you are more than likely to spend it on things you simply do not need — limited funds forces the entrepreneur to create the absolute minimum viable product.

It also helps them determine if they can gain traction organically without a huge marketing budget or team of sales reps.

Can you get someone to refer your product or service to a friend? Are people engaging with you and giving you good feedback?

Money can’t buy these indicators, which also happen to be some of the best signals that your company is going in the right direction.

Additionally, as another entrepreneur I heard from pointed out, your business model or concept is likely going to change in the first few years, so wouldn’t you rather spend money once you have a better idea of what’s working.

“Another really important insight was knowing that how we would spend a dollar today might be very different than how we would spend a dollar six months from now,” said Adam Alpert, co-founder of the app Pangea, a platform that helps startups hire college students for projects and internships. “The longer you can wait to raise funding, the more impactful you can ultimately be with that capital.”