Every year, many startups fail due to a lack of cash. Many founders spend a long time searching for and contacting investors before they have a product/market fit. Although a few entrepreneurs are lucky enough to raise funds with just an idea or prototype, most are not. In many cases, bootstrapping can be the best option for early-stage startups. This article will discuss bootstrapping and the perfect time to raise an investment.
Many successful startups started with little or no money and became giants. Microsoft started by bootstrapping. The only investment it raised was in 1981, after which it reached a value of $20 million. According to Bill Gates, Microsoft raised only $1 million from TVI – Technology Venture Investors – just to get them on board. Although they didn’t need this money at the time, having the venture capital team on board was extremely useful.
In addition, many successful startups didn’t raise an investment at all. For example, Zoho has been relying on bootstrapping from the very beginning. It started with only an online word process. Later, it expanded its portfolio to include many other products, like business CRM, mails, contact management, etc. In addition to Zoho, many 100-million-dollar startups didn’t raise money at all. TechCrunch, POF, ESRI, and Storm8 are just a few examples.
It is worth noting that there is one sector in which bootstrapping have a high chance of success: the software / IT sector. Software startups don’t have to build factories or hire large teams to succeed. In addition, they don’t need to make any investment to sell an additional license, subscription, or usage. Today’s technology, such as Software-as-a-Service (SaaS), make it easy to launch products without raising any investment.
On the other hand, most sectors other than software cannot go into operation without first raising investment. Even in the software sector, startups that cannot charge their users from the first day will definitely need some funds to survive. In addition, bootstrapping may not work for startups that must reach large customer bases before becoming profitable. Many giants raised billions of dollars before becoming profitable, like Amazon, FedEx, and Tesla.
Pros and cons of raising investment
Everything in life has pros and cons, and raising funds is no different. Let’s start with the pros. Startups that raise funds can proceed faster than those that bootstrap because investors like to see their money work. Therefore, those who raise funds are more likely to spend it on customer acquisition, increasing scope, improving product, etc. On the other hand, those founders who bootstrap are very careful about spending money. Moreover, they tend to think a lot before they make decisions due to their limited resources.
In addition to the money, angels and VCs provide startups with experience. In some cases, acquiring this experience can be the only reason why founders decide to raise money. According to Bill Gates, the only reason why Microsoft raised investment was to acquire the experience of the venture capital team. Having angels or VCs on board can save founders lots of time and effort. In addition, they have a wealth of contacts who can help the entrepreneurs on their journey. These contacts can also help the startups establish strategic partnerships in a very short time.
What about the cons? In my opinion, raising investment in the early stage can have many disadvantages. The first one is the equity that investors take. A startup is like the founders’ child. The loss of part of it will definitely lower their interest. In addition, raising funds usually leads to some loss in control. Many angels may force founders to move in a direction they don’t want to move. In most cases, this direction is better for both the founders and angels. However, if the founders are not 100% convinced about this direction, the results may be catastrophic for the business.
In addition, raising funds can be time-consuming. Founders usually spend three to six months before closing a deal. During this time, angels will make the key founders busy preparing lots of documents. Moreover, reaching the right investors can be a challenging process. Founders may spend months searching for those who are interested in their business. This hectic process can be very harmful for the founders if they cannot make progress during this time (like improving the product, acquiring new customers, etc.).
Accelerators are no different from VCs and angels. During the incubation time, founders may receive contradictory advice from their mentors. Moreover, most accelerators focus on helping founders raise another round. If the product wasn’t already established in the market, they would lose the time they spent in the accelerator, in addition to the time they spent convincing investors.
The perfect time to raise
According to many experts, the perfect time is when the startup has secured at least one stable sales channel. Many angels avoid startups that have no clear revenue model. In addition, meaningful traction is the best proof that a need exists for the product. Although revenue is important for most angels and VCs, it is not the only factor they consider. In addition to revenue, traction includes user count, traffic, profitability, engagement, etc.
Traction will increase the startup value, which means the founders can give less shares to investors. In addition, metrics in hand (like customer acquisition cost, customer lifetime value, and monthly growth rate) will help founders determine how much funds they need. Finally, traction will shorten the time the investors need to make up their minds.
Convertible notes vs. equity
Convertible notes, also known as convertible debt, constitute a sort of bridge financing in which founders get money in the form of debt from business angels until the next round. To reward those angels, these notes must have a high interest rate (usually between 20% and 25%) and a capping value, like $10 million. For example, if a startup is currently valued at $2 million but is expected to grow to $10 million in the next round, which may be after one year. If they are raising $500K with equity, they must give them 25% of the startup. However, if they used notes, they must give only 5% in addition to 1.25% for interest.
In most cases, these notes have many advantages over equity. First, they can save lots of time and effort when negotiating with angels about the startup value. Second, most investors will take 20% to 30% shares in each round regardless of the amount they’re investing. These notes can be a workaround to this rule. Finally, such notes will keep control of the startup with its founders for a longer period of time, as they will retain the stock majority.
However, as with everything in life, these notes can have some disadvantages. First, most angels prefer to get shares for their money. They believe that the risk they took when investing in early-stage startups should be rewarded with shares. In addition, many of them will refuse to invest in startups that offer them notes instead of shares. Moreover, if for any reason the startup doesn’t grow at a higher rate than the agreed-upon interest rate, the founders will end up giving them more shares. Finally, angels who get equity are usually more willing to help than are those who get convertible notes.
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