I’ve been blessed to have talked to a growing number of young entrepreneurs over the past few months. One common concern for the would-be-startup-owner is funding. How do you get the funding to start?
The two general answers are bootstrapping and raising investment money.
There are other interesting fund-raising strategies arising, like crowdsourcing, but that’s a topic for another post
Before I give my bootstrap-biased opinion on this, let me give the easy answer first, which is: it depends on the idea.
THE EASY ANSWER:
Generally, you can look at the following things when determining which path to take:
1. Do you need a huge capital investment to break even?
2. How big is the market and how fast will it develop?
3. How strong are the barriers to entry?
This is a bit obvious. If your idea plans to generate a huge sum of money, but needs, say, P20 million in initial capital to start, then you probably need funding. If you are making a significant play on retail and do not have generous family members or friends, then you probably would need funding. This is why technology firms are so attractive – a mere ten years ago would need millions to set up an internet firm. Nowadays, the costs are becoming almost negligible. If you do not need a large sum to start, bootstrap.
Market Size and Growth
If you are planning to immediately take on a huge market, or a market which will grow really, really fast, then you probably need to acquire funding. Capturing a sizeable market requires investment (usually for marketing and sales). Witness Serenitea. They were the first milk tea place of its kind in the country (as far as I know). When competitors started appearing left and right, they suddenly had to put up a lot of sites (and invest in new technology, like those circular buzzers) to defend their position. Putting up those sites required funding.
Barriers to Entry
If your idea has low capital requirements to get started AND has the potential to be a big business, then it will boil down to barriers to entry. If your idea is NOT defensible (an individual with deep pockets can set up a competitor really fast), then it is advisable to acquire funding to capture market share immediately and seize the opportunity. If there is little chance for a competitor to beat you to scale because you are doing something really unique, or IP, then it might be best to bootstrap.
The guidelines above can be considered as general guidelines for figuring out how to finance your startup. Here’s my opinion though:
MY OPINION: As much as you can, always bootstrap.
Early this year we had an idea which, according to the guidelines above, was much better suited for funding than bootstrapping. So my team went around fundraising for P4-5 million. Established venture capital firms found the idea a bit too small to fund.
note: venture capital firms raise millions of dollars of funding for startups – but they can’t spread themselves too thin by spreading it out to too many small opportunities, they’d rather select few, bigger opportunities which have the potential multiplying their investment 10x, or even more, in 4-5 years
We then tried to go after Angels and other investment houses. Basically, we were trying to sell 20% of the firm for around P4 million of funding, at a P20 million company valuation. This was a typical way startups in the US did it, according to my extensive review of the literature.
Here’s the typical response:
“Idea sounds great, but if we are taking on the entire risk, then we would require 60%-80% of your firm.”
After getting the same quote from a good number of investors, we figured it was just a bit different here than what US literature suggests.
A team of bootstrappers, there was NO WAY we would have been amenable to those terms. So we regrouped, re-calculated our figures, tightened our belts, and basically, innovated. This new firm will now be launched within a month.
Here’s three reasons why you should try bootstrapping first before resorting to funding:
a) You are forced to be more creative
Spending your own, hard-earned cash will force you to have an augmented sense of fiscal responsibility, create a deep sense of urgency, and will make you exhaust all possibilities for solutions. Sounds like the ingredients necessary for a successful startup.
Spending other people’s money is very much akin to how most of us manage our credit cards – poorly.
b) You will have more power on the negotiating table
Once you generate traction (your business starts making money), then it is but logical that you will find yourself with more leverage on the negotiating table, in the event you want to seek investor money to finance further growth. If you have shown NO PROOF that your idea can work and you need money, then that 80% equity request will seem to be logical from the point of view of the one shelling all the cash out. Oh, and investors won’t treat surveys nor “research findings” as traction. You have to show money to show you are making money.
c) We often over-estimate market size, market growth, and competition
A number of the pitches I’ve seen reflect eye-popping numbers when it comes to market size and growth. Bluntly speaking, these are just guesses – and more often than not, the numbers will prove to be more earth-bound. More earth-bound numbers lessen the actual need for funding (in accordance to the general guidelines above).
Competition is also typically exaggerated. (Once people get a hold of this idea, it will spread like wildfire! So we have to act now!) After years of listening to ideas, I’ve yet to see an idea “spread like wildfire.” After all, it’s really in the execution.
Instead of market guesses, the best thing to do is to build an actual low-cost MVP, try to sell it, and gain traction.
In other words, bootstrap.
d) Why hire a captain of your own ship?
One HUGE reason I went the entrepreneur route was freedom. I wanted to be my own boss. If someone else buys 60% of your firm, then guess what?
You aren’t the captain anymore.
e) Raising funds is distracting
The first order of business when you have a startup is taking care of the product. You have to learn more about it, talk to potential and current customers, iterate, strategize, create. In raising funds, it’s easy to get distracted about the allure of raising millions for your startup. Then there’s all the “due-diligence” you need to work on, meetings to attend, figuring out the numbers. This can become a real attention grabber, keeping you from focusing on what is truly important.