Guest Post (Response): Bootstrapping is the New Black

As part of our commitment to bringing you information and opinions about entrepreneurship and technology, this Guest Post features regular contributor John Seiffer, small business advisor, angel investor,and President of the Angel Investor Forum of Connecticut.  Through programs like his “Bootstrapper’s Bootcamp,” he helps a different type of venture grow in a different way.  John’s Guest Post is a response to a recent post by Elon Boms entitled “We Need More Angels.”

There’s a Lot Going on in Connecticut

In my work, I see a lot of companies looking for investment. At the AIF (Angel Investor Forum) where I’m president, we screen a few hundred companies per year, ask a couple dozen to present to us and actively pursue diligence on 10 or so.

And what’s new since Elon Boms paid attention to AIF is we just closed our first fund a couple of months ago. It has already made 2 investments, and AIF members have added on to those investments: in one case more than doubling what the fund put in.

Plus I mentor or judge at a couple of startup weekends each year and go to 5 or 6 accelerator demo days. As I said, there’s a lot going on in Connecticut. And I agree with Elon, that we still need more angel investors. To that end AIF has already scheduled a training session on September 19th open to anyone who’s considering becoming an angel investor. Details here. End of shameless plug.

But I also have my foot in another camp. I’ve been an entrepreneur since 1979 starting and running companies – none you’ve ever heard of. They’ve all been bootstrapped – companies that I grew and profited from with no outside funding. And I’ve been consulting since 1994 primarily to people who run such companies. The difference between bootstrapped companies and those with outside investment is quite stark.

The Entrepreneurial World is Changing

The problem I see is that everyone thinks starting a company and raising money go hand in hand. They don’t, but you’d never know it from reading the press. Until now. But from my perspective, with a foot in each camp, I see things changing. Or rather changing back. You see, there was no venture capital industry before the late 1940’s. And some pretty big companies were started back then. Many are still around, like IBM, AT&T, GM, Xerox. Even into the 70’s and 80’s when companies like Microsoft and Oracle, and Dell were started – they didn’t go after outside investment first. They first went after customers.

Only in the last 20 years or so has raising money become the first thing entrepreneurs think of. But in the last few months, people are starting to see the error of that approach. Don’t get me wrong – there’s a place for angels and VC’s in the entrepreneurial ecosystem. I’ll get to that in a minute. But here’s what people are missing.

The kind of investment that’s right for your company is not up to you – any more than the size of your shoes is a fashion choice. The style of  your shoes is your choice, but not the size.

I hear from entrepreneurs all the time why they need money. They’ll grow faster, hire more sales people, get new features added etc. But investors don’t invest to grow your company. They invest to get a return on their investment. If people sold products the way they ask for investment they’d be saying “You should buy my stuff because then I’ll be able to upgrade my internet service to a faster line.” It doesn’t matter whether investment will make your company better – but whether your company makes a good investment. And in my work I see a whole lot of really good companies that are lousy investments.

A Good Company is not the Same as a Good Investment

The idea that there’s a difference between a good company and a good investment is starting to gain traction. Have you heard about the Series A crunch? Companies that got some early seed funding, now can’t get funded when they need to raise $1 million or more. Maybe they should have gotten their seed funding from selling their product to customers rather than selling their concept to investors.

Did you read this profile of 2 companies in the same industry? RJMetrics got started with $10,000 of bootstrapping money and got their first customer in 3 months. GoodData went for funding first and has now raised $75 Million. The founders of the RJMetrics own 80% of their company. Not so for the founders of the GoodData. And the money quote:

…if RJMetrics were to sell for, say, $50 million, the founders would be set for life financially. If GoodData were to sell for $50 million, it would be a disaster.

And just today, arrived in the mail, a copy of INC magazine with an article about a company – ESRI – that does almost a billion dollars in revenue, and has grown for 43 years without a layoff or downsizing. Here’s what Jack Dangermond, co-founder says.

One thing that has made us so successful is that we’ve never taken outside investment. That means we can concentrate on what our customers want – not what the stockholders or VCs want. That’s a strategic advantage.

In the last 10 years or so, the cost of starting many types of companies has come way down. Between cloud computing, hardware getting cheaper, open source software being more powerful. Hell, you can even get a 3D printer for under a thousand bucks. That reduces much of the cost and risk of getting a product to market.

Add to that the newly discovered concepts of learning entrepreneurship. The phrase “business model” is not just a change in terminology replacing business plans and competitions. It is in fact a new way to start a company with less risk. Customer Development, Lean Startups, Business model canvases – these are all new ways to help entrepreneurs earn their craft faster and better. So they can start companies more rapidly, with less capital and with less risk.

Bootstrapping is Becoming more Well Known

So why aren’t more companies bootstrapping? They are. And I think you’ll see the press reporting on it more and more in the next few months. Things work differently when you bootstrap a company. You focus on getting cash in fast from customers. You learn quicker what customers want to pay for. You grow slower, but when it works, you end up owning more of your company. And all that time that others spend raising money? You can spend it growing your company.

According to Chris Dixon (himself a VC with Andreeson Horowitz)

There are lots of tech companies that are very successful but don’t fit the VC model. If they don’t raise VC, the founders can make money, create jobs, and work on something they love. If they raise VC, a wide range of outcomes that would otherwise be good become bad.

The numbers support this concept. At least 500,000 companies get started every year in the US. Many people are surprised to learn the VCs only fund about 3,000, angels probably fund another 60,000. These numbers are approximate, but the order of magnitude is right. That leaves a lot of companies to bootstrap. Why? Not because they can’t find investors, but because their model isn’t right for equity investment.

What is the right model for raising money from equity investors? When you can generate the kind of returns investors need. At minimum that means being able to sell your company and returning to investors 10 times their money in 5 to 7 years or 3 times their money in 2 to 3 years. Minimum. That generally happens when one of the following is true.

  • You have a market that’s large enough to create a billion dollar company.
  • Your market is large AND is such that there will only be one key player (like eBay) so you have to grow very fast to annihilate all the competition.
  • You have invented some technology that’s protectable and desirable to an acquirer for strategic reasons.

These returns generally don’t happen when several others are pursuing the same idea, when your technology can be easily replicated, or when your success depends on the whims of fashion. In those cases you can make a very good bootstrapped business by executing well, but it’s much harder to have an exit that gives investors the returns they want.

A strong ecosystem emerges when there are companies at every level and scale: Those that should be funded by angels and VCs and those that should bootstrap. But equally important is that entrepreneurs learn what it takes to make a strong company and learn which kind of funding is right.

 

About Michael Romano

One comment

  1. Excellent post. More companies should bootstrap. Bootstrapping forces entrepreneurs to be more disciplined and enables solid organic growth. I’ve counseled several of my clients to bootstrap after they’ve hired me to write a business plan so that they could raise outside funding. Each case is different, but John’s points are spot on. I’m co-writing a book on entrepreneurship which also supports the practice of bootstrapping.

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