The Art of Bootstrapping

In today’s market, as extremely well-funded companies grow at exponential rates and achieve unimaginable valuations, the assumption that companies need angel and venture capital funding to grow has never been more prominent. However, fully founder-owned companies are quietly exiting at high valuations as well, with Mailchimp’s $12 billion sale to Intuit serving as just one example. Bootstrapping is the funding of a startup without outside equity investment, and almost every venture bootstraps for at least a couple of months following company inception. Some ventures, like Mailchimp, have managed to take bootstrapping techniques one step further and avoid raising equity financing altogether. While bootstrapping in this sense is a difficult feat, the premise of keeping 100% of profits and exit is tempting. This article explores how and why to bootstrap a company indefinitely.

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Is Bootstrapping Right For Me?

Advantages

Financial Awareness: Whereas companies raising financing rounds can sometimes spend money in ways that are inefficient to stimulating business growth, bootstrapped companies have no choice but to invest their money as efficiently as possible. Working with one’s own money brings about a heightened awareness of company spending and eases the transition to a “lean” business model by necessitating it.

Full Control & Maximized Returns: Without external investors, founder equity and control over the company is not diluted. This ensures that the company moves in the direction the founding team intended, in accordance with founder vision and values. It also means that profits produced by the company, whether through net income or through an exit, do not have to be split with investors.

Saves Founders’ Time: Raising money from investors is a stressful full-time job. Without this burden placed on founders, they can focus their attention fully on core aspects of the business such as product development and sales. Bootstrapping also makes it much easier to raise capital once the founding team needs or wants to, as investors feel much more confident investing in businesses with “sweat equity” and financial backing from founders.

Disadvantages

Lack of Capital & Higher Failure Rate: Because no outside capital is coming into the business, the success of the company relies on the founders’ personal capital contributions and their ability to generate positive cash flow. Due to the increased importance placed on the ability of the founding team to generate sales and manage cash flows, founders new to entrepreneurship or business in general may suffer from higher failure rates. Additionally, fully bootstrapped companies are vulnerable in the event of poor economic conditions or internal cash flow problems, due to the lack of outside capital they can rely on.

Growth & Overhead Limitations: Companies with high initial overhead requirements are unlikely to succeed as fully bootstrapped startups, because they need a large amount of capital upfront to start generating the revenue that the company would need to live off of. Another benefit to raising capital in a company’s early stages includes the acceleration of growth that comes with having cash on hand to deploy at the outset. In industries where rapid growth is crucial to compete with incumbent competitors, bootstrapped startups are going to struggle as well. Companies that must go without profits for a long period of time, such as BioTech companies, are also unlikely to succeed in bootstrapping because profit is needed to keep bootstrapped businesses alive in the short-term.

Lack of Investor Expertise & Networks: Most early-stage investors have either been entrepreneurs before and/or have domain expertise, as well as knowing high-level contacts that could be game changers for their portfolio companies. Oftentimes, the expertise or networks of a venture’s investors can be the difference between success and failure, but fully bootstrapped companies cannot reap these benefits because they do not have outside investors.

Debt: By cutting off access to equity financing, bootstrapped companies often turn to debt to service their needs for capital. While debt comes with advantages such as predictability and lack of the need to give up equity, it also comes with downside. Debt payments cut out of the revenue that bootstrapped companies ultimately need to grow and become a mature, self-sustaining business. Bootstrapped companies that rely too heavily on debt can find themselves shrinking rather than growing, for this reason. Debt also comes with covenants: financial and non-financial requirements beyond making payments that if violated, can drive a company into technical bankruptcy. Lastly, debt can also be difficult to obtain in a company’s early stages when it needs capital the most, because at this point in a company’s development it generally has a low credit rating. Fortunately, debt and revenue-based financing solutions tailored to startups are emerging from innovative firms such as Venture-RBF to address these problems.

Stress: Entrepreneurship is one of the most stressful pursuits in the world, but adding the constraint of lessened capital makes the job even more stressful. This is especially the case if the founder relies too heavily on personal loans or financial contributions from friends and family.

Exacerbation of Founder Equity Issues: Because bootstrapped companies rely heavily on founder capital, the differences between each founder’s contributions can become more obvious. If the distribution of equity across founders does not match the financial, time, and experience contributions of each founder, conflict may arise over time.

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Bootstrapping Best Practices

Stages of a Bootstrapped Company

1. Beginning Stage

The beginning stage of bootstrapping is one that most entrepreneurs experience, whether they decide to bootstrap indefinitely or not. In this stage, the business is financed from founders’ personal savings and loans, and/or borrowed money from friends and family. The founding team may start by working on the company as a side project, using income from their day jobs to fuel the business.

2. Customer-Funded Stage

In the customer-funded stage, revenues from customers keep the company in operation. Once operating costs are met, growth starts to ramp up.

3. Credit Stage

In the credit stage, the entrepreneur takes out various loans (on the business’s balance sheet this time) to fund large purchases and expansion projects, such as equipment, land, and real estate, or massive waves of new hires.

Financial Resourcefulness & Tactics

Once an entrepreneur decides to continue bootstrapping indefinitely, several financial considerations become even more important than they normally would be. Radical cost reduction and making early sales are critical when bootstrapping, as the first priority is reaching cash flow positivity and financial sustainability as quickly as possible. Once cash flow positive, the company can then start to think about the nice-to-haves. Before this point, company spending should be based on a strict budget rather than wishes.

Inventory minimization is one way to lower costs significantly. The minimization of inventory allows for greater efficiency of capital and reduces storage costs. There are many methods of minimizing inventory costs, but one virtually eliminates inventory from consideration. Some companies have successfully negotiated agreements with suppliers in which the supplier ships products directly to the firm’s customers. Though this only works with specific business models, it is worth considering when it is applicable. One reason why software companies are particularly good candidates for bootstrapping is simply because they have zero cost of replication and distribution.

Another financial consideration worth mentioning is how to finance the business. Founder contributions are the lifeblood of bootstrapped startups, but some practices such as incurring personal debt to finance the startup, can exacerbate the stress and financial hardship already inherent to starting a company. Key financial resources that bootstrapping companies can take advantage of include grants, government subsidies, and tax benefits. These financial resources can often be found with minimal effort and can ease the burden of financing a startup by oneself.

Business Model

Bootstrapped companies need to design their business models to produce strong, reliable revenues. A few factors to consider include:

Customer concentration: Don’t rely too much on one or a few customers for all of the company’s revenue.

Low churn rates/high retention rates: Design the product/service to be sticky with customers to avoid the high costs associated with acquiring new customers.

Recurring revenues: Structure the revenue model such that recurring revenues are produced rather than one-time purchases; subscription models are a great example of a revenue model that produces reliable revenues.

Profit margins: Developing high quality products/services helps companies justify charging higher initial prices; high gross profit margins facilitate top-line growth.

Ecommerce vs. physical retail location: Consider ecommerce over physical retail space; not only is ecommerce a preferred channel for many consumers, but it is far cheaper to run an ecommerce operation than a physical retail location.

Social Media Marketing

Social media accounts are free and if used correctly, can be an incredibly effective method of marketing. By using social media as a primary marketing channel, customer acquisition cost can be greatly reduced while still effectively marketing the business’s product offering.

Paying Employees

Bootstrapped companies need employees to grow, but often lack the cash they need to afford talented new hires. As such, many bootstrapped companies actively seek employees who will work solely for equity in the company and/or for a temporarily reduced salary until the company has the revenue to pay full salaries. Additionally, founders of bootstrapped companies will often take on multiple roles (especially early in the company’s development) to avoid having to pay for employees the business cannot yet afford.

Seek Advisors

Because fully bootstrapped companies do not have the benefit of leaning on investors for their networks and industry experience, seeking experienced advisors early on is crucial to a bootstrapped startup’s success. Not only can advisors provide advice, domain knowledge, and access to vast networks, but they also provide validation for the company to other stakeholders (i.e. potential employees, suppliers, & customers). Organizations such as the Small Business Administration (SBA) offer free or low-cost business advising.

Founder Equity Split

Splitting equity between founders is never straightforward but fortunately there are methods out there to reduce the tension and feeling of unfairness. A common method used in Silicon Valley is the 20/80 Approach. In this approach, founders determine the percentage of each founders’ contributions in the present and in the future. Twenty percent of equity is allocated to present contributions and eighty percent is allocated to future contributions.

So, for example, if at the inception of a company, two founders believe they have each contributed an equal amount of time/effort/capital to the company, but anticipate that the CEO will make 70% of future contributions while the co-founder will make 30%, the equity is split as follows:

CEO Equity Share: (0.5 * 0.2) + (0.7 * 0.8) = 66%

Co-Founder Equity Share: (0.5 * 0.2) + (0.3 * 0.8) = 34%

Another important technique in equity issuance is vesting (also used in ESOPs - employee stock options plans). By vesting, a founder’s shares are issued over a period of time rather than all at once, so if a founder quits the team, they only take with them the shares that they earned while working at the company. When using vesting cliffs, founders or employees are not issued any shares in the company until they have worked at the company for a predetermined period of time (usually 6 months to 2 years). A standard vesting schedule takes four years to issue all of the founder’s/employee’s shares with a one year cliff. Having a predetermined method of fairly distributing equity can ease the conflict inherent to splitting founder equity.

Cash Flow-Related Agreements

Trade credit: Trade credit is a method of borrowing from suppliers and service providers in which the company receives merchandise immediately, but pays for it after 90 or 180 days. This gives the receiving company the chance to collect cash payments from customers for sold inventory before paying the supplier while avoiding taking out loans to finance merchandise purchases.

Factoring: Factoring is when a business sells its receivables to a factoring company in exchange for immediate cash. The factoring company charges a factoring fee that generally comes right out of the cash payment to the business, ranging from 5% to 15% depending on the business’s credit rating and industry, as well as the condition of the economy. Factoring is a good way to obtain cash immediately when it is needed, particularly if the company has customers that take a long time to pay.

Office Space

Entrepreneurs bootstrapping their companies shouldn’t get office space until they have a comfortable amount of revenue to pay for it. For most companies, office spaces are nice-to-haves but are often treated as needs. This is why many famously now-massive corporations such as Apple and Amazon were originally run out of basements, garages, and parents’ homes. It is also worth considering going fully remote considering all the cost savings associated with working remotely and the existence of advanced conferencing and collaboration tools to support remote work.

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While bootstrapping may not be the easiest entrepreneurial path, it can be the most rewarding, profitable, and values-aligned approach if the founders successfully execute an effective bootstrapping strategy.