Given the current economic conditions, it’s gotten a lot harder for startups to raise the kind of funding rounds that were once the norm a few years ago.
Either by choice or because they haven’t been able to close a round, this has led many startups to consider whether the VC path is actually the right one for them or whether they are better off trying to bootstrap their business.
However, this isn’t a decision that should be taken lightly and there are a multitude of factors (ranging from product, company, founding team, market, etc.) that largely determine which path is right for you and your software business.
I’ve been fortunate to be part of 3 startups (Invision, Campaign Monitor and SafetyCulture) that have taken a combined $830 million in funding as well as bootstrapped several startups myself, and have spent a lot of time thinking about why and when VC funding should be taken on.
Why bootstrapping vs VC could be the single most important decision you make
Rand Fishkin, the founder of well known SEO software company Moz, wrote a brilliantly open and honest book called Lost and Founder a few years back. In the book, he uses an example VC fund called “Scorpio Ventures” to outline some of the fundamentals of how venture capital firms work.
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Scorpio Ventures goes out to a series of limited partners (LPs) and pitches them on how good they are at picking great startups to invest in. They raise a $400 million fund.
Typically, LPs would expect a 3-4X return on their investment over the course of a decade in order to make it worthwhile and effectively ‘beat the market’ (ie. get a greater return than the 8-10% annual growth they’d get by putting their money into public stocks, bonds, etc).
This means that in 10 years’ time, Scorpio has to return about $1.2 billion to its investors in order to be considered successful.
With their new money in the bank, Scorpio comes along and invests in your company, Globex Corporation. They invest $15 million at a $45 million valuation, taking 33% of the company. You use this money and grow like crazy over the next 5 years.
The next thing you know, Burns, Inc. comes along and offers you a whopping $450 million for the company.
As the founder, you’re ecstatic. You stand to make almost $300 million. Enough to buy a waterfront house with a yacht and a Maserati and enjoy the rest of your life with your family and friends. However, while you’re having the best day of your life, Scorpio Ventures is having one of its worst.
Although they stand to make about $150 million from the deal (10x their original investment), your company was one of their most promising investments, and if you take the deal it’s unlikely they’ll be able to return the $1.2 billion they need to in order to deliver the 3X they promised their LPs.
Now you’re in a tough spot. You want to take the money and spend more time with your family, but Scorpio Ventures is pushing you to reject the offer.
And because the investment terms give them veto rights over any transaction, you’re now in a position where you’ve built an amazing business, have a huge offer on the table, and want to get out, but can’t.
All because 5 years ago you took VC funding.
While this fable might seem a bit hyperbolic, it’s reflective of how the venture capital business works and shows that taking funding from a VC firm could literally be one of the most consequential decisions of your life and career.
5 factors to consider when choosing to bootstrap or raise
Now that you fully understand the importance of the decision, let’s next look at a few factors you should consider when deciding which path to go down.
There are four key factors to evaluate when choosing to bootstrap or to seek funding, and each has a number of considerations.
1. Market: Size, competition, and maturity
The market you are entering (who you are targeting, existing competition, maturity, etc.) is a key factor in determining whether to bootstrap or not:
Total addressable market
How big is the market opportunity you are going after? Is it big enough that if you were to take a portion of it you could generate hundreds of millions in revenue?
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Or is it a small niche market where even if you were successful, you’d only be generating $1-2 million in revenue?
Many years ago I founded a SaaS startup called Shaperbase. It was an order management app for surfboard shapers. Most estimates put the number of surfboard shapers in the world at 1,000-2,000 and with a price point that varies from $20-$100 per month, the reality for this business is that even if we were to somehow take 100% of the market, the maximum revenue we could really generate was around $1 million ARR.
So while this would make a wonderful bootstrapped, lifestyle business, it’s not going to be compatible with the business model of a VC.
So when considering whether to start pitching investors, think about what the total addressable market is for your business and whether or not it’s going to be big enough to be interesting to them.
Competition
How much competition is there in the market? And have they taken funding? If so, how much and what stage?
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If you have a number of competitors who have taken venture-backed funding, then they’re going to be using their considerable financial war chests to grow. They’ll be outbidding you on Google Ads, showing Facebook ads to all of your potential customers, and they’ll have bigger booths and presences at industry events.
Over time, this generally means they’ll outgrow you. They’ll build a bigger brand, network effects and virality will snowball, and they’ll eventually take the market.
A good example of this is Saasu, an online accounting application you’ve probably never heard of. They launched a full six years before Xero and for a long time they had a comparable (or even better) product.
However, while SaaSu bootstrapped their business Xero went out and raised $680 million in funding over nine rounds and used this funding to accelerate their growth and product development. They did TV and out-of-home ads, they ran huge conferences across the world, and they built a huge network of accountants who loved their product and referred their clients to it.
Ultimately, Xero became a global SaaS behemoth with over $550 million in revenue, 2,500+ employees and a $12 billion valuation. Saasu, on the other hand, is still a small business with around 20 employees.
So when thinking about taking VC funding, consider what your competitors are doing and whether you need the funding to match their spending on growth.
Maturity
How mature is the market for your product? Is it a well-known market category like email marketing software, or are you trying to create a new one, like Inbound Marketing?
Generally speaking, if you’re trying to build a new market it’s going to be difficult to do without VC funding, as it takes a lot of money and resources to educate people on why they need the category of product (let alone your product specifically.)
Hubspot is a good example of this. They famously created the category of Inbound Marketing, but it wasn’t cheap to do. They raised over $100 million from venture capitalists and used that considerable war chest to promote inbound marketing as the ‘new’ way of doing marketing.
They created a conference, an academy, free tools, tens of thousands of blog posts and hundreds of eBooks. At one point, their content team included 50 people with multiple blog post writers and editors, a podcast team, a video team, a co-marketing team, and more. None of which would have been possible without a huge warchest of VC funds.
As such, it’s worth considering the market maturity when making your decision about VC funding vs bootstrap. If you need to build the market in order to grow your business (rather than just capturing existing demand), then you’re likely going to need some outside funding to do it.
2. Resources: Current capacity, resellers, and partners
The resources you have at your disposal should be another key factor in determining whether venture capital or bootstrapping is the right path for you. Here’s what you need to think about when it comes to your resources.
Current team resources
What does your current team look like? Do you have skills and experience in both product and go-to-market? Salesforce Co-Founder Marc Benioff once said “Great companies are at the intersection of a great product and a great go-to-market strategy”
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It’s hard to build a great company if you only have product/development capacity and no experience in go-to-market functions like marketing, sales, and customer success.
One of my more recent startups is a product called Simul Docs, which provides a version control and collaboration tool for Microsoft Word documents.
We are fortunate enough to have both development and go-to-market resources in our founding team with my co-founder being a Senior Engineer at Canva and myself having go-to-market experience from InVision, SafetyCulture and Campaign Monitor.
Because of this, it’s much more possible for us to go down the bootstrap route because even with our small founding team, we have the experience needed to develop, market, sell and support the product.
So when you’re considering bootstrapping vs VC, look around and see what skills you already have within your team (and whether that’s enough to achieve what you’re hoping to achieve.) If not, you’ll need to wait until you have enough revenue to hire out that expertise, or it might make more sense to take venture capital so you can access the expertise you need to reach your objectives.
Availability of resellers/partners
If you don’t have the required skills in-house, are there partners or resellers that you could lean on to bring them to the table?
Mandoe, an Australian digital signage software company, didn’t have all of the necessary resources in-house when it first started, so it sold its product exclusively through Telstra.
Mandoe focused on creating a great product while Telstra’s army of thousands of salespeople across the country sold its product to the beauty salons, retail stores, and cafes to whom they already provided telephone and internet services.
It was a successful strategy for Mandoe: It fuelled growth to a rumoured $50 million acquisition.
The lesson here: If you don’t have the resources and expertise in-house to handle certain parts of development or go-to-market functions, it’s worth considering whether or not there are strategic partners or resellers you could leverage before you start looking at venture capital.
3. Go-to-market model: Channels and conversions
The go-to-market model you use also has a significant impact on your bootstrap vs VC decision. As you weigh the factors in this arena, be sure to consider your channels and conversion model.
Channels
What channels are available to you to attract potential customers to your product? Are there low-cost channels like SEO and virality, or is it going to be more events, paid marketing, sponsorships, etc.?
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Attributer is a SaaS product I co-founded earlier this year. Essentially it passes marketing attribution information (like the fact a lead came from your Google Ads or Facebook Ads) into your CRM so you know where your leads and customers are coming from.
The product works with hundreds of different CMS systems, form builders, and CRM systems and as a result, there is a huge SEO opportunity with people searching for things like ‘Track Google Ads in Salesforce’ or ‘Capture UTM parameters in WordPress Forms’.
As a result, we can tap into this audience of people who are searching for a solution to the problem our product solves, and we can drive new signups and customers at a low cost.
However, if low-cost channels aren’t available to you (e.g. because there’s not a lot of search volume), then you may need to look at higher-cost channels like events or advertising, which would usually require large amounts of capital to do well.
So when you’re deciding to go the VC or bootstrapped route, consider what channels you might use to get your product in the hands of potential customers. If it seems like there are low-cost options that could have enough volume to help reach your goals, you may be able to do it without a huge amount of capital. However, if your channels are all paid (i.e. advertising, events, sponsorships, etc.) then it’s likely you’re going to need some capital to pay for those more expensive acquisition channels.
Conversion model
How do you convert people interested in your product into paying customers? Do you have a self-service product where people sign up and pay using their credit cards within the product, or do you primarily convert people through a sales team?
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Generally speaking, self-service businesses are cheaper to scale in the early days and likely more fitting to a bootstrapped path. Many successful bootstrapped companies (including Zoho, Basecamp, MailChimp, and Aweber) are primarily self-service.
Launchpad6, a company I previously founded, made a video CMS product that companies used to create their own video sites. We used an inside sales model to sell the product and then had a Customer Success team that helped with the implementation of the site.
The problem was: With just two people in the founding team, I was in charge of marketing, sales, and customer success. After we signed a contract with a new customer, I’d spend weeks bogged down in overseeing the implementation and would dedicate zero time to bringing in new customers through sales and marketing activities. If we’d taken VC funding, we would have been able to hire a few more people and dedicate them to each function — and as result, we would have been able to grow and scale the company more.
When thinking about your bootstrapped vs VC path, consider the resources you need to build the sales and marketing machine that will drive your revenue growth. If you have a self-serve model, it’s likely you can achieve some scale with fewer resources, but if your product requires people to market, sell, and then implement the tool, it’s likely you’ll need to hire dedicated team members who can get the machine humming. That costs money.
4. Product: Adoption cycle and roadmap
Aspects of the product you sell also have a significant impact on your bootstrapped vs VC decision, so before you make the call, be sure you’ve thought through the product-related aspects of the equation.
Adoption cycle
What does it take to get started using your product? Is it as simple as uploading a document (like Dropbox, for instance)? Or do customers need to do a full company-wide implementation of your product (i.e. HR software like Gusto or Bamboo HR)?
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Earlier we talked about the effect your go-to-market model has on your decision and how self-serve business can often scale with fewer people. However, even self-serve businesses have different adoption cycles.
For instance, if you look at the standard self-service funnel, it typically looks something like:
- Signup: The moment when a person signs up for an account
- Activation: The moment a person completes an action where they see the value your product provides
- Subscribe: The moment a person upgrades their account to become a paying customer
Depending on the nature of your product, the signup to activation rates can vary dramatically.
In the case of Simul Docs (the aforementioned version control tool for Microsoft Word), all a user needed to do was to upload a Word document, open it, make a change, and the software then automatically creates a new version — which is when the user realizes the value of the product. Because it’s only three quick steps, the activation rate is around 30%.
However, for more complex products (like Shopify, for instance) the process of getting started is much more complex. In order to launch a store, you’d have to create your account, upload products, set prices, set up shipping options, connect payment providers, etc. With so many required actions, the activation rate is likely much lower.
This then gives you two options: You either need to have huge volumes at the top of your funnel in order to overcome low activation rates, OR you need Customer Success and Support employees to help users reach the activation point. Both cost money.
So when thinking about bootstrapping vs taking VC, consider how easy it is to adopt your product, what that would mean for your funnel metrics and unit economics, and ultimately what kind of resources you need to support that.
Roadmap
No product is ever complete, but some are likely a lot closer to their vision than others. How far along are you in your product roadmap? Are there still outstanding features that your product still needs to have to be considered viable, or is it quite mature already?
Qwilr, a tool for creating sales proposals as beautiful web pages, is an interesting example of how the maturity of the roadmap can change as the target market changes.
Originally built for smaller businesses and freelancers to help them win more work by sending better-looking proposals, the early product was at a mature stage with a solid editor for building proposals — complete with hundreds of templates, digital signatures, payments, and more. It had everything a freelancer or small business would need to send great proposals and win more work.
However, as larger organizations started to use the product, the roadmap extended. Larger organizations needed features small businesses and freelancers didn’t (like collaborative editing of proposals so multiple people can work on them at the same time, or integrations with enterprise-level CRMs such as Salesforce.)
As a result, the company built out a team of product managers, designers, and engineers dedicated to designing and building these features in order to better serve the needs of larger customers.
The lesson: When thinking about whether or not to go down the VC path, consider not just what your roadmap might look like now and what your product needs for your current market, but where you might need to get it to for future markets as well.
If you think your current resources can handle that then bootstrapping might be viable for you, but if they can’t then it may be best to go down the VC path.
5. Desire
If you’re running a software company, it’s likely that you read a lot of content and opinions from VCs.
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This is a good thing, as the likes of Jason Lemkin, Tomas Tunguz, Christoph Janz, David Skok and the rest of them have produced some amazing content over the years that has genuinely progressed the knowledge and understanding that we all have of the SaaS business model.
However, if you’ve spent enough time reading these posts, you’ve likely been led to believe that the only definition of success is creating a billion-dollar company (or a Unicorn as they’ve named it).
This just simply isn’t true.
As Basecamp Co-Founder David Heinemeier Hansson points out in this Twitter thread, building a billion-dollar company isn’t the only definition of success.
Despite what VC’s will have you believe, it’s actually perfectly fine to want to build a smaller, profitable business that allows you to enjoy a good but modest lifestyle, appropriate work/life balance, so you can have more time with family.
So when thinking about whether you want to take on VC funding, think about what you want your life and your company to look like. Do you want to build a large company with hundreds of employees, working long hours in an attempt to turn it into a Unicorn in 10 years’ time?
Or would you rather build a smaller company with fewer employees, maintain a healthy work/life balance and enjoy the freedom of not answering to anyone?
Both are perfectly acceptable paths, but it’s important you consider which one is right for you and the other stakeholders because the VC path typically isn’t compatible with that ‘small company, healthy work/life balance’ desire.
Wrap Up
Your decision around whether you should go down the VC or bootstrapped path is one of the most important decisions in any company’s existence. It can have a significant impact on the kind of company you create and its outcomes.
So before you rush out and take VC funding (or think your company is finished if you can’t get it), consider some of the above factors to decide whether it’s really the right path for you.
- Aaron Beashel is the cofounder of Attributer and Simul Docs
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