“Should your startup bootstrap or seek out venture funding?” As a new addition to the entrepreneurial community at the iSchool, it did not take me long to realize how often this question is discussed among student entrepreneurs and their mentors. It makes sense given that the approach entrepreneurs take to finance their companies is one of the most critical decisions they will make throughout the course of their startups’ existence.
As with most complex questions, there are no definitive right or wrong answers. However, there appears to be one universal truth when it comes to addressing financing: it all depends upon the type of business involved. With that said, this post seeks to articulate additional considerations a startup should likely examine.
Bootstrapping and venture funding defined:
Before diving in, we must first define bootstrapping and venture funding. In the context of this post, bootstrapping refers to the means in which a startup supports itself financially so as to maintain a significant stake of ownership equity in their company. That is to say, the startup seeks to become a self-sustaining business as quickly as possible. In some cases, doing so might require the startup to raise a modest sum of capital through angel money or family, friends and fools (FFFs) in return for a modest sum of equity. Conversely, venture funding implies a startup is willing to accept larger quantities of capital (i.e. venture capital) often in return for larger quantities of ownership equity. There are different stages of venture funding (seed round, series A round, series B round, etc), all of which are done with the interest of generating a return through an eventual “realization event” such as an IPO or sale of the company.
Aligning financial structure with the size of the business opportunity and capital needs:
With an understanding of these definitions, one can see that a startup’s financing structure must be appropriately aligned with the existing business opportunity (i.e. how significant is the opportunity), and also the startup’s capital needs (i.e. the amount of money it will take for the startup to break-even or be successful). This notion is represented visually in the featured image at the top left corner of this post [from Mark Peter Davis’ “Get Venture” blog].
Additional financing considerations:
In addition to aligning financial structure with the size of the business opportunity and capital needs, some of the more granular financing considerations startups are encouraged to take into account include:
- Product/service validation: Is there a need or desire for the product and/or service the startup is offering, and has their target market validated so?
- Control and ownership: How important is control of the company to the founding team? What level of control and ownership are necessary for the team to successfully implement their strategic vision?
- Time requirements: Can the founding team afford to invest a significant amount of time in raising capital? How will this impact the amount of time available to carry out other tasks critical to business operations?
- Economies of scale: How important is it for the startup to scale rapidly? Is their product first to market? Must they consume as much market real estate as quickly as possible, before competition has a chance to escalate?
- Network and talent recruitment: Does the startup require networking and talent recruitment opportunities that institutional investors might be able to help with? Are they critical to the future success of the business?
- Liquidity preferences: In the case of a “realization event” (i.e. IPO or sale of the company), to what extent does the founding team wish to minimize liquidity preferences?
These are just a few of the many considerations entrepreneurs are encouraged to evaluate when contemplating financing options. As mentioned before, such considerations are entirely dependent upon the business itself. Founders are encouraged to know their businesses, comprehend the contexts of their businesses and markets, and ultimately understand the implications their visions and strategies will have upon their financing options.
What other important financing considerations am I leaving out? Let me know in the comments below — thanks!