Bootstrapping Vs Venture Capital

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For over a decade, I’ve started multiple companies that optimized towards raising venture capital. I was following the narrative Silicon-Valley and the tech media have been pushing for ever – that the path to building a successful tech companies goes through raising venture capital from “smart” and “value-add” investors.

The first company didn’t go much further than an unbaked prototype. Second company generated decent traction, and raised a seed round from angles and VC – but was shuttered 2 years later.

I wanted to try something different next.

“Lifestyle Business”

I was burnt out on the Silicon-Valley model of how to build a tech company. Taking venture capital changed the dynamics of the company. We were trying to manufacture growth chasing an outsized outcome for us and our investors – hiring people and spending money before we knew how to make our product successful.

I thought receiving outside funds would give us the resources we needed to succeed, but I was wrong. For my next company, I wanted to take it slow, and build it completely self sufficient from the start. Any growth should be fueled only by the revenue it generated. Like a real business.

I was completely content with building a “lifestyle business”, a term sometimes used in a somewhat derogative way to describe a company / founder that is serving a small market with little ambition of becoming a “Unicorn” – a company with a valuation of over $1 Billion.

What I wanted to do is have freedom – freedom to take decisions that are not fully optimized for growth or profit, but align with how I wanted to work, and do so at my own pace, without answering to anyone. If that means that it doesn’t go anywhere for years, that’s fine too. There was no pressure or expectations, just the goal of being my own boss and building the product I wanted to build.

I ended up taking a full time job for 3 years, while working on the product slowly over the weekends, and revenue would grow very slowly until it reached the point where I could work on it full time.

And it continued to grow, passing $1 million in annual recurring revenue and 8 fulltime employees in 2022. And it continues growing at a healthy, steady pace at the time of writing this post. It was cashflow positive from the start.

Those are not growth or revenue numbers that will get any VC excited. Taking 8+ years to get this point would have been seen as a massive failure had I raised capital, and the company would likely have shut down long ago.

My Theory On Why (Most) Venture Backed Companies Fail

The common assumption for venture capital, is that out of 10 VC companies, 3-4 will fail completely, 3-4 will return the original investment, and only 1-2 companies will have significant returns for the fund.

Returning just the original investment typically means an acquihire / fire sale since the valuation of the company basically did not change over multiple years despite having access to funding. So in all reality, 80-90% of VC backed companies fail to become successful, growing businesses. And this despite those companies being selected by professional investors after significant due-diligence from a massive pool of talent.

Having gone through this process myself several times, and then later building a bootstrapped company, I think I can explain why this happens –

  • Bootstrapped companies typically grow within their means. You cannot spend money you don’t have without going into debt. As long as you’re spending less than you’re making, you can keep going.
  • Venture Backed companies are given funding to grow the company. In order to grow, the company starts spending those funds, by hiring people, buying ads and so forth – increasing spend way ahead of the revenue. The goal is then to have enough runway for either revenue to catch up with spend – unlikely, as spend has a tendency to continue growing as the company grows – or just show enough traction to get to the next funding round.

By definition, VC backed companies start on borrowed time. From the moment they raise and start spending money way above their revenue generation, most companies have 2-3 years at the most (usually less) before running out funds.

2-3 years is not enough for many companies to reach product-market fit (PMF) or profitability. It takes time to really understand what customers need, and how to build it. But VC backed companies do not have that luxury. At most, they’re able to show just enough promise to get more funding to continue aiming for PMF.

And that is why most VC companies end up shutting down or acquired just before they do – as they were running on borrowed time from the start.

VCs like to call it “making bets”, and aiming for 1 in 10 panning out. I strongly believe many of those companies would done quite well as bootstrapped companies, giving them enough time to figure it out before increasing spend.

There’s only so many markets and product ideas that can reach $1B+ in valuation. Building a company generating 7 or 8 digits in annual recurring revenue, is a massive success in my book, though it’s a not good fit for the VC model.

When Venture Capital Makes Sense

There are some cases where raising funds makes sense, or perhaps is the only way –

  • When you have basic PMF, and have found an acquisition channel that works – and you want to lean heavily into it
  • For capital intensive products, such as hardware products or products requiring extremely specialized technical expertise or expensive licensing
  • When you have longer sales cycles / payback periods, and need funding to bridge the gap until you get return on your spend (though there is non-dilutive capital for this as well)
  • You’re in a massive market with entrenched players, and need funding to make inroads
  • Your product does not generate revenue until it has a massive captive audience (for example, social networks)

There are many companies who do not fit the above model, and would be better served trying to grow initially as bootstrapped company for as long as possible. Optimizing your company for raising funds vs trying to reach profitability heavily influences how you build it.

Build your business, not your slide deck

Rob Walling, TinySeed

AUTHOR

Eran Galperin

Founder / CEO @ Gymdesk, B2B SaaS for gyms and other fitness and wellness businesses

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