When starting a business, a breakthrough idea and an efficient team isn’t enough. Entrepreneurs need money to manifest the business. But should they use their savings or approach VCs?
When Sarah John wanted to turn her beer-brewing hobby into a business in 2014, she faced the same decision every entrepreneur does – what would be the ideal way to fund the startup? After carefully weighing all options, John smashed her piggy bank, used her savings and gave life to Boss Brewing, the Swansea-based microbrewery. "It has been the best thing I ever did," she says. "I believed in my vision and put my own resources on the line. I now have a company that's growing and has beaten the business plan and I don't owe anyone anything."
What she did is called bootstrapping, which essentially means she used her own money to get the company off the ground. Where VC funding would mean entrepreneurs gave up some equity and control of their business, this funding route leaves founders with all the power. "Your destiny truly is in your own hands which for me was the whole point of becoming an entrepreneur in the first place," John adds. "The fun of having your own business is that you don't need other people's permission to make decisions that you think are necessary – you're accountable only to your staff, your customers and yourself." She is hardly alone to think so. In fact, figures from Opus Energy, the energy supplier, showed that of 505 SMEs surveyed, 50% used their savings to finance the business while only 9% borrowed from family and friends. This is testament that many chiefs prefer to pump in their money rather than use external forces.
Indeed, bootstrapping has been a successful strategy for many big businesses when they started out. From Microsoft and Dell to Apple and HP, the founders were the only ones in the driving seat as they used their savings to give these companies flight. Of course, this means they often had to go without a salary for months until they saw profits. Still, John believes bootstrapping makes head honchos rise to the top purely on the strength of their vision and mettle – making the company more sustainable in the long run. "[It] forces you to really think outside the box and be more creative," she argues. The limited amount of money also makes the owners as well as the employees increasingly frugal, encouraging them to reduce unnecessary expenditure. "The money will be limited, so if done properly you will learn to find ways to maximise every resource available to you and to become a pro at limited resource utilisation," she adds. "You quickly find alternatives, identify things that don't work and find solutions, as repeating the same mistake twice is costly for a bootstrapped business where funds are limited." And these restrictions could encourage you to innovate.
However, while bootstrapping gives you the ability to take the reins, it comes with the burden of facing all the risks alone. "You're putting your own money and resources on the line and there is [the] possibility of course that [you'll] go into massive debt or that the money will simply run out," John warns. Indeed, when flying solo, if the company runs into a crisis, inevitably the owner is solely responsible for the financial losses and other damages. And since every penny is counted, there is a bigger burden to make a profit. "With limited cash, you feel the pressure to quickly become cashflow positive but the reality is that it can take years to break even in many sectors, so you need to be realistic about that," she continues. "Don't just think about startup capital and initial costs – be honest with yourself about the working capital you will need, which can disappear quickly. When you're starting from scratch, be very aware that [you'll undoubtedly] need more money than you think."
While bootstrapping is a great option, the money is clearly limited. And hence, many founders will seemingly agree that raising VC capital is a more viable option. One such entrepreneur is Polina Montano, co-founder of JOB TODAY, the hiring app. She raised more than £60m via four funding rounds. "Yes, working with investors is demanding and sets the bar high but it's definitely worth it," she says. And it's not just the money but also the guidance good VCs can give you on your journey. "Experienced investors ask the right questions, they can be tough [but these] questions are the ones that will ultimately help you make the right decisions for your business," Montano continues. Undoubtedly, VC investment is the quickest way to get a bigger amount of money as the VCs look for a return on their investment when executing the business plan.
Additionally, along with capital, VC investment comes with the venture partners' network of people and their business acumen that entrepreneurs get access to. "There are definitely advantages to working with VCs and angel investors as they may well have experience and contacts that you can tap into," says Frazer Fearnhead, CEO and co-founder of The House Crowd, the property crowdfunding platform. But don't just approach them when you have your idea. If you want to be successful, you must have something to offer. "If you do decide to pursue VCs, make sure to approach them with as close to a working product or solution as possible, as it will increase their confidence in your proposition," he advises.
While this path provides access to money as well as investors' expertise, it also comes attached with a few caveats. For instance, VCs expect a say in all the business decisions and actively influence the day-to-day operations. Additionally, business owners are also required to give a certain amount of equity to the investors. By doing so, they let go of complete control of their business. And this is what stopped John from taking this route. "We have never gone down the VC route as firstly we didn't want to give equity away when we are pouring our heart and soul, blood, sweat and tears into something," she says. Indeed, a study by credit specialist Caple reveals more than half of 298 SMEs surveyed were unlikely to issue equity to fund growth. To add on, 76% preferred to raise money through long-term debt rather than give away equity in their business. "Of course it is in [VCs'] interest to see a return on their investment as quickly as possible, which might mean influencing decisions that are not best for the business growth overall," John adds. "For example, they could pressure you to sell your company should an opportunity come along even if exiting at that time was not part of your vision."
Apart from giving away equity, another challenge which comes with raising money through VCs is getting too much money as it gives unviable solutions the appearance of being successful. For instance, Jawbone, the fitness tracker business, became the second most costliest startup failures, according to CB Insights after it raised $983m and was evaluated at $3.2bn. While it seemed the startup was on its way to compete with bigger players like Fitbit, it collapsed as its devices didn't take off.
Looking at the pros and cons both the paths entail, it's the nature of a company coupled with the founders objective which must be the deciding factor when choosing a funding method. "Every option carries different risks and there is no silver bullet or one solution that fits all and so with that, comes your first challenge as an entrepreneur: how will you pick the right way to finance your dream?," Montano says.
It's important for companies to understand that to be successful, not every company needs to sprint to a unicorn status. Gaining a level of confidence and comfort in a business model – whether it means being supported by all investors and advisors, or taking it slow by growing the business – is where scaling successfully comes from. Today, looking at the slew of options available for startup owners – from crowdfunding to bank loans – it's imperative for them to analyse the best option for their business. "There are plenty of ways to get funding and more than enough money out there up for grabs," Montano concludes. "What's rare are the great ideas and amazing teams that can make them happen.