To find out, I asked 12 entrepreneurs from Young Entrepreneur Council (YEC) when it’s necessary to involve outside investors. Their answers are below.
1. Raise money to accelerate growth
While the answer depends on the type of business and business model, it’s often critical to raise money instead of bootstrapping if you really need to accelerate growth or invest in product development. For example, many SAAS businesses require large upfront investment in the product before they ever make a dime, so raising money is critical for those types of companies.
2. Raise money in certain cases
Third-party money is most helpful when either you: have competitors in the same space and you need to scale up quickly to out execute them or be left in the dust; have a product that relies on having a large user database to be effective (think LinkedIn); or have a product that allows you to test a business out more quickly so that if it fails you can more quickly move on to your next idea.
That being said, some of our happiest clients never took on third party financing. By being patient and self-financing their business they have a much larger piece of the equity pie when their company did take off than our clients who relied on raising third-party money and have to share the success with investors.
3. Raise money if you’re first to market
If you’re in a space where the first to market will have a massive moat that will be hard to compete against, raising funds will be necessary for success. If you skip raising for a more linear approach to growth and marketshare, companies founded after you will raise significant funds, build strong sales and marketing organizations and quickly negate your first-mover advantage.
This isn’t true in spaces that are more long term, like consulting, marketing and advertising.
4. Raise money if your business has network effects
Network effects occur when a business becomes more valuable with each new user. For any business with network effects, there is usually one major winner (YouTube, LinkedIn, Dropbox), and many obsolete losers who will be worth next to nothing. In these markets, you should raise as much money as you can and aim to dominate the market. If you don’t, your business will eventually erode. On the other hand, if you are running a more conventional business (consulting, retail, business services), then network effects are not as relevant and you are much better off bootstrapping your company.
5. Bootstrap only if you can afford to
Depending on your industry and company type, bootstrapping may not be an option for you. Raising capital can pose many advantages and in some instances is the only way to grow or scale a business. (In some sectors it is even considered a red flag to have no outside funding.) Investors can be a valuable source of advice and — since they hold you accountable to meet goals and deliver on promises — they can help you stay on track.
6. Neither is intrinsically better
There is no ideal capitalization structure for a startup. Do you want to build a lifestyle business or reshape a capital-intensive industry? Do your market dynamics necessitate rapid growth to capture the opportunity or does a slower-growth trajectory make more sense? There is no one-size-fits-all answer when it comes to this. If you’re attacking a huge opportunity where speed of execution and lots of capital are table stakes for success, than raising money is probably required. Bootstrapping is probably appropriate for the opposite. Instead of determining whether you should raise or bootstrap, consider your priorities as a founder, the size of your opportunity and the market dynamics. Then make an informed choice based on those inputs.
7. Raise money only if you have a track record
It is better to bootstrap until you have proof of concept. Unless you are an entrepreneur with a proven track record, the valuation you will receive before proof of concept will be substantially less than the valuation you will receive after proof of concept.
8. Raise money only when absolutely necessary
I favor bootstrapping until VC money is absolutely necessary for you to bring your product to market. Bootstrapping gives you so much control over the direction and timing of your product. Sometimes VC money can muddle your vision.
J.R. Garrett, LogoGarden
9. Raise money with a purpose
A purposeful bridge can be a healthy and productive way to bring your company to the next step. Some entrepreneurs obsess over bootstrapping to a fault, but if you use capital as a stepping stone instead of a band-aid, there is no need for the stigma. As long as you are crystal clear about the need for funding in order to create value and are 100% comfortable with the investment terms, there is no reason to beat yourself up over not bootstrapping.
10. Never raise money unless you have to
Traditionally, there are two ways to build a business: slow growth (bootstrapping) and fast growth (venture capital). Raising venture funds allows founders to build their team faster as well as spend capital to learn faster. However, it may not be the best approach for everyone. Remember, when you have a hammer everything looks like a nail. When your company is flush with cash it’s tempting to solve your problems by throwing more capital at them.
Before determining if you want to raise money at all, you first must decide how you would like to build your business. If building your business slowly is feasible, I always recommend entrepreneurs choose bootstrapping. While riskier, it leads founders to make more intelligent and calculated decisions and produces stable businesses.
11. Raise enough to achieve product-market fit
The most important aspect of having a startup is being successful. This can be defined as finding a market that buys your product. Having enough money to achieve product-market fit is important. Once you achieve product-market fit, you should continue to raise a substantial amount that exceeds your estimated costs. The number one rule of business is “never run out of money.” Having more money than you think you need gives you insurance. Not raising enough, or bootstrapping, risks the survival of your company.
12. Raise capital at the right moment
Capital is necessary to rapidly scale a small business. You must pull the trigger at the right moment, and start the educational process and meetings well in advance to ensure that you lock in the right partner with eyes wide open, not desperate for money. Securing a good capital relationship can take a lot longer than you think. The capital exploration period then informs and inspires the bootstrapping stage. Guide your company in the present based on a clear vision of the future, and pull that trigger with confidence.