By Tomasz Tunguz.
“Would you compare a bootstrapped SaaS company to a seeded company? At what point does the bootstrapped company have to raise if it’s profitable, if ever?” One founder asked me this question recently.
I hesitate to compare and contrast bootstrapped and venture backed businesses, because I’m a venture capitalist and it’s very easy to dismiss any analysis as biased in favor of venture investment. As I’ve said countless times, there are many ways of building a very successful business.
Atlassian in the best known bootstrapped software company and it’s worth nearly $8B as I write this. Only a handful of next-generation, venture backed software companies are larger: Salesforce, Workday, Palo Alto Networks. I’m only going to consider the financial differences between the two models. With those caveats, let’s continue.
To compare the differences between a bootstrap and a venture business, I’ve created a very basic financial model on Google spreadsheets. You can download this model or clone it in your Google docs to play around with it. Again it’s very basic.
Here’s the scenario. Imagine two founders start a company. They sell email marketing software for $5k annually on average, with a 14 month payback period. They agree on a few management principles early on. First, they invest 30% of their total cash in customer acquisition no matter the state of the business. Second, for every 100 customers, they hire another employee. All employees cost $50k per year. They spend six months building the product before they acquire their first customer. When they do pay to acquire a customer, they must invest the CAC dollars two months ahead of revenue (60 day sales cycle). As they grow the business, these two founders experience no churn, collect revenue monthly, and observe that for every 10 paid customers, 3 new customers arrive organically. Last, they value their business at 7x revenues; and their execution in both cases is flawless.
Let’s create two universes. In the bootstrapped case, the founders keep all of their equity and invest $150k of their own money. In the seed case, they sell 25% to investors for $1.5M.
Here’s the punchline. The key financial difference between the two companies is speed. The company that raises the seed round has more capital to acquire customers earlier in its life. These customers generate more revenue sooner, which can be reinvested to acquire more customers, hire more employees, and so on. The 10x larger seed round gets the flywheel spinning faster, and so the company attains a faster growth rate quicker.
Reverting to the original question, when should a profitable company raise capital, if ever? The answer is the same for all businesses regardless of financing history: Raise capital when you are confident that you can use it to attain a higher growth rate and the higher growth rate is worth a trade-off in dilution. Higher growth rates increase the value of a business. Higher growth rates fetch greater multiples.
There are tradeoffs to raising capital. You must sell equity and dilute your stake. You will likely grant a board seat to an investor. The investor may have an opinion on how to run the business and his/her own motivations, that ideally, but not always, align with yours. These are just a few. Venture capital is not the right capital source for most businesses for many reasons.
This analysis isn’t perfect. It simplifies many things, and only evaluates this question on metrics. But I hope the rudimentary financial model provides founders with some initial framework for comparing two financing strategies.