A comprehensive overview of bootstrapped and VC funding
Imagine you’re a Canadian entrepreneur with a big idea for a tech business. Where do you turn for the precious startup financing to see you through the early stages of turning your dream into a durable commercial success? Entrepreneurs often face the dilemma of choosing between bootstrapping and venture capital as two primary means of funding their startups. While bootstrapping involves self-financing and balancing modest growth with profitability, venture capital (seed, series A, series B, series C or beyond) entails seeking external investment in exchange for equity.
In this article, we’ll delve into the definitions, stages, pros and cons, and considerations of bootstrapping and VC funding. We’ll also explore tips on how you can bootstrap your startup and determine which form of funding could work best, depending on your situation.
What is bootstrapping?
Bootstrapping refers to the process of starting and growing a business using personal savings, revenue generated from early sales, and reinvesting profits. Essentially, it’s a self-sustaining approach where the founder builds the startup with internal resources and funds, rather than relying on external capital to grow.
For some entrepreneurs, the decision to bootstrap is a matter of personal preference, one that possibly reflects both debt aversion and pride in self-reliance; for others, it’s simply the only option that can be exercised in the absence of any viable funding alternatives.
Different stages of a bootstrapped startup
1. Beginner stage
At this nascent stage, entrepreneurs utilize their personal savings or borrow small amounts of money from friends and family to kick-start their business.
2. Customer-funded stage
Once the business gains traction, revenue generated from early customers becomes the primary source of funding. This approach allows the business to be self-sustaining.
3. Credit stage
As the company expands, entrepreneurs may seek credit options such as business loans for startups, lines of credit, or credit cards to finance further growth.
Advantages of bootstrapping
- Freedom: Bootstrapping offers complete control and decision-making power, allowing entrepreneurs to steer their business according to their vision. This autonomy can be especially beneficial as sources of external funding may not always align with the venture’s growth trajectory and core values.
- Built-in business discipline: Bootstrapped founders develop strong financial discipline as they are accountable for every penny spent, fostering a frugal and capital efficient mindset from day one.
- Focus on core aspects: With limited resources, bootstrapping often encourages founders to prioritize the most essential aspects of the business, resulting in lean operations and a strong foundation.
- Less vulnerable to funding deterioration: Though VC-backed companies may scale faster, they have an increasingly large reliance on the availability of capital to survive. If funding dries up, so could their business. Bootstrapped companies, by nature, are less vulnerable to the impacts caused by VC downturns.
- Attractive to future investors: While myriad factors go into investors’ funding decisions, a successful bootstrapped startup that can demonstrate sustainable growth and profitability can be particularly appealing to potential investors who value proven resilience.
According to John Rikhtegar, RBCx’s VP of Growth Capital, the allure fundamentally comes down to de-risking the initial investment. “Bootstrapped businesses have bet on themselves, managed to operate under a tight budget with lean operations, and gone through the valley of death,” he says, referring to the period when a startup is operational but hasn’t yet generated revenue. “This is one of the best signs that any early-stage VC could witness in a prospective founding team, especially in our current economic climate.”
“Bootstrapping a business is one of the best signs that any early-stage VC could witness in a prospective founding team, especially in our current economic climate.”
Plus, by getting to a level where the business has proven out initial product market fit, bootstrapped founders are better positioned to partner with the right VC, to negotiate a better deal, and to keep more control.
Disadvantages of bootstrapping
- Limited capital and resource constraints: Limited funds can hinder the ability to scale the business, invest in marketing and top talent, or seize growth opportunities. A lack of entrepreneurial experience and know-how can compound the problem.
- Competition: In industries where competitors receive substantial external funding, bootstrapped startups might struggle to keep up with well-funded and resource-rich competitors.
- Equity issues: Without external investment, founders may find it difficult to share equity with key team members. Further, fairness issues may arise when multiple founders are on board who bring an imbalance of capital, time, experience, and resources to the table. Keeping proper records of founders’ capital investments, consulting a good business lawyer and avoiding any commingling of personal and company funds can help alleviate these problems from the outset.
- High failure rate: Knowing that 90 per cent of startups in Canada fail, bootstrapped founders must be aware that the odds are stacked against them. So, while bootstrapping means founders can maintain their ownership, having the lion’s share of an insolvent business won’t produce any positive return.
- Personal stress: Entrepreneurs bear the burden of financial risk and undoubtedly face personal stress due to the demands of bootstrapping a business.
To minimize the amount of outside debt and equity financing needed to keep your company afloat, bootstrapped businesses may look at:
- Owner financing: Tapping into personal savings and income.
- Personal debt: Credit cards and/or establishing a line of credit with a bank for startups or other financial institutions that can provide initial capital.
- Sweat equity: Founders can compensate for the lack of financial resources by investing their time, skills, and expertise.
- Subsidies: Accessing small enterprise grants, tax credits, and loan programs through various levels of government. For example, the Scientific Research and Experimental Development (SR&ED), a federal tax incentive program designed to encourage Canadian businesses to conduct research and development (R&D) in Canada. RBCx offers scaling tech companies enhanced lending solutions for SR&ED; speak to one of our advisors to learn more.
- Lean operations: Focus on optimizing costs by embracing lean methodologies, cutting unnecessary expenses, and operating with efficiency.
- Reinvesting profits: Instead of taking significant salaries or dividends, reinvesting profits back into the business fuels organic growth and expansion. “The faster a founder can begin fueling operations by reinvesting the profits rather than injecting greater levels of their own cash, the more self-sustaining it will become and the less of a financial burden the founder will have,” explains John. “Though the difficulty of doing so cannot be overstated, this is the goal for bootstrapped founders: grow the business through re-investing the profits, rather than increasing your own personal liability.”
“This is the goal for bootstrapped founders: grow the business through re-investing the profits, rather than increasing your own personal liability.”
What is venture capital funding?
Venture funding involves securing external investments from venture capital firms, angel investors, or institutional investors in exchange for equity. This funding option is suitable for startups with high growth potential and ambitious expansion plans. Given VC-backed companies require venture funding across their entire lifecycle as a private company, VCs can be categorized by the stage at which they invest in. That said, it should be noted that maturation of the VC ecosystem has enabled many VCs to actively invest across multiple stages, and are classified as ‘multi-stage’ VCs.
Different stages of VC investment:
The earliest stage of venture capital funding, typically comprised of small investments from friends and family, angel investors, or other micro-VCs to validate the startup’s concept and begin early-stage product development. Pre-seed investments typically range from $250,000 to $1 million and, given the increased costs and complexities associated with raising a formal priced equity round, are usually structured through convertible debt or a simple agreement for future equity (i.e. SAFE).
2. Seed funding
Similar to pre-seed, this stage includes many of the same startup capital providers but a higher proportion are dedicated seed-stage VCs. At this stage, the business would have established early signs of product-market fit through specific product, revenue, market, or team traction. Seed investments can range from $1 million to $5 million and are structured through convertible debt, SAFEs, or priced equity rounds.
3. Series A
Enter the first formal institutional equity round raised for a company. The company would have shown strong signs of product-market fit and are raising proceeds to finance the company’s growth with things like hiring key personnel, enhancing product capabilities, investing in revenue initiatives, and maturing the overall business. Series A investments typically range between $5 million and $15 million and mark the final round of ‘early-stage’ financing.
4. Series B
Once a startup has successfully progressed through the Series A stage, it may hit the fundraising trail again for additional funding in a Series B round. Venture capital raised at the Series B round comes into play when the business has shown substantial growth and, ideally, met key milestones targets since its Series A funding. As the company’s valuation and potential have increased, Series B investments often involve larger funding amounts than Series A in the range of (between $15 million to $30 million), and are used to turbocharge growth and position the business as a legitimate, market-ready competitor.
5. Series C
Series C+ venture capital investments represent subsequent rounds of financing that follow Series A and Series B stages. These investments are typically +$25 million in size and can be led by capital providers beyond traditional VC firms, including private equity firms, public companies, and strategic investors. At this stage, startups may have already achieved profitability or are on the path to profitability, making them attractive to investors seeking a later-stage investment opportunity. Series C+ investments enable startups to capitalize on their success, strengthen their competitive advantage, and potentially prepare for an initial public offering (IPO) or acquisition in the future.
Advantages of venture capital funding
- Faster growth: With ample financial resources, startups can quickly expand their operations, hire top talent, invest in marketing, and capture a larger market share.
- Don’t need assets to secure funding: Unlike traditional loans, venture capital doesn’t require startups to pledge collateral, enabling founders to obtain funding even without substantial assets.
- Support: Venture capitalists provide not only financial backing but also guidance, mentoring, and access to extensive networks, offering valuable expertise and industry connections.
- Credibility: Venture capital funding can lend instant cachet to startups, signalling to potential customers—not to mention other investors, banks, partners, and employees—that the business has attracted professional investors who believe in its potential.
- Less risky for founders: By sharing the financial risk with investors, founders can mitigate personal financial liabilities and focus on building the business.
- Exit opportunities: Venture capitalists often seek an exit strategy within a specific timeframe, which can align with the goals of founders looking to capitalize on their startup’s success.
Disadvantages of venture capital funding
- Less time for the business: Well before achieving venture-backed status, founders are in a grinding period of pitching investors and courting funds which inevitably takes time away from the day-to-day management of their business. And since the vast majority of startups won’t ever qualify for VC (just 706 deals materialized last year, per the Canadian Venture Capital & Private Equity Association (CVCA), out of the hundreds of startups that are established every day), that time might be better spent building the business without it.
- Intense competition: The availability of venture capital funding has led to increased competition among startups, making it more challenging to secure investments. The issue is even more acute within the tech sector which, post-pandemic, has grappled with mass layoffs, tanking valuations, and seen investor exuberance wane.
- Gender bias: The increased competition is magnified exponentially if you’re a woman. Unfortunately, venture funding tends to favour male entrepreneurs, posing challenges for female-identifying and non-binary folks seeking startup capital. According to The51, just 10 per cent of VC deals in Canada have gone to women-led startups since 2014. In the US, Pitchbook data shows that women received just 1.9% percent of VC funds last year. The numbers are even more dismal if you factor race into account.
The disparity is due in part to the fact that women investors aren’t at the table. Reports indicate that women are twice as likely to invest in women-led startups but account for only 19.4 per cent of cheque-writers in Canada. In light of this depressing data, what is a female tech entrepreneur seeking a potential VC to do? One option is to look to women-led VCs that focus specifically on investing in female founders, such as Michelle McBane’s StandUp Ventures and Janet Bannister’s Staircase Ventures, both of which RBCx is a proud investor in.
- Loss of control: External investors typically require a significant equity share, resulting in dilution of ownership and a potential loss of control over strategic decisions.
- Less financial discipline: One need look no further than WeWork’s ill-fated IPO to see why more money can mean more problems. The infusion of external startup capital can lead to a loosening of financial discipline, with businesses potentially spending lavishly without achieving profitability.
- Pressure to exit: Venture capitalists expect a substantial return on their investment within a specific time frame (or die trying), which may force founders to sell or take the company public prematurely.
Bootstrap or borrow: which is the best way to fund?
Deciding whether to bootstrap your business or seek venture capital funding depends on several factors, including the nature of the business, growth potential, personal risk tolerance, and long-term objectives.
Here are a few considerations to help make an informed decision:
- Evaluate growth potential: Startups with a scalable business model and substantial growth potential may benefit from VC funding, which can provide the necessary capital to rapidly expand operations and capture market share. Conversely, businesses with limited growth prospects or those targeting niche markets might find bootstrapping more suitable.
- Assess financial requirements: Carefully analyze the financial needs of your business. If significant startup capital is required to develop a product, build infrastructure, and/or penetrate the market, venture capital may be the preferred option. However, if the startup can sustain itself with limited external capital and incremental growth, bootstrapping could be your best bet.
- Consider control and ownership: Determine the level of control and ownership you’re willing to sacrifice. Bootstrapping allows you to be your own boss but with limited access to external expertise and networks. VC funding, on the other hand, increases your network and attractiveness to other potential investors or banks however, usually comes with not just a dilution of equity, but a relinquishing of decision-making authority. All of a sudden there’s the proverbial ‘adult in the room,’ which can change the dynamic overall.
- Understand risk tolerance: Assess your appetite for risk and personal financial liability. Bootstrapping means the burden of financial risk is placed firmly on the founder, while venture capital shares the risk with external investors. Consider your comfort level with assuming personal liability and the potential consequences of a failed venture.
- Seek expert advice: Engage with mentors, advisors, and industry experts to gain insights into the funding landscape and their experiences. They can provide valuable guidance tailored to your specific business and industry.
John sums it up this way: “If a bootstrapped founder is willing to bet on themselves to build in an untapped and underserved market, has the right initial team by their side, and is ultimately comfortable taking on a larger financial burden over the course of a multiyear period, bootstrapping can be well worth the risk.”
“On the flip side, founders have typically taken VC funding so that they do not have to rely on being the sole source of capital in the company, especially given the high mortality rates that exist for early-stage tech,” he says. “As VCs, by nature, are trained to take on equity risk at the prospect of generating a strong risk-adjusted return, capital from the right VC partner can be catalytic in building a high-growth business and a fair trade-off for control and ownership.”
The hybrid approach
Thankfully, the means of funding a tech startup need not be a binary decision indefinitely. Most founders bootstrapped in the beginning and then went on to accept outside funding. Indeed, some of the most successful startups today—Apple, Meta, Dell, Coca-Cola Microsoft, to name a few—had humble starts as bootstrapped enterprises before securing the VC that allowed them to become the mega billion dollar unicorns that they are today.
Some of the most successful startups today—Apple, Meta, Dell, Coca-Cola, Microsoft, to name a few—had humble starts as bootstrapped enterprises before securing the VC that allowed them to become the mega billion dollar unicorns that they are today.
“If bootstrapped founders can show a clear path to healthy unit economics and the business manages to be near self-sustaining, taking VC dollars can be a great lever to grow a well-equipped business into a notable player in a much larger total addressable market,” says John.
Should I bootstrap or use VC?
While VC is a common denominator for the most successful tech startups, it’s not a prerequisite, especially at the early stages. Bootstrapping and venture capital are two distinct approaches to startup funding, each with its own set of advantages and drawbacks. Bootstrapping offers freedom, flexibility, control, and a focus on financial discipline, while venture capital funding provides rapid growth potential, support, and credibility.
Ultimately, the decision between the two depends on the startup’s specific circumstances, growth aspirations, risk tolerance, and long-term objectives. By carefully considering these factors and seeking advice from experienced individuals, founders can make an informed choice that aligns with their vision for the business. For John, the choice between bootstrapping and VC-backing really only comes down to two things: what kind of company you want to build and how you envision building it.
“The choice between bootstrapping and VC-backing really only comes down to two things: what kind of company you want to build and how you envision building it.”
“As a founder, do you desire fast growth accompanied by a loss of ownership and control, directed toward an inevitable liquidity event (i.e. exit) down the road? Or would you prefer growing organically at a slower, preferred pace, while maintaining a greater reliance on your own resources, but also retaining full ownership and control of the business for as long as you desire?” he says.
“As founders begin to think it through, the answer of whether to bootstrap versus raise capital for their business will become clear.”
RBCx backs some of Canada’s most daring tech companies and idea generators. We turn our experience, networks, and capital into your competitive advantage to help drive lasting change. Speak with a RBCx Technology Advisor to learn more about how we can help your business grow, or click to learn more about our Venture Capital solutions.