Editor’s Note: Our latest “startup math” piece comes to you from Found|READ contributor Steve Nielsen. He is founder and CEO of PartnerUp , the online network that helps entrepreneurs find good business partners. Steve’s last post was a handy index of the major Web2.0 M&A deals in 2007: 100 M&A Deals. 100 Startup Lessons. It’s another great reference for you.
No matter the size of the venture, all startups need one very important ingredient to start, succeed and ultimately survive: money. Some startups get it from venture capitalists or angel investors. Some lucky ventures are even built with small-business loans and grants. But if you’re panicking because you’re not getting the financing you need from these sources, relax and follow in the footsteps of successful startups like Dell, Inc. or Craigslist, Inc.
The founders of these famous companies pulled themselves up by their bootstraps and invested in their ventures with their own money. Bootstrapping your business, the act of avoiding external investors, means going solo in the financing department, all the while–stretching your money as far as possible–keeping expenses to a minimum.
Many business schools widely promote the use of external investors. They teach you to write a lengthy, in-depth business plan and then pitch it to investors. But burning through someone else’s money is not always an option, nor is it always the smartest route. The plain truth of the matter is that finding other people (i.e. venture capitalists, angel investors, banks, the government, etc.) who are willing to gamble their money on you is just plain unlikely.
If you’re thinking of getting a small-business loan from the bank, think again. Startups are risky endeavors, and banks are not well-know for their risk taking. In the end they are not willing to waste their money on you, so don’t waste too much of your time on them. That’s not to say that small-business loans aren’t out there for you, just don’t hold your breath. Small-business grants from the government work much the same way, except that they are even harder to come by, and the time it takes to search for them rarely pays off.
Most startups try to go the route of venture capitalists or angel investors (also know as “angels”). In 2006, venture capitalists invested $25.5 billion in startups and businesses, according to the National Venture Capital Association (NVCA). Angels put up similar numbers, investing $25.6 billion in 2006, according to the Center of Venture Research (CVR) at the University of New Hampshire. These figures are staggering, but if you take a deeper look, they are also very deceiving.
Far less than 1 percent of companies that pitch venture capitalists actually receive funding. They invest billions, but they do so for only a select number of ventures. Venture capitalists are generally interested in larger investments. Deals under $1 million are infrequent, while pricier deals occur daily. Venture capitalists are also more willing to invest money in companies that already have a solid base, not fledgling startups.
Less than 2 percent of pitches to angel investors are ever even considered. An average of 30 percent of these deals that are considered by angel investors is actually accepted, according to the CVR. Again, 30 percent sounds like a promising figure, but it also has its holes. An angel is typically an affluent individual who, much like a venture capitalist, provides capital for startups. The problem with pitching an angel, however, is that it can be very difficult to grab his or her attention, and angles usually consider very few deals.
Striking a deal with an angel is not impossible, though. To get the attention of an angle, your business should be in the same field that he or she has come from or is interested in. If your business is in the restaurant or hospitality realm, don’t pitch to an angel whose life’s work is in Internet technology. Once you’ve found your angel, the best way to get in touch with him or her is through a trusted referral (i.e. accountant, lawyer, etc.). Angels often shy away from complete strangers. When or if you do get a meeting with an angel make sure that you have three things firmly in place—a knowledgeable founder, a solid team and a sound investment for the angle. If you don’t have all three, you’re probably wasting your time.
Financing your business the conventional way—with someone else’s money—involves spending a lot of time chasing deep-pocketed investors who, when all is said and done, are statistically more likely to be uninterested than they are likely to be interested. Bootstrappers, on the other hand, focus their energy on making money and being smart with it, not raising money and wasting it.
Bootstrappers get financing in several different ways. Some of the more common forms are credit cards, personal savings, or friends and family. If you’re thinking to yourself, “Wow, that’s really risky!” You’re right. It’s very, very, very risky. But there is a reason bootstrapping is increasing in popularity.
Bootstrappers maintain a customer-focused mentality from day one. They have to. Externally funded business owners, on the other hand, are often fooled into thinking that they already have a business because they can pay salaries and rent. But the truth is you only have a business when you have paying customers. Bootstrappers have nothing to focus on but their customers. They also build cost-effective businesses right off the bat. They can’t waste much money when there isn’t much money to waste. Bootstrapping is a solid investment for anyone with the determination and brainpower to find a way to make it work.
Make no mistake; I’m not writing off the use of external investors. For some startups they are the right choice, but so few startups have that choice. Instead the majority of them are forced to start with little or no money. But don’t be discouraged, it is probably a blessing in disguise. Not only do you end up owning most, if not all that you create, you also get to run it with the freedom and flexibility that only comes with a bootstrapped business. Bootstrapping is a risky venture, but the payoff is usually worth it in the end.
And, think about how much more interested VCs, angels, and banks will be when you can call them and tell them about how much money you’re already making and how much more you would be making if you had their capital for expansion. Getting them to buy into an operating business is a lot easier than getting them to buy into a concept.
Steve Nielsen is the founder and CEO of PartnerUp, a site where entrepreneurs can find cofounders, business partners, advisors and other business resources. Read his Found|READ posts about how to refine your startup ideas, and tips for choosing your cofounder. You can read even more at Steve’s StartUp Blog.