You may have come up with a business idea for the most ground-breaking startup, ready to become Australia’s next $1 billion business. Your idea and business plan are solid and the timing is right for you to enter the market. Here, the question of how you are going to have enough money to grow your business arises. Most businesses cannot generate large-scale profits rapidly, so you are going to need capital to launch the business and to continue to grow and scale the business. You will need to consider where the funds will come from. This article will explore the differences between bootstrapping and raising external capital and will outline their respective benefits and disadvantages.
What is Capital?
A company’s capital is the amount of money that is invested in the company as a way to fund the business operations and objectives. Any money that is invested in the company is considered capital. This capital can be used to:
- design and develop technology;
- purchase assets;
- hire and pay employees;
- further marketing objectives; or
- meet any of your startup’s particular needs.
Capital is the money that your startup needs to launch, operate and produce its goods or services.
What Are the Options for My Startup’s Capital?
There are two terms that are commonly used in the startup world with respect to capital: bootstrapping and external capital raising.
Bootstrapping is the act of funding a startup yourself. As a founder, if you personally inject your own money into your startup, you are putting your own capital into the company. When you are bootstrapping, you are not speaking to external investors. The money earned from customers is re-invested into the company to continue funding its activities and growth. It is taking a minimalist approach, working within the startup’s means.
External Capital Raising
A capital raise refers to the act of seeking external investment. This typically involves the founder approaching investors and pitching their startup. If the investor and the founder agree on the terms of the investment – i.e. the startup’s valuation and a number of rights – the investor will provide the startup with capital, in return for a stake in the company. This stake is usually in the form of equity.
What Are the Benefits and Disadvantages of Bootstrapping?
When a startup is bootstrapping, they are self-funding the startup through the founder’s personal capital and resources to start and grow the business.
One of the key benefits of bootstrapping your startup is that you own all of the equity in the business. You are not taking direction from anyone else, besides your co-founders. This allows you to:
- choose what direction your startup takes;
- make decisions easily; and
- ultimately have total control of the company.
Additionally, bootstrapping your startup can lead to founders thinking more carefully and critically about the decisions they make. It encourages founders to come up with creative strategies to operate effectively. When bootstrapping, funds are treasured and often this prevents unnecessary expenditure.
Firstly, bootstrapping may make it difficult for you to tap into the capital that you need to get to your next milestone or grow your startup. When bootstrapping, running your company relies on:
- your own funds; and
- the company making sales and generating profits.
If you need a certain amount of money for an item of expenditure and you do not have that capital, revenue or profit, you will not be able to pay for the item until you can access those funds. It is for this reason that bootstrapping a startup often means slower growth. If a key to your startup’s success is being first to market or moving quickly, then bootstrapping may not be right for you.
Additionally, you might find that when bootstrapping, one aspect of your startup suffers because you do not have the funds and it is not the highest priority. For instance, your startup may want to undertake an upgrade to your product that is not crucial, but you know that it would yield great results. If you are bootstrapping and you do not have the funds for this upgrade, it is something that will have to sit on the sidelines while you spend money on the critical expenditures.
What Are the Benefits and Disadvantages of Raising External Capital?
Raising external capital can be a means of catapulting your startup to growing in a way which it would not have been able to otherwise. When you raise external capital, you have extra funds to spend on all types of growth activities, including:
- developing technology;
- implementing more technology;
- increasing sales;
- bettering products and services; and
- paying rent and other expenses.
Further, this may give you the opportunity to hire key people you would not have otherwise been able to or to launch the marketing campaign that you could not afford.
Additionally, you may have the chance to secure an investor who has a great deal of experience, contacts and mentorship abilities. A more active investor can provide your startup with a wide range of benefits based on their background and business history. If possible, find investors whose goals align with yours in that they want the business to succeed.
When you raise external capital, you will have to answer to your shareholders. When an investor purchases shares, they become a shareholder in your company, giving them certain rights and expectations. Although they invested in you because they have faith in you as a founder, the reality is that they are looking for a return on their investment. Your equity will dilute as a result of their owning a share in the company.
Usually, an investor will expect a future liquidity event – i.e. an exit or an Initial Public Offering – to occur, given that this is how they will receive that return on their investment. For most startups, this is the ultimate goal. However, before raising the external capital, you should consider whether this aligns with your intentions and personal goals for your startup.
Which One Is Better for My Startup?
Ultimately, neither bootstrapping or raising capital is “best”. Plenty of startups have been able to bootstrap their way to success, while many others have raised capital externally. Essentially, it comes down to your startup’s:
- specific goals;
- needs; and
- ability to create a financial return for investors.
Often, it can be easier to get to the next level when you raise external capital because you have more money to invest in your startup, allowing you to reach milestones quickly. However, when you raise external capital, you are responsible for answering to shareholders.
Given that bringing on an investor means that you are diluting your equity, you will want to ensure that it is valuable to your startup. You should raise external capital if your diluted equity amount is more valuable, even though the percentage that you own has decreased.
If you can raise enough money from an investor who will help your business and increase your startup’s value, then it may be appropriate to raise capital. Otherwise, if the investor will not benefit your startup, you should consider bootstrapping.
Bootstrapping and external capital raising are both viable ways of funding your startup and reaching your goals. Which one you choose will depend upon your startup’s:
- needs; and
- ability to create a financial return for investors.
Considering the benefits a potential investor could bring to the business is an excellent place to start when considering whether you should bootstrap or raise capital externally. If you have any questions about capital raising, contact LegalVision’s capital raising lawyers on 1300 544 755 or fill out the form on this page.
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