Bootstrapping in vogue
India, with the third largest startup ecosystem in the world, has been one of the hotbeds of startup activity over the past few years. We have nearly a million registered startups, increasing 200x since 2016, adding around 9 Lakh direct job opportunities since 2017. The past two years, 2021 and 2022, have attracted almost 60 billion USD in venture capital funding. Compare that with the 8-year period between 2012 and 2020, when just 50 billion USD was invested in Indian startups. The acceleration of funding over the past two years was unprecedented. While it seemed throughout that the funding taps would never run out, it has simmered down quite a bit. Indian startups have raised around 8 billion USD of capital in the 9 months this year, 60% less than in 2022, when startups raised around 20 billion USD. And if you compare this number with 2021, the drop in funding seems even more severe. Given these circumstances, it is natural that ‘funding winter’ is written about often, and more startups are considering the idea of bootstrapping. Here is a snapshot of the Indian VC funding ecosystem from Inc42.
Bootstrapping our way out of the funding winter and the advantages
Bootstrapping is defined as building a startup without any or with minimal external funding. Founders often bring in their own capital or use revenues generated to scale operations as they go along.
A slightly different perspective on bootstrapping was shared by Paul Graham, one of Silicon Valley’s iconic investors -
Bootstrapping is a proper subset of taking venture funding. Taking venture funding lets a company choose its growth rate. One end of this continuum is to raise zero dollars and just take whatever default growth rate you can get off your own revenues. Source
And that is quite profound for our times, isn’t it? Given how venture capital raged from 2020 until late 2022, it became the only de facto option for founders wanting to build any company. In his Tweet, Paul Graham suggests external funding is optional for any founder. And I could not agree more.
Throughout history, an insane amount of venture capital available to startups normalises one specific thing - founders frequently raising equity capital at relatively higher valuations. The chase becomes all about getting marquee investors onboard and stockpiling cash in the bank. It is lucrative and unescapable since you see everyone around you doing it. You see news articles glorifying larger and larger fundraises. It happened in 2000 and 2008, and it is what repeated over the past two years. In hindsight,
I have often said that external capital fundraises always come at a cost, in various forms - founder time spent away from building products and teams, dilution of founder equity, relinquishing of control of the company to an extent (shareholder rights and such) and the added responsibility to match up to the valuation before the company runs out of money.
And it continues - as excess capital found its way to startups with uncertain spending plans. Eventually, the capital was shelled out on expenses that could have been avoided. While I was on a panel recently, Mr Narayan Murthy said founders in the early stages of the org building must live like a saint, think like a scholar and act like a warrior. And that captures the essence of bootstrapping in itself.
Of course, there were outlier startups that prudently used the capital. But collectively, it was lost on most of us that not all businesses are venture-fundable or need venture capital.
It must be said often and loudly that VC funding is only sometimes a precursor to success. The funding winter must not bother any founder wanting to build a company that intends to be around for the long haul. Because if you are building a great product and solving a real problem, investors will eventually find you and help you mainstream what you are building.
If you ask venture investors to list characteristics they would want to see in startups, in all likelihood, it would be - one, has the startup proven the existence of a problem statement? And two, proof that a growing market exists for the solution to the problem and that customers are willing to pay for what a startup offers. Eventually, the startup will also have to prove that, as a company, you can sell what you are building at a profit, or atleast show a path to profitability. While convincing investors of a bright future is not the biggest challenge, keeping up with investor expectations takes a toll. Remember, they must return 25% IRR to the LPs, which means the pressure is on the founders to deliver that IRR. Does that additional pressure help founders? Certainly not.
Building a company takes time. And a successful founder’s long and arduous journey is littered with ups and downs. And paraphrasing Paul Graham again, building a startup in its truest essence is about building something users love and spending less than you make. In addition, starting up is also about closely-knit teams working on something they are passionate about and innately curious about. Without which bad times and troubles would eventually have the upper hand. And we have evidence for it now, dont we? All of us can remember several startups which raised millions of dollars and shut down overnight as soon as things went south. But thousands of startups did the exact opposite - when things were tough, they stuck together and took it one day at a time. That does not happen magically; it results from how carefully an organisation is built and with the right values and motivations. And bootstrapping helps develop this mentality.
Is bootstrapping the silver bullet for all problems? Absolutely not. However, it does give startups and founders enough time to understand the market, learn more about the product, gather and implement customer feedback and figure out weaknesses before raising institutional funding. Isn’t that the real journey of building a startup? Do actions not speak louder than words?
Irrespective, I reiterate that funding winter does not impede India’s startup ecosystem. If anything, this will ensure that over the next few years, we have the best startups being built in the country. Now is a great time for all founders to put their heads down and build. Whatever may be the problem being solved, if you build something customers are willing to pay for, investors will follow.
Bootstrapping, among other benefits, also forces you to build a business model which works and can produce positive cash flow and profits right out of the blocks — the foundations on which great companies are built.
How to think about external funding
While we spoke about bootstrapping, it is well known that not all businesses can bootstrap for many reasons. And that is perfectly fine. Founders and startups should, however, keep in mind the tradeoffs and implications/riders of investor capital,
If the capital has been invested at a certain valuation, it brings more expectations to prove the valuation and keep up with it.
While bootstrapped companies can move steadily and sensibly, investor-funded startups are expected to use capital to grow faster. There is also the fiduciary duty towards the investors, who demand a return for the risk and capital, manifesting into growth at all costs.
Restrictions and investor rights - while the news article of fundraising leads to a dopamine hit. The far-reaching implications are clear only when the fine print in the shareholder agreements is understood - liquidation preference, restrictions with company operations through reserved matters, and vesting schedule of founder equity, to name a few.
Exit and down rounds - this is an extension of point 3 noted above but needs to be spoken about specifically. Investors who back you are looking to exit the investment in about 7-10 years, which brings about its own set of complications—misalignment of incentives due to misalignment of outcomes. Eventually, if an exit does not materialise, investors often resort to a forced sale, which might mean more complications and in certain cases, a down round and drastic dilution of founder equity.
Case in point, irrespective of the benefits of bootstrapping, if you want to raise venture capital, keep these pointers in mind and make peace with it. Getting an investor onboard is quite a critical decision, and it deserves tons of time to think through. But no amount of exuberance in the funding markets should influence your decision and rush you into something that you will find difficult to reverse. And if there is a north star that can help with decisions when at a crossroads - it is the introspection of what you would want to build and how you would want to build it.
Challenges of Bootstrapping
As I said earlier, not all companies can bootstrap. If you are a startup looking to invest in capex to start with, or need capital to hire specialised teams, or would want to target multiple geographies from the outset, capital can certainly make a difference. So venture capital is a necessary option, despite some of the drawbacks.
And the bootstrapping journey is not for the faint-hearted. It forces companies to be frugal and patient while competitors acquire market share. It certainly takes tons of perseverance and belief in the ideas and values a startup is being built.
Here are a few challenges to be mindful of,
With limited financial cushion, bootstrapped companies have less room for error. A single financial setback or misjudged investment can have a significant impact.
Bootstrapping often means starting with limited financial resources. This can constrain the ability to invest in critical areas like marketing, technology, and talent acquisition. It may lead to slower growth and competitiveness in the market.
Bootstrapped companies may need help to scale rapidly, especially in industries where large capital investments are necessary to seize market opportunities quickly, especially in fast-moving markets, where bootstrapped companies may need to catch up with competitors with access to more substantial product development and marketing resources.
Managing cash flow and covering operational expenses can be stressful, especially during slow revenue growth or economic downturns.
Conclusion
We often hear that if you want to build a startup that will withstand fast-paced growth at some point in its lifecycle, it must have a rock-solid foundation. Areas like governance standards and financial decision-making improve with time and careful attention to fixing subtle deficiencies. Would venture funding alone enable this? Unlikely. This means even though bootstrapping has its set of challenges, startups that build their organisations in the initial years with care will persist the test of time in the long run. After all, adversity breeds innovation. And scarcity moulds efficiency.
It is not a given that bootstrapping a startup would mean success. 95% of startups eventually fail within the first 2-3 years. But bootstrapping does give founders time to think through the kind of business they want to build and not participate in the rat race of growth.
Funded startups made all the news in the last few years and attracted the best of talent. Things are changing. Joining a startup is no longer based on funding round announcements - this was amplified by millions worth of ESOP value destroyed over the last year or so with all the down rounds and valuation markdowns among venture-funded startups. This naturally meant that folks looking to join startups are now screening for meaning and purpose in the problem statement and vision rather than anything else - I hope. Back to basics much?
It is also increasingly becoming clear to me that the role of VCs is also going through a significant shift. The 1950s introduced risk capital and led to the beast that is the modern VC industry, but investment firms might have to adapt to the realities of the times and deal with an increasing number of founders wanting to look the other way. Investors on the cap table must bring more than just capital. Investors must inherently understand the businesses they invest in and help founders by asking some tough questions they otherwise would not ask themselves. And for investors to stay relevant, they must also align incentives with founders to ensure that the capital returns align with expectations.
Either way, it is well-known that the VC industry is cyclical, and the funding frenzy will return. And we might forget why bootstrapping as a concept works. But as long as the chase for startups will be to build great teams, solve difficult problems and get customers to share feedback in the early stages of development. It’s half the battle won. As I mentioned right at the top, India continues to be a good place to build for the world - be it venture-funded or bootstrapped.