One of the very first critical decisions for a SaaS startup is deciding whether to seeking outside funding from Angels or VCs – or fund initially through a bootstrap approach. There are many factors that should be considered in this decision, some of which are the specifics of the market you are entering, your own personal considerations and goals as well as the ability to raise money for this particular venture.
Let’s take a look at some of the most important considerations for this decision:
First of all consider what your absolutely non-negotiable expenses will be. The idea is to build a Spartan – even skeletal startup budget to see if it’s even possible to fund the company internally for some period of time. Every situation is different, but here are some of the more typical things to consider:
- Office Space – Will you need a place to conduct businesses? Many SaaS startups can actually get pretty far with a “virtual” approach and no physical office location. But your personal communication style, comfort level with virtual management approaches and sometimes other business considerations may demand that you have an office. If you do, that’s rent that needs to be paid every month – so start your budget there.
- Staff – Unless everyone is on-board working for equity-only, you’re going to have to pay some salaries as well. Obviously a SaaS startup wants to minimize this expense as much as possible, especially in the early days. But it’s not always possible to assemble a team – or keep it together for as long as you need – with an equity-only approach.
- Product Development – Again, unless you’ve managed to delay this expense with an equity-only strategy, you’re going to have to pay to get the product built. This is where the makeup of the founders can make a big difference in reducing early expenses. If the founders are programmers, or if they have a following of programmers willing to work until revenue starts flowing for equity-only, maybe you can get by here without much expense. But if the founders aren’t technical and you need to outsource the work of building the software, it’s likely this will be a proportionally large expense early on.
- Cost of Goods Sold – Even though the software business is very high margin, the SaaS business model isn’t quite as attractive as the old on-premise model when it comes to COGS. Since you are hosting the product for your customers (essentially acting as their virtual IT department for your product) there are fixed and variable COGS associated with delivering the product. You will have fixed expenses just to get the product ready to deliver to the first customer, and these costs will scale as you have volume. Now margins are still great and these costs should be modest compared to your revenue. But they aren’t zero, so an estimate of them should make it onto your early budget.
- Legal Expenses – Attempts should be made to minimize these early on, but a few critical expenses might be necessary in the form of corporate formation, patent protection, etc.
The above list is by definition incomplete, and you should think about what other expenses your particular situation may call for. What this exercise brings to the forefront, however, is the need to be extremely capital-efficient if you are planning to bootstrap. Unless you are independently wealthy going in, bootstrapping means that utilizing strategies such as heavy use of equity in lieu of salaries, offshore software development, and a virtual, distributed organization utilizing low-cost locations for labor become very important.
Capital Available from the Founding Team
This brings us to the other half of the equation in the bootstrap vs. fundraising decision: how much capital can the founding team bring to the table. Approaches like salary deferral and equity in place of salary can be very useful. But at the end of the day, you’re going to need SOME cash, even if you’re bootstrapping. So after you’ve assembled your startup budget, take a second inventory; this time add up the total amount of actual cash the founders can bring to the business.
At this point, it’s pretty simple math. If you have enough cash available to carry you through the desired startup budgetary time-frame, it may be reasonable to give bootstrapping a shot, rather than immediately turn to external fundraising. But that still doesn’t mean it’s the right thing to do in your situation.
Let’s now look some more complex aspects of the bootstrapping vs. fundraising decision that you should ponder, prior to moving forward down either path:
SaaS Market Segment Structure and Competition
As I stated above, just because it’s theoretically possible to bootstrap your SaaS startup doesn’t mean you should. Consider these aspects as well:
- It’s important to be able to compete with the other players in the market. Put it simply, whatever your choice, you need to be in a market that “won’t kill you”. As a SaaS startup which is bootstrapping, you are much more vulnerable to crib-death (although it’s quite possible to choose a market segment that will kill you quite easily, even if you’re relatively well-funded). So make sure it’s possible to compete as a bootstrapped startup in the market segment of choice.
- It’s also important to choose a market segment that won’t cause you to run out of money before you reach traction, just because of the realities of that segment. For example, it’s harder to sell (with much longer sales cycles) enterprise-wide applications as a resource-limited startup, than it is to sell SaaS to SMBs or to individual silos within larger enterprises.
- Too many competitors (especially market segments fueled by venture-backed money) make it very hard to “stand out from the crowd”, even if you would otherwise be able to compete with them. This is the startup equivalent of death due to lack of oxygen.
- Even if you feel like you’ve chosen “virgin ground” in a market segment with little or no existing competition, it’s important to look ahead and decide what the barriers to entry for new competitors would be. A market segment with few barriers to entry is likely to attract many more competitors, especially if it is large or growing quickly.
- Market size: if you’re bootstrapping, it’s often unwise to pick the largest or most attractive market segment. This is true for ANY SaaS startup, but it’s particularly critical for the bootstrapped variety. Of course, you need to pick a segment this is large enough for you to grow and thrive. So a bootstrapping SaaS startup needs to be really cognizant of finding that “Goldilocks” niche: Not to large, not too small, but “just the right size”. If the market appears to be “too big”, you may need to raise money even if other analytic considerations point toward bootstrapping.
It’s important to have enough money (whether through external fundraising or bootstrapping) and to pick a market that “won’t kill you” right off the bat. But at the end of the day, imo, the biggest factor for SaaS startup success is your competitive advantage. If it’s not significant enough, it’s likely that the bootstrapping vs. fundraising decision is moot. Do you have a competitive advantage which will allow you to win against better funded rivals? I wouldn’t go into ANY SaaS startup without feeling good about the answer to this question. But the reality is that no competitive advantage is permanent in the software business, and bootstrapping almost always slows down your progress toward obtaining “going concern” traction in the market. So if you’re planning on bootstrapping your software business, you generally need a larger lead or greater competitive advantage, than you would if your coffers are flush due to raising money externally.
The Personal Characteristics of Your Management Team
Last but not least, the personal characteristics of the founding management team should be considered. This requires an honest self-assessment by the team, including:
- Patience and time-frame – How long are you willing to go prior to some exit event? Do you have the disposition to “play the long game?”. This is critical to success when bootstrapping, as it likely will add years to any possible exit strategy.
- How much you value autonomy – I believe this is a critical consideration in making this decision. Some executives abhor having someone looking over their shoulder; it’s often why they may have left a cushy corporate job for the uncertainty of startup land. If this is the case, having outside investors might not be a great fit. But if you’re more of the collaborative, coach-able type, having the right outside investors might add quite a bit of value, past just the additional capital.
- Are you afraid of penny-pinching – There are naturally frugal folks in this world to whom penny-pinching is second nature. I would propose that a certain level of this mentality is required in ANY SaaS startup, even the VC-backed kind. But it comes more naturally to some than others. If you’re bootstrapping, it better be close to second nature.
- Afraid of being an underdog – Some managers thrive by being “taken lightly”, using it as the fuel that stokes their drive to succeed. Others may be less comfortable in this role and might find it demoralizing or even paralyzing. These second category of folks will benefit from “leveling the playing field” as much as possible when it comes to the availability of capital. Understand exactly who YOU ARE from a psychological perspective, when it comes to characterizing your founding management team in this area.
So those are my views on the fundraising vs. bootstrapping decision that many startup SaaS founders are presented with. How have you funded your own business and do you have any regrets? Please fill us in with your own startup capital stories and philosophies by posting a comment below.
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