There are few things in this world that are as exciting as having a business that is thriving and growing. In today’s modern business environment there are several ways to go about financing the growth of your business. Some founders opt for more of a “bootstrapped” approach. Whereas others seek outside capital in order to grow. Today we are going to look at those two different approaches – growth through internal capitalization and growth by leveraging outside capital.
Let’s define both of these concepts. While the concepts both entail growing without outside funding they do have different meanings.
Bootstrapping is more about how a company uses its limited cash flow. It is more than just being frugal with the money that you have. Although that is certainly a component of bootstrapping. The term is also used when talking about a startup that forgoes raising capital from outside investors and the founders are funding the company’s growth from their own pockets.
So, when do companies take this route? Some make the deliberate choice. Others have no other, or few other, options. For example, most investors are not overly interested in financing lifestyle businesses. Investors are looking for a large return on their investment. Lifestyle businesses are likely to produce an income for the founder but often their goal isn’t to experience significant growth or they lack the potential to experience significant growth. Therefore, bootstrapping and growth by consistently increasing sales is their best growth option.
Sometimes founders aren’t willing to give up any amount of ownership in their business. They also may not qualify for or may not want to take on debt in order to grow. If that is the case they have no option other than to grow by increasing their internal resources.
What you will see with companies that take this path is that they work hard to keep their expenses low by adding help through part-time freelancers and/or outsourcing certain roles, as well as consistently reinvesting discretionary revenue back into the business.
You can think of organic growth as growth that is accomplished via internal resources. Companies that experience organic growth see it typically come from an increase in sales revenues.
Another example of organic growth can be seen with companies that don’t need to advertise in order to attract customers. Those companies might rely on word-of-mouth advertising and/or referrals.
There are two main reasons entrepreneurs aim for bootstrapped or organic growth – 1) they just don’t want to run a high-growth company and all the complexity that comes with managing that type of business; 2) they want to maximize the company’s valuation for when they do take on outside investors.
The alternative path involves funding growth by taking on outside investment. Don’t let the word “investment” lead you to believe that we are only talking about capital from investors such as angel investors, private equity, or venture capital. Lenders are also “investing” in your business when they are loaning your business money. It is just through a different set of terms. There is also a hybrid approach called venture debt which we talked about the article What is Venture Debt.
Funding growth with equity
More and more people have become familiar with equity investing because of the popularity of TV shows such as Shark Tank, The Profit, and others. In this model, the founder is giving up equity, or ownership, in their business to the investor. The investor does not get a recurring payment. Rather they recoup their investment when the company experiences some sort of exit such as being acquired.
Funded growth with equity works well for company’s that desire very high growth rates. Those lofty goals take a lot of capital to achieve. Even when funding is achieved, businesses typically show a net revenue loss for multiple years. As such, investors are willing to risk the company going out of business in exchange for a possible big win in the future.
There are a few exceptions, but when a business doesn’t have the potential for high growth it isn’t a great candidate for funded growth through investors.
Funding growth with loans
While taking on debt may not be right for every company it does make sense for some. Using debt to fund growth has its benefits. One of the biggest benefits, when compared to funding growth with equity, is that it is non-dilutive. Which means you aren’t giving up ownership in the company for the capital. Loans also have the potential to scale with the growth of your business. It can take a lot of time and energy to close an equity round of funding. When you use loans to fund your growth, such as with recurring revenue financing, the available balance increases as your revenue increases.
You should be noticing the inverse relationship between the two models of funding growth. Where bootstrapping and organic growth excel is where funded growth generally struggles. The inverse is also true.
The key here is to understand which model is the most appropriate for your business. Otherwise, you are going to take on funded capital that you don’t really need and then have investors with high expectations or you won’t be able to grow fast enough to defend your market share against the competition.
It is really important that you also weigh your own personal preferences as a founder. While raising millions of dollars might sound really exciting it isn’t necessarily for everyone. In fact, it means that you as the founder just took on a lot more responsibility. Because now the success, or failure, of the business doesn’t just impact you and your employees but it also determines whether your investors lose their money or not.