How to decide if you should go for external funding?

The Truth: There’s no easy answer. It all depends on your situation. I dont know the answer, but that does not stop me from offering an opinion 🙂

My bias is always to bootstrap. Bootstrapping helps you get creative, it forces you to validate your idea and execution plan well and it teaches you many intricacies of finance that most entrepreneurs dont bother to learn.

That said I read an interesting post brought to my attention that had me thinking about when one should go to a VC (or angel investor for funding).

Lets assume there are 2 options ahead of you:

1. Stay bootstrapped: Which means (by and large) grow slowly with accruals, be cautious on expenses and grow as you need. The upside is you own the company, the direction and the future. Lets call this the “Vembu way” after Zoho CEO Sridhar.

2. Get funded (either with angels or Venture Capital) and scale really fast and quick. This means you are focusing on growth (initially). Lets call this the “Bahl” way after Snapdeal CEO Kunal.

Neither approach is wrong or “better” fortunately. It all boils down to how you want to answer these questions:

1. How big is your market / idea? Bigger markets require more capital usually (But Zoho’s going after a huge market you say. Yes, he’s a rare breed).  Hypothetically, if you build a company that has $100 Million in revenues in 5 years, and you are valued at say $500 Million (5 times revenue), and at exit (due to dilution) you own 15% of the company, you will be worth $75 Million. If however you bootstrap, and your company does $25 million in revenue in the same time, is valued at $75 Million (3 times revenue) , you potentially are worth the same if you took venture funding.

Generally VC’s dont invest in companies that address small markets (i.e less than $1 Billion) because the time and effort to help build a company is the same, they might as well go after a large market and have the potential to have a huge return.

2. How quickly do you think the market will develop? If you believe the market for your product or service is going to be large very quickly, then you’ll need external funding.

3. How quickly do you need to scale? If the market demands that you need to scale quickly and need to invest money before to meet the potential demand, then you’ll need financing to help you invest before (or just before) the demand.

Unfortunately, there are only 1 in 20-50 (depending on VC firm) companies that meet all the criteria for VC investment – a) addressing large market, b) quick growth & fast to scale, and c) exit in 5-7 years. Most VC firms invest in not more than 10-15 companies a year out of over 200-500 (or more) they look at. So even if you believe you need the funds, if you dont meet the a, b and c, together, you’ll likely not get funded by a VC.

P.S. I admire Sridhar, so I may be biased on this one, and I really respect Kunal too, so I really mean it when I say there’s not a right or wrong way. They are different guys with different ambitions. Who do you guys admire?

Update: a relevant article and a pertinent quote:

” At the end of the day, there is a fairly narrow band in the total spectrum of business opportunities that are venture fundable (though that band still represents infinite opportunities). If through whatever process of filtering, coaching and pivoting, the resulting companies don’t represent an opportunity for plausible venture returns, then by definition those companies will not get funded.”

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12 thoughts on “How to decide if you should go for external funding?”

  1. The most important thing missing here is: how much money do you have? Bootstrapping with a million dollars in a personal account is different from bootstrapping by asking family for money. If someone has worked in the US, has decent money in his account, and is bootstrapping a company in India by spending say 10-20k USD because he can afford to, that is a different scenario from someone who is starting fresh out of college with little or no money borrowed from family. The whole VC analysis presented here doesn’t factor too much – in this case if our latter guy IMO should bootstrap to a stage where he gets good inbound angel/investor interest (everything else remaining same).

    If someone is starting a “lifestyle” business then this question of “external funding” doesn’t arise in the first place. If someone’s considering it, then the implicit assumption is that he’s going after a big enough market which could excite investors.

    Just thought I’d add a few dimensions to this post.

    1. Aditya
      Good point. Let me present an alternative point of view. You are back from US. You have 2 kids and a large home mortgage, school fees, etc. You have some money saved but not enough to retire in most cases. This is the average person that “returns to India” from the US. Very few have made “millions” as you point out. In fact I know over 100 people back from the states and fewer than 5 are millionaires.

      If you just graduated from college, you would most likely live at home with parents or share a room with a few others. Overheads and expenses are low and you can get “Ramen profitable” or (Maggi noodles profitable in India) very quickly.

      My point is not to say folks from college have it easy compared to folks who have been in the US.

      My point is bootstrapping is the way to go for *everyone* regardless of age, gender, experience, bank account etc. So I disagree with your point on fresh out of college should bootstrap to a stage. You can bootstrap until any point and build a successful business if you wish. 95% of companies and entrepreneurs in the world build successful businesses without VC funding.

  2. Thanks Sir,

    It was my post in pluggd.in/forum. Thanks for these detailed reply with case. It helps me a lot to take a decision.

    I am putting more thoughts on this to pluggd.in post, which is reproduced from your blog.

    Once again Thanks,

    1. Semil, You are very welcome. Thanks for providing fodder for a blog post. Good luck with your venture.

    1. Thanks for the comment Chirag. I dont consider VC the “dark side”. Quite the opposite. Its an extremely valuable source of funds if you meet their criteria that I laid out.

  3. Mukund,
    Your points seem to be applicable more to an investor than to an entrepreneur.

    As you yourself said, a large market/idea is definitely a good-to-have but doesn’t influence your funding/bootstrapping decision one way or the other.

    And I would argue that if you think that a market develops quickly, you are better off bootstrapping rather than raise funding as you are more likely to hit your revenue/profitability goals in a large, quickly developing market than in one that develops much more slowly (on the other hand, one might make the case that it might make sense to try to raise funding if the market develops slowly so that you can “wait it out until the stars align”!).

    A much-simpler and more actionable framework would start off with just two questions:

    1) How much money do I need to get to a desired point/goal? This could any meaningful – revenue, profit, users.
    2) How much money do I have currently and how much can I get over the time period of traversing to this desired goal (revenues primarily)?

    Now, if 1 is significantly larger than 2, it would make sense to attempt to raise funding. Of course, this doesn’t make the task of actually raising funds any easier but it is probably a better way to look at things rather than prematurely conflate the investor’s imperatives with your own goals.

    Cheers,
    Sumanth

    1. I understand where you are coming from and disagree on your points. The questions you ask are not actionable for most companies, since projecting revenues is just not possible for most companies and entrepreneurs I know. At best you have a 3-6 (maybe 12 at the most) month window into your business.

      1. Mukund,
        Won’t argue with that but I don’t think the inability to project your revenues accurately is remedied if you do take funding in which case you are no better off than before.

        My point was that your post mixes two disparate things – “Should I try to get external funding” and “What does a VC look for to fund a co”. While both of these are necessary, they need to be examined separately.

        And specifically, with regard to your points about large market size and a growing market, the presence or absence of either/both does not provide you with an actionable template to take a call on which way to swing.

        Cheers,
        Sumanth

  4. Got it Sumanth. Understand more clearly now. But dont you think its two sides of the same coin? What they want is what you have to give, else you dont get “it”, right?

    1. True that but since it is a linear flow from the entrepreneur’s perspective (first decide if you need external funding and then figure out how to get it), the plan can be tweaked. Let’s say you decide that you need funding, figure out if you can get angel investment (which presumably has a lower barrier). If your funding requirements are huge and beyond the mien of most angel investors, you have two options – see if you can tell/sell your story to a VC to fit their imperatives (including the items that you mentioned in your blog post) and if that is not possible, try to raise angel funding and progress to a point where you can convince a VC for a larger tranche.
      Of course, all of this is easier said than done but as a template to work against, this was something that I found useful.

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