Bootstrap vs Angel vs VC
What are the key differences to consider?
“Getting rid of an investor is harder than getting a divorce.” or so I was told by a friend back in the day when we were pitching our business to investors. It kind of stuck with me. I’ve never been through a divorce but I imagine they’re up there with root canal treatment as the top ten fun things to do.
The whole raise investment/don’t raise investment debate feels to be as hot as ever at the moment. Almost everyone starting a product business seems to be wrestling with the same challenge. It’s not just whether to raise investment, it’s whether it’s even possible to raise investment. And then should you talk to Angels or VCs? And then how much money should you raise? So many questions - where do you begin? Especially if you are an agency owner who has grown out of margins and never needed to think about this before.
Tim Jackson, a VC who invested in my company, ScreenCloud as well as another company I’m a NED of, Attractions.io, says this:
In principle, the best source of capital to grow your business is cash flow from customers.
The second best is debt, if you can get it.
The third best is giving away a share of your company in equity.
So, you kind of have a VC saying that you should only get a VC on board as a last resort. So, why would you ever even go down the route of external funding?
Today’s article is primarily based on my own experience and the experience of others. I’m sure there will be people who disagree with my take, but hope it’s useful.
Bootstrapping
If you’re an agency founder, you’re probably a seasoned bootstrapper. You’ve probably bootstrapped your business from a standing start because you were able to generate enough revenue early on to grow out of margins.
There are loads of benefits to bootstrapping, perhaps the biggest one being that you can do whatever you (and your cofounders if you have any) want. You’re only answerable to yourself. You want to do something radical in the future, like start a side product or buy a competitor, then that decision is yours and yours alone.
On top of that, you own all of the equity. If someone buys your business after your years of hard work, you get all of the upside. There are some examples of product companies that have successfully bootstrapped and ploughed their own path to get there: Mailchimp and Basecamp (37 Signals) both spring to mind. Both great companies that have made their founders very wealthy.
Basecamp is still owned by the founders, but the business is so successful that they have managed to be well rewarded for their efforts along the way. Mailchimp was sold to Intuit Inc for is $12 billion in cash and shares.
So, yes bootstrapping has got a lot going for it, but there are two major issues about funding it yourself:
You are restricted from fulfilling your potential. Funding is there to help you grow faster and give yourself a better chance of survival as a result. The oft-quoted maxim here is:
“Getting to a $1m in ARR is impossible. Going from $1m to $10m is improbable. And going from $10m to $100m is inevitable.”
The idea being that the bigger you are, the less likely you are to be killed off by the competition or run out of money. At $15m, when you are technically ‘inevitable’, you should be able to grow the company profitably if that’s what you want. But at $1m, it’s harder. It will slow you down.
You may not have the money yourself to bootstrap. Forget the whole ‘should we/shouldn’t we?’ debate. I you don’t have the resources yourself then you need to get the money from somewhere.
It may be that, if this is a side product, then your main business can fund it. It could be that building and running your product can be done on a shoestring. But the reality for most is that great success actually requires more money than modest success and you might not have the resources (or the appetite) to keep funding it yourself.
When I coach clients, a big part of what I do is helping them get a sense of breaking the journey into a series of mini-targets where we quantify the investment required and can get to a yes/no point where we decide whether we’re happy with what we’ve learnt to invest further. Part of that is deciding whether that investment can be met internally or do they need to go out and get external funding.
Statistically, though, a bootstrapped SaaS won’t do as well as a funded one. Now, what’s not clear is whether this is cause or effect. Better SaaS companies will be more successful at raising investment. So, comparing two cohorts based purely on whether they have funding or not may not be as clearcut as it first appears.
But here are some broad differences between bootstrapped and equity-backed SaaS startups (this is a table from my book, by the way):
Bear in mind that this is a generalization and of course, not every business fits this analysis.
Angels
An Angel is normally a high-net-worth individual (or syndicate comprised of several) who invest in startups that they find interesting. In some countries, the UK being a prime example, there are some very generous tax incentives for Angels to invest in early-stage companies, often at the pre-revenue stage.
In the UK the SEIS and EIS Schemes encourage individuals to invest and be able to offset some of that investment against their personal tax liability as well offer relief around Capital Gains. The result is a vibrant Angel Community and in fact, it makes it easier to raise the first bit of money than the subsequent one.
Finding Angels to invest in your startup is just a case of doing the research. In the UK you could start by looking at Angel Investment Network which has a network of investors. Or you could approach VCTs (Venture Capital Trusts), where high-net-worth individuals invest in the VCT, get the tax benefits but it’s the VCT that invests in your business. In many ways, having a VCT invest in your business might ‘feel’ more like having a VC on your cap table than a collection of individual Angels.
To my mind there are some key differences which some might see as a ‘pro’ and some might see as a ‘con’ when it comes to having Angels as investors.
Assuming you need to raise at least $500k, you will likely need more than one Angel. In fact, you might have more than 10. We did an Angel round and probably had close to 20 individuals as investors. It can sometimes be a bit of an admin nightmare if you have to get people to sign documentation. If you’re one of several investments they have made, the fact that you need them to sign your legal doc urgently so you can issue stock options to staff, might not register as much of a priority for them. It’s OK, but it’s just an added task among many that you have as a founder.
You will probably end up having at least one of your Angel investors on your board. Probably the one who put the most in (if they want it). They may just be an advisor, or a fellow board member, or even the Chair. It’s very likely that at least one of your investors will have some oversight of what you’re doing and be there to hold you accountable (to an extent).
There is a good chance they won’t be experts in your field. If you’re launching a SaaS, you may find an Angel with a background in SaaS but it’s certainly not a given. They may invest just because they like you or are interested in the sector. It may be that they just like to have a series of small investments in businesses they think are ‘cool’ so they can show off to their mates. The point is, they may not bring much added value to your business other than their moral support and encouragement.
They will probably agree to the Shareholders Agreement that your lawyers draft. In other words, you won’t be pressured into accepting any weirdness that a VC might want to include in their Terms.
They won’t be on your case (probably) in the same way a VC would. They’ll want to know you aren’t doing anything crazy with their money, but they are unlikely to have the time, inclination or perhaps the technical understanding to get too deep into the weeds.
If you need to raise multi-millions, you’re probably not going to do that effectively with Angels, unless you happen to know someone very rich who just wants to back you because it’s you.
VCs
A Venture Capitalist (VC) is a professional investor or firm that provides funding to high-growth SaaS companies in exchange for equity, typically at the early to growth stages. Unlike Angels, VCs manage pooled funds from institutions, high-net-worth individuals, and pension funds.
Incidentally (not covering this today) but VCs differ from Private Equity (PE) firms who tend to invest in more mature, often profitable businesses, aiming for operational improvements and eventual exit via acquisition or IPO.
Raising money from a VC is harder, IMHO, than raising from Angels. Firstly, the tax incentives (depending on where you are based) might only apply to individuals not companies. This is certainly the case in the UK.
Secondly, their whole job is to invest the money that they work very hard to raise from institutions and rich people. This means that they aren’t ever going to invest in something just because it’s cool. They invest a lot of time and effort into assessing the potential of any business they back. If they make too many mistakes, then they face reputational damage alongside the financial one.
There are a few things to consider when it comes from raising from a VC:
Securing VC investment is a big green tick. It shows that a professional firm has taken a view that you are a worthwhile bet. This can be a badge of credibility that you can wear to reassure potential customers and, possibly more importantly, potential employees to join you. If you were an ambitious marketing person looking to go on a roller-coaster ride with a startup would you rather join the one where the founders were watching every penny, or the one that was backed by a VC with the funds to make change happen? On a personal level, as a founder it feels great to have that affirmation.
VCs will want to protect their investment, even though they are minority shareholders. This might include vetoes on what you can and can’t spend money on, future investment rounds and mergers or acquisitions. It will also likely give their shares a higher status than yours. For example, if the company sells, they may get their money back before other shareholders (Liquidation Preference). They might insist that in the event of a ‘down round’, they protect the value of their initial investment (Anti-Dilution Protection). In extreme cases, founders end up getting no money when they sell because the investors’ claim hoovers everything up. Decent VCs have ‘founder friendly’ Term Sheets which mean that there aren’t any unreasonably harsh terms in there, but it’s ALWAYS VITAL that you get a lawyer who understands this stuff when an investor asks you to sign their terms. I was surprised to learn, first time round, that you really don’t have to accept everything an investor tries to get you to. It’s OK and normal to push back on anything you are unhappy with. You might not get your way and then you have to make a call, but if someone is asking for something unreasonable then you’re fine to tell them so.
VC rounds are generally bigger than Angel rounds. Suddenly having all that money in the bank account is a nice shock when it first comes. But….
…you are firmly on the fast-growth track now. Not only have you ‘exchanged’ some of your equity for faster growth, the expectation from your VC is that this is what will happen. Your VC won’t be impressed if your plan is to stick that money in a high-interest savings account and not touch it in order to help you sleep better at night.
VCs who invest in you will know what they are investing in. They might not know your vertical as well as you, but if they are SaaS investors, they will know the science behind SaaS (and the accompanying metrics) really well. For me this was a positive since it kept us focused on what mattered most. We were told that most of our numbers were ‘exemplary’ but there were two that were out of kilter with the rest of their portfolio of investments and we were able to address them. Which brings me onto….
….being part of a portfolio. Your Angels might have a series of investments under their belt, but its unlikely they’ll be setting up events where they can all meet and share experiences. VCs on the other hand will almost certainly make sure that the value of being part of a wider cohort of businesses is realised. Our investor, Point Nine, arranged an annual meet-up of all of their investments and brings along incredible speakers to present to the group.
And so the winner is…
I think what Tim Jackson is saying is that there is additional risk associated to raising money. So if you don’t need to take on that risk, then you shouldn’t. And let’s not forget that it’s scary. I remember lying awake at night fretting that we were about to make the biggest mistake of our lives when we took our first VC money.
But on the other hand, not having enough money acts as a shackle to growth. You are restrained because you can’t make the most of every opportunity. And you can be sure that if you’re not doing it, someone else will be.
You just need to go into it with your eyes wide open and protect yourself from overreach by any investor. In my personal experience, investment was a positive experience on the whole and helped propel the business forward.
PreviousNext
