Bootstrapping, raising funding and value drivers: a fireside chat.

HB Bootstrapping vs raising funding a fireside chat with Howard Blake

Howard is one of the co-founders of bizval and a not-so-silent partner, which is exactly the way his co-founders like it. In this article, he shares decades’ worth of wisdom on the most important topic of all for entrepreneurs: raising funding and the importance of understanding value drivers.

You’ve been doing this a long time, Howard.

Yes – and I’ve lost count of the number of startups I’ve built. I’ll attribute that partly to age and partly to my belief that the number of startups doesn’t matter. What matters is the number of profitable ventures.

The longest distance one can travel has to be from when a would-be entrepreneur feels the seed of an idea germinate in their brain, through to when the income statement shows at worst a breakeven result and at best a profit. Take note: there’s no room for ongoing losses! One needs to understand the value drivers of the business.

Of course, this leads founders to a burning question: how long can I survive the walk through the non-profit desert?

Profits certainly matter – and that concept sits at the core of our valuation techniques, even when valuing startups. Profits can’t easily fall out of the air though. What are your thoughts on funding?

Look, the manner in which a startup is funded will impact the long-term capital structure of the enterprise when it can finally call itself that. This is the financial foundation of the dream that an entrepreneur is building.

There’s a delicate balance here. Too little in the way of capital can stifle growth, whereas unchecked availability of funding can easily lead to inefficiencies and a culture of accepting losses and assuming that funding will always be there.

Founders would do well to remember that even if it’s less obvious when raising equity rather than debt, capital that is squandered is capital that is effectively owed to somebody else. And you may not realise it at the time, but equity capital is the most expensive funding you’ll ever raise.

Let’s go through the approaches that a business can take. At one extreme, we’ve got bootstrapped operations. What does this mean in practice?

This is a self-funded enterprise, fuelled by the founder’s money, energy, time, enthusiasm and pure grit. Resources are limited and breakeven isn’t a nice-to-have; it’s a must. An important point is that although it may seem “cheaper” for the founder because money isn’t raised elsewhere, a bootstrapped enterprise absorbs a lot of time and that is a double-edged sword.

On one hand, there’s a certain magic to bootstrapping. Sweat equity, endless anxiety and long nights of tossing and turning certainly lead to traumatic bonding with the business. When victory comes, the taste is as sweet as can be. A successful bootstrap is the ultimate test of any entrepreneur.

But, it gives your competitors time to latch onto your idea and either catch-up to or overtake you thanks to having the funding to do so. If there’s a golden window of opportunity, you need to take it as quickly as you can.

Interestingly, in a world that focuses on the likes of Amazon and Airbnb as great examples of success, bootstrapped businesses tend to be the quiet successes lurking in the corner of the room. They never needed to raise money, so they also didn’t need to spend time telling the story to anyone willing to listen.

Most businesses fall into the bootstrap category, resulting in self-employment rather than the creation of equity value in the initial years. There is always a funding element, even if it means just enough to carry a couple of months of trading until the cash burn slows down (and that’s an optimistic scenario). I have recent experience in the garment industry where the business was profitable from day one, but the founder had contributed the machinery and a month’s worth of expenses. The business has now had 18 profitable months, with profits reinvested into machinery, premises and staff.

A bootstrap entrepreneur often carries a substantial loan account that is seldom recovered unless the business is sold or runs profitably for several years.

Arguably, bootstraps have the best chance of survival once they get through the initial phase, as the founder faces real and immediate consequences at every step in the journey. There isn’t the luxury of calling for another funding round while “experimenting” and “pivoting” and all the rest. In a bootstrapped enterprise, the DNA is all about agility and accountability, achieving growth because of frugality rather than in spite of it.

So basically, short-term pain for long-term gain. It sounds good in practice. Is there a less extreme version?

At bizval we like to refer to a “hybrid bootstrap” model to describe an enterprise that has limited 3rd party funding. Shareholders working in the startup sacrifice market-related remuneration to keep costs down, but they still need to pay school fees and cover the mortgage. By focusing on the right strategy rather than always having to pay next week’s bills, a hybrid bootstrap can effectively enjoy the best of both worlds.

Some months are profitable and others are not, with cash burn kept to a minimum. From time to time, a strategic decision to pursue an initiative (even if it burns more cash) may be taken, with all parties on board for what that means. This is still a lean strategy; it’s just a turbocharged version of a pure bootstrap.

In these cases, meticulous reviews of the cash budget against the strategic plan are needed. Where mistakes are made, it’s never the result of money being squandered through lack of care or extravagance. Every dollar (or other currency) deployed into the business must have a reasonable and foreseeable prospect of return. Importantly, we focus on deeply understanding our value drivers.

The shareholders working in the business are incentivised to achieve financial normalcy, managing their personal cash burn as well as that of the business. The level of stress builds a self-regulating environment with healthy checks and balances, which can lead to a highly sustainable and faster growth trajectory.

A hybrid bootstrap approach works particularly well in businesses with a digital route to market, as being able to go faster (but without spoiling the unit economics and value drivers) is richly rewarded.

We can’t finish this discussion without touching on fully funded startups that have managed to tap into venture capital investment. What are your views on this?

Sadly, this is where the term “capital efficiency” can quickly become an oxymoron. Capital is deployed to fund an idea on a whiteboard rather than a business that has near-term prospects. The founders are often younger and have very low personal overheads, so they operate under the mistaken belief that they have a great deal of time available to make the idea work. This leads to a culture of taking risk without spending enough time thinking about returns, which is a very long and expensive runway of burning cash.

In markets like the US, the risk of failure is readily accepted by venture capitalists. When they make it big on a single investment, they make it really big and the graveyard of failed businesses doesn’t matter. The culture is all around learning from failure rather than avoiding it, which does create an innovative environment, even if it also leads to plenty of wasteful “investment” in opportunities.

Most markets outside of the US don’t work like this. Due to the lower overall returns on offer (the total addressable market is smaller than for US-based companies), failure is punished rather than encouraged. Once a founder has burnt through capital with little to show for it, the next raise is exceptionally difficult (if not impossible). This is a tragic lesson for a founder to learn, as the online content (articles and podcasts) about the ecosystem of venture capital in the US have little application outside of that market. “Fail fast” should rather be “don’t fail at all” – but that realisation comes too late.

This isn’t to say that all VC-funded firms will fail, of course. It’s just a difficult starting point that doesn’t create the right culture around capital allocation. We saw an extreme version of this during the pandemic when interest rates went to zero and there was an almost complete disconnect from value drivers. We’ve seen an even more extreme correction in the post-pandemic period, witnessed by the sheer scale of lay-offs in the tech sector even in the United States.

When thinking about funding, entrepreneurs (and investors) would do well to consider the DNA of the business that they are trying to build and what the culture around capital allocation will be.

Howard Blake is a co-founder of bizval, which is following the hybrid bootstrap model referred to above. When bizval works with entrepreneurs, they benefit not just from our technical expertise in unpacking value drivers, but our real-life experience as founders as well.