Bootstrapping and Ankle Sprains
Updated: Jun 22, 2020
Should bootstrapped startups raise funds?
Seal of Quality
Everyone loves a bootstrapped company, right? A strong team of visionaries just took a leap of faith, moonlighted or quit their lucrative jobs, and launched their venture - finding initial customers, generating real cash, living off their work.
Don't you have tremendous appreciation to the guts, and talent, needed to pull this off? I know I do.
Let's discuss the growth of bootstrapped companies: Once initiated, they work for several months to build their product, find first customers, and develop their corporate identity.
After reaching initial sales, they pay off whatever debt they had, and start to incur wages, rent, wages, and other expenses. Even with high margin software, they usually need to spend on support, hosting, and have additional cost of sales.
Unless their product or service is virally self selling, they will have to invest in marketing, customer development, and other expenses. They will have to travel far and often to reach global markets, and they will have to spend on local representation.
All this to show that growth will always be constrained by available excess cash.
Is this a problem? In a non-competitive world, not necessarily. Entrepreneurs can grow their business at their leisure, one step at the time.
But do such worlds even exist?...
The premise here is that whatever your startup is, you'll face fierce competition - Especially if your idea is worthy. When that is the case, you might encounter a better financed competitor, which would send those extra sales person to the convention you gave up on.
They would write that extra blog post, generating additional leads. They might extend credit or offer promotions, which cash constrained vendors won't.
They may release better tested features more frequently, simply because they have the resources, which non-funded startups do not.
And that may tip the scale.
In this post, I'd like to dwell on some simple phenomena underlying the competitive technology world. It has a "bigger is Better" characteristic to it.
The underlying principle is that technology enables entrepreneurs to build infrastructures that serve any amount of users. This principle set the rules of the game.
Economies of Scale - Demand Flexibility
In a competitive world, where every product or service has its alternatives, price does play a role, and demand flexibility kicks in.
Demand flexibility is the term describing the tendency of more customers to purchase, as they face declining prices:
[In this classic micro economics 101 diagram, the lower price (dashed curve) results in an equilibrium at a larger quantity. ]
Economies of Scale - Marginal Unit Cost, Profit
Some technology investments result in reduction of the marginal cost of serving additional users.
This usually creates an asymptotic down-sloping cost structure where the first units sold are more expensive than the following units (note, though, that the minimum price cannot be surpassed sustainably. Consider the cost of electricity for, say, mining crypto currencies)
At the same time profit increases, since the fixed costs associated with maintaining the organization, servers, developers, do not change with quantity, while profit per unit keeps accumulating:
[In this diagram, the product is profitable once the 551st unit is produced. Marginal Profit AKA profit contribution, is the difference between the revenue and cost per unit]
Growth oriented companies will benefit from investment proceeds for the following reasons:
All things being equal, lower user costs and broader market access result in higher unit sales, higher profits.
Oftentimes, expensive technology infrastructure is needed to produce a low-cost user solution (product, service). The venture must sustain at loss initial expenses developing and maintaining these infrastructures, until revenue streams start to pay for it. Technology investment will drive the users' price down, demand up.
Market penetration is accelerated by available cash: Exposure, awareness, lead generation, and the ensuing sales process: All precede revenues, and require cash on hand. As additional prospects convert to paying customers, the revenue starts to accumulate.
A successful operational structure will create a cash positive "money machine", where every marketing dollar spent generates profit. If you are able to build the underlying infrastructure, sustain the initial marketing cost, your venture is taking off!
Are you ready for funding?
The reasoning is clear. Being first to fund is part of being first to market. Are you ready for funding? Do you accept the logic? Are you willing to commit to the process?
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