Having traversed both paths — raising funds for CollegeWikis and bootstrapping on two other occasions — Joe offers a unique perspective on the advantages, challenges, and underlying dynamics of each approach.
From evaluating the fit for venture capital to managing the sometimes delicate nature of friends and family funding, Joe touches upon the various financing strategies a SaaS founder might consider. He underscores the significance of timing, the evolving nature of financing decisions, and the importance of remaining adaptive and informed.
Dive into the transcript below for a detailed breakdown of Joe’s insights and experiences.
What do you need to know about bootstrapping SaaS vs raising VC?
Raising VC can indeed be challenging, but if navigated well, it can significantly supercharge your business. Though it entails surrendering a large stake, it’s all in exchange for a larger piece of the pie.
Bootstrapping SaaS, on the other hand, leaves you bound in certain ways, let’s say it keeps you ‘strapped’ in more ways than one. Be prepared for this, and also brace yourself for the kind of intense commitment your business will require.
Just recently, a business school colleague and I were mulling over which option was better—where is the grass truly greener? It seems like proponents of both approaches believe the other side to be more appealing.
Many bootstrappers often perceive the grass to be greener on the venture capital side, and similarly, those who’ve embraced venture capital often imagine a rosier scenario with bootstrapping SaaS. Both paths have their merits.
I would suggest exploring both avenues, testing the market iteratively, and gauging where you think your journey will lead you. Keep in mind that there are specific market-based guidelines that can indicate whether you necessarily need to pursue VC or not.
In essence, that’s my journey – twice bootstrapped, and once each with VC and Angel investments.
What are the pros and cons of Bootstrapping SaaS in your experience?
We all understand that once you’ve discovered product-market fit, it opens the door to venture capital (VC), or even angel or precursor to VC, serving as a powerful catalyst to expedite your growth.
Let’s delve into the advantages and disadvantages of bootstrapping SaaS. As Ben mentioned, it’s a topic Nathan often explores. With my experience at Regroup, which I started in the late 2000s, now surpassing 15 years, there are certainly both pros and cons.
You retain a considerable portion of equity, but it might lead to a slower growth rate. Also, the risk rests solely on your shoulders.
While diversification is considered the golden rule of investing, bootstrapping SaaS doesn’t necessarily offer that, and you’re often alone in the game. So, there’s no obligation for anyone to assist you.
I’ll also touch on the ‘gray areas’ of funding in this presentation, exploring various strategies to alleviate some of the burdens. It’s about knowing how to assess yourself, your business, and the timing.
Timing, in my opinion, doesn’t get enough attention. Given that we’re in 2023, it’s definitely a crucial factor to consider. Let’s not forget how the market dynamics can shift.
Looking back, even SaaS multiples used to be about 2X on a revenue basis, compared to today. There have been instances where I’ve seen multiples surge to an average of 16x in certain studies, only to later settle around 6x times sales. Hence, everything hinges on timing.
What was your experience in raising VC? Was it the right choice?
It’s already been touched on a few times today, but we must remember that only 1% of companies secure VC funding. Drawing from my experience with CollegeWikis, even though I was residing in the Bay Area while we were based in New York, we undertook the extensive process of reaching Series A.
This involved pitching to numerous angel groups such as New York Angels, Boston Harbor Angels, East Coast Angels, and Sand Hill Angels, regardless of whether these groups still exist today.
That was our journey in the world of venture capital. I recall having 11 meetings with Foundation Capital before they ultimately declined. In the end, we secured funding from High Bar Partners for College Wikis.
It’s important to realize that securing funding is a long, distracting process. But it can pay off by helping diversify risk. Although College Wikis didn’t succeed, in hindsight, our choice to pursue funding was a wise decision, considering the circumstances.
How do you know if you’re a good candidate for VC? What about Angel investors?
We all understand that the investment process portrayed on shows like Shark Tank, where most are selling a tangible product or service, is far from reality. Very few VCs actually invest in such enterprises. It might make for entertaining TV, but the reality is somewhat different.
It seems everyone here has fulfilled the prerequisite of having a software or SaaS product. Additionally, having a technical co-founder and demonstrating some traction is often key.
Even when approaching angel groups, be prepared for high expectations. I recall my conversation with David Rose of New York Angels. While it’s not quite a 1% acceptance rate, only about 5% of companies applying to them secure angel funding.
Based on my experience with angel investors, I’ve found that approaching individual angels tends to be easier than presenting to a group.
Let’s discuss VC, which for me also encompasses the angel market, and assess if it’s a viable option for you. Software is attractive to investors due to its low cost of goods sold and scalability – points I’m sure you’re already familiar with.
When it comes to the stage and team, investors often want to see that you have some skin in the game. You’ll frequently find founders who have garnered investment from friends and family, or are repeat entrepreneurs. So, it’s important to show your commitment as a founder and demonstrate some traction.
However, for venture capital, most of the decisions regarding the direction of your business will hinge on the size of your market.
If you’re targeting a very specific niche, you could potentially bootstrap your SaaS to a $10 million ARR, sell for a $100 million ARR, and achieve the same result as building a unicorn.
However, the higher your ARR needs to be for a good exit, the more challenging the journey becomes. This is a balancing act of benefits and drawbacks.
If you’re operating in a niche, bootstrapping SaaS could be a viable approach. Conversely, if you’re vying against large companies in a vast market, you might need to raise money and accelerate your growth.
What is important to keep in mind about bootstrapping SaaS?
Many people, if they can, lean towards bootstrapping. Speaking with several founders here today who’ve bootstrapped, it seems to revolve around a few key factors – primarily creative financing.
Being at a conference sponsored by a company that facilitates revenue-based factoring, we see there are inventive methods to finance a business. However, these do require revenue.
Early stages often involve friends and family rounds, raised as convertible debt. This method, though, has lost some popularity since Y Combinator revised its contract, which now sections off parts of the company, even in these early rounds.
There are other ways to acquire Angel capital as debt, though, which theoretically could be repaid once you reach revenue milestones. One strategy I adopted with Regroup was to greatly rely on everyone I knew for potential early customers.
It’s about using your network to its fullest extent, conducting in-person meetings, leveraging existing open source software, and building on top of it to sell that minimum viable product.
When you decide to bootstrap, it becomes essential to either generate some revenue or maintain extremely light costs. It could mean living in your parent’s basement, as I did. It takes a lot, but it’s manageable if you can generate some revenue, keep expenses low, and find a niche within your network to sell.
However, if you aren’t making sales, that’s a problem.
How do you solve the “catch-22” of needing financing to build a product and revenue to raise money?
The problem is – and I’ve recently been discussing this with a friend of mine – everyone recognizes that it’s a bit of a catch-22.
How do you build a product without financing? And how do you raise money without revenue? It’s a catch-22, indeed. This is the challenge that everyone is tasked with and has to figure out on their own.
There are some patterns to follow, though. For example, when we raised for College Wikis, we utilized the open-source media wiki platform that Wikipedia used and then added some enhancements to it.
So you can innovate on things that already exist, or you can leverage your network as much as possible to generate initial clients. Many people begin their entrepreneurial journey while working at a company and then spin it out. Hence, there are some options and strategies to get around this.
What are the pros and cons of friends and family funding? Does it add extra stress?
We’ve discussed various options for fundraising and what it means if you’re getting funding without bootstrapping. One thing that’s recently been in the news is the idea of ‘Nepo babies’, which made me think about friends and family funding.
It reminded me of Elon Musk’s situation – unless your dad happens to have an extra emerald mine handy, friends and family funding can put a lot of stress on your personal relationships.
Furthermore, it may let you avoid the rigorous path of getting to revenue as swiftly as possible. I’ve witnessed a lot of friends and family funding rounds that didn’t turn out as planned.
It can be a necessary evil; I was just listening to another founder’s talk about maxing out his credit cards. This is a situation many founders face, and it’s one I’ve experienced at some point as well.
Doing what’s necessary to generate revenue is crucial, but the friends and family financing route can be incredibly stressful.
Studies suggest that if you’re an entrepreneur, there’s a high likelihood – around 80% according to one study and 53% according to another – that you have entrepreneurs within your close network or family. This could mean that your network has a familiarity with risk-taking.
However, my advice is to seek out an Angel investor who’s had success with a venture similar to yours. These individuals often have a bias towards the success of your endeavor and are typically the easiest to raise funds from, especially if you’re looking to individual angels at that early stage.
Moreover, with the right structure, some terms can preserve your equity even at the Angel stage.
How can your financing strategy change over time? Can you go from bootstrapping SaaS to raising VC or vice versa?
I came across something during my research for this, something I’ve noticed before but haven’t seen much discussion about. In a fascinating conversation with Nathan Latka of Founderpath and two other founders, Chris Savage and Mads Fosselius, Chris revealed something quite interesting about his company.
Despite the common idea that the dream is to bootstrap a company all the way to unicorn status, the terms can change along the journey, sometimes to the benefit of the founder.
In Chris’s case, he had raised a substantial amount of equity by 2017—$1.7 billion. Once his company was generating revenue and had the capability to take on debt, he opted to buy out his investors. As a result, he and his team gained full ownership of the business and were free to steer it in new product directions.
This is something of a gray area, and I know several other founders who’ve made similar moves.
When speaking with other founders, I’ve found there are many decisions we make that are more iterative than we might realize. Financing, for instance, can be iterative, whether you’re bootstrapping or a VC-backed company.
The composition of your board can evolve over time, as can your founding team.
What I’ve observed is that these processes can be quite iterative. There’s often a great deal of stress over these decisions, but the reality is that we usually have to make the best choices based on the information we have at that moment. It’s important to remember that if we’re committed to running our businesses for a decade or more, things will inevitably change—and these changes can still occur even if you’ve already secured funding.
However, I do resonate with the sentiment that bringing someone onto your board is a lot like entering into a marriage. This isn’t a decision to be taken lightly. It’s vital to find someone who can champion your cause.
I’ve seen and experienced both the positives and negatives of this.
So, you’d want to ensure that this person isn’t just coming in with a strict finance background but also understands the intricacies of entrepreneurship, which, surprisingly, some investors may not.
How can providing services help founders generate revenue?
If any of you offer services as part of your business model, it’s worth noting that while this might command a smaller revenue multiple when you’re looking to raise money, services can provide immediate revenue.
I’m aware of many founders who’ve supplemented their core business with services to quickly generate revenue.
Is it risky to bootstrap your SaaS for too long?
The question has been asked if it’s risky to bootstrap SaaS for too long. I’ve observed something that might seem counterintuitive. For instance, angels, unlike VCs, sometimes ask for more when a company has been bootstrapping for a while.
Take the 11 meetings I had as an example; we already had a product launched and some traction, but we had to present our progress in various ways to convince them. Conversely, I’ve seen the opposite happen when you just have a team and an idea, and you’re planning to hit the market hard.
In such cases, investors can’t really question you on specifics. They can’t say, “Oh, you’re not Facebook, so we don’t want to invest.” They only have to decide if the idea sounds promising or not.
So, surprisingly, bootstrapping for too long can sometimes be counterproductive when dealing with angel investors. But with venture capitalists, I believe it’s not so much an issue. It’s more about reaching specific milestones, regardless of the time it takes.