Bootstrap your business and then find yourself an investor

You’ve managed to bootstrap your business without the help of outside capital, now it’s time to pick the right investor. Michael Elias and Hillel Zidel of Kennet Partners write

Self-financed or ‘bootstrapped’ companies are unusual in many ways. Having been built without the use of external capital, they are usually run by their original founders. As a matter of necessity, bootstrapped companies tend to be tightly run, with strong margins, satisfied customers, controlled expenses, and a strong emphasis on cash management. Founders that have successfully built bootstrapped companies are notoriously careful when it comes to choosing an investor, and rightly so. If things go wrong, they have much more to lose than a start-up entrepreneur.

Bootstrapped companies have common challenges, with growth often constrained by a lack of capital, expertise in scaling a business and management. Frequently, founders of bootstrapped businesses don’t have the management resources or extra cash required to take the company to the next level of growth. They are forced to focus on the more immediate concerns such as cash flow rather than thinking ahead to maximise long-term value for the company. Sometimes these businesses stagnate as the founder becomes averse to risking the business he/she has built. With the right investment partner, bootstrapped businesses can be propelled to a new level of success.

It is fundamental that these companies find the right investor. Bootstrapped companies need an investor that understands their unique challenges and opportunities and has significant experience working with similar businesses. While traditional venture capital may be an option for some, it means being part of a portfolio which operates on a ‘hits’ model. In typical VC portfolios, 50% or more of the companies won’t survive, with the hope that among the remaining 50%, there will be one or two big successes that make up for all the losses. Having independently built a successful business with real value, most bootstrapped founders are very reluctant to have an investor that sees a failed portfolio company as simply part of the expected portfolio strategy. Investors with experience backing bootstrapped companies will have low portfolio loss rates and more modest investment returns spread among many investments rather one or two companies which drive fund returns. Timing, experience and investment approach are key considerations when selecting an investor.

Founders should grill their prospective investors in the same way that investors grill them. What are examples of bootstrapped companies they have previously backed? What is their historical portfolio loss rate? What is their expected return on each investment? Ask to speak to the founders of bootstrapped companies they have backed – and make sure they include troubled investments on that reference list as well as those that went well.

Why bring in an external investor? In short, it’s an opportunity to add fuel to the engine and supercharge the expansion of the business. Often a competitor has raised external capital, profoundly changing what was previously a level playing field. A stronger balance sheet allows founders to expand their business without the immediate cashflow worries. A good investor will help to strengthen the management team, to build a useful board of directors, and will act as a sounding board – based on their experience of working with scores of similar businesses.

Most founders of bootstrapped companies have most of their personal assets held within the company. As the business grows, there is a natural tendency to become risk averse – there is much more to lose than when the business was a start-up. Many investors will be open to purchasing existing shares in the business from the founder or others. This allows founders to diversify their personal wealth and to feel more at ease in expanding the business with its associated risks/rewards. It provides freedom for bigger decisions and calculated risks.

The financial backing of a well-established investor also adds additional credibility to a business. Without financial backing, it can be hard to convince world-class talent to join the company. The presence of an external investor is seen as a stamp of approval, and with it comes heightened exposure to a range of industry contacts including senior industry players, potential hires and potential acquirors of the company.

An important step for growth, which is a stumbling block for many bootstrapped companies, is geographical expansion. A strong external investor can be key to this effort, employing local expertise to accelerate growth into new regions such as the US and continental Europe. Geographical presence, local market knowledge and hiring local talent are all essential and can all be facilitated through the correct partner.

Tech companies are sometimes overwhelmed by choice when it comes to exploring financial options to scale up their business. The range of choice often leads to founders avoiding the decision altogether and stalling growth as a result. When selecting an investor, bootstrapped companies should pick a partner whose vision for the business is aligned with their own, who can provide guidance and support where needed, and where the timeline to exit will work for both sides. The decision as to which investor to bring in must be based on trust, and it is a decision that should be explored thoroughly and carefully. Like any long-term partnership, there will inevitably be bumps in the road, but trust and a firm alignment of values is the foundation for success.

Michael Elias and Hillel Zidel are managing directors of PE Kennet Partners

Further reading

Top 5 sectors attracting venture capital finance in 2019

Michael Elias

Michael founded Kennet in 1997 and is managing director. Earlier, he was responsible for establishing the international operations of investment firm Thompson Clive & Partners in Silicon Valley and...

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