Bootstrap or capital raise: which one is right for your startup

So you have an exciting idea for a startup and you're ready to get to work. One of the biggest hurdles founders face is raising the initial capital to get started.

Whether you're a first-time founder or a seasoned business owner, this article will provide valuable insights and actionable tips to help you secure the funds to turn your startup dream into a reality. How else are you going to hire your dream team and begin developing and marketing your product?

Bootstrapping vs capital raise

To bootstrap or to raise, that's the question.

• You dig deep into your pockets, you crack that money box, and even sell that fancy car of yours to pull together the required funds yourself, otherwise referred to as bootstrapping; or..
• You offer others (whether they are family, friends, wealthy folk or even venture capital funds) a share of your business in return for capital injected into your business, which is what we refer to as a capital raise.

Both options have pros and cons, and different businesses will suit different approaches best. The key is evaluating your long term vision, required growth rate, and tolerance for external input or reduced ownership. Consider:

• How quickly do you need to scale and hire?
• How much control over your company's vision and direction is non-negotiable?
• Would external investment speed time to profitability, making it worthwhile?

Weigh these factors to determine if bootstrapping, capital raise, or a hybrid approach best matches your specific goals and priorities. Just be sure to make a decision that aligns with your company's long term objectives.

At Cake, we’ve seen our fair share of start-ups at this fork in the road, and our focus is to make sure they always manage their equity in the most effective way possible.

Bootstrapping, explained

What is bootstrapping — why, how, when?

Bootstrapping means launching or growing a venture using the founder’s own funds, and sustaining it by its own revenues. This means you will be dipping into your savings accounts, selling those golf clubs (that you never use), or even working two jobs to keep the venture going.

Put simply, it means funding your business growth through savings, loans, profits, and credit.

While we may make it sound kind of, well, horrible, it’s not all doom and gloom. A key difference between bootstrapping and a capital raise is that you retain all the equity in your company. In other words, you are not giving away any ownership, or shares – it’s all you!

This means that if you do manage to get through those early bootstrapped founder times, and your business booms, you can forget about shareholder meetings, paying dividends to investors and worrying about who is doing what with their shares – the business is your game, and you call the shots.

Why would I bootstrap instead of doing a capital raise?

There are a few situations that may indicate bootstrapping will work for you, such as:

• you have enough savings to put money into the business yourself, and you’re not overly concerned of the risk of losing it if things don’t work out as planned;
• the cash-flow of the business is strong, and you’re able to invest profits straight back into the company (ahhh, a profit making start-up, the dream); or
• maybe you actually don’t need much money to keep the business growing at all, many online businesses have low overheads and are able to grow steadily without large cash injections

However, to be clear, just because you might choose to bootstrap initially doesn’t mean you’re a bootstrapper for life. Often, it is quite the opposite. If a start-up can bootstrap for a while, this will mean that once they are ready for raising the big bucks, they have more shares to give!

Bootstrap now, raise later

Just look at Australia’s arguably most successful start-up, Atlassian, who bootstrapped for 8 years before jumping into the raising game and injecting over $200 million in just four years!

Or another favourite example of ours, Bean Ninjas, where founder Meryl Johnston launched the business in only 7 days with just $1,000, wasting no time looking for paying customers, to get the (now highly successful) ball rolling. Following that, Bean Ninja’s also took the capital raising route, and have been growing steadily ever since.

Capital raise, explained

What is capital raise — why, how, when?

A capital raise refers to funds a company raises from investors in exchange for equity, or ownership, in the business. When a company undergoes a capital raise, it's usually for one of two reasons:

1. The company needs funds to cover operating costs and fuel growth. Bootstrapping can only go so far for many businesses before they need an influx of capital. A capital raise provides that necessary cash.
2. The company wants to take advantage of favorable market conditions. If investor interest is high and valuations are on the upswing, a capital raise can bring in funds at a higher valuation.

However, giving up equity also means giving up some control. Investors will want a say in the company's decisions and strategic direction. So the decision to do a capital raise should not be taken lightly.

A capital raise can actually be one of the most vital ingredients to the growth and success of any start-up. The key is knowing how to go about it, and what it may involve – don’t just sing loud about it, make it happen, and make it work.

Learn more about how to raise capital for startups.

Common sources of capital

So, where do you find people who will invest into your vision?

Family and friends

If you’re just getting started, there is often no point going straight to the silk-suited hotshots, asking for the big bucks. Here, the stage you’re at is usually considered as a ‘Pre-Seed Round’.

Start with your family, friends, and close contacts. Here, often the family and friends are investing in you, rather than your business. They want to come along on your journey, and want to see you succeed.

But beware, just because they are close doesn’t mean you don’t need share terms, share certificates, and official documentation. Do your share issues properly, and avoid sticky situations down the road.

Angels

If you’re already on the way, and you’re looking for some bigger bucks than Uncle Joe may be willing to dish out, consider finding an ‘Angel’.

An Angel is a high-net-worth individual who generally has a special expertise in a given field (for example, app development), and who invests in early stage companies.

Angels are frequently involved in early fundraising rounds called ‘Seed Rounds’. They get in early, and are rewarded in decent equity for the higher risk they take.

The plus with these folk is that not only will they come into your business with money, but they come with skills, expertise, and contacts – they are now part of your business, and they will help to make it work.

Venture capital

If you’re really looking to go large, maybe you can consider approaching a venture capital fund. Generally VC funds are looking for the next big thing. They are planting a lot of money, and want it to grow, a lot.

But to be clear, these VCs are busy and in high demand. A cold email with a 2-page business proposal simply won’t cut it. VCs want to see proven revenue, growth, and return. If you’re not at that stage, they generally won’t give you the time of day.

If you are looking to go for the VC route, you will want your pitch documents and presentations in perfect condition to even get close to sealing that deal. The VC will want to do a major due diligence review of your business before committing any capital, so make sure it is all squeaky clean.

Convertible notes

So this one is a little bit different to the others, so stay with us. A convertible note is a way to fundraise through a mixture of debt (a loan) and equity (giving away shares).

It involves an agreement between the company and the investor to loan money to the company, in return for shares on the happening of some certain event. For example, paying back when the company completes a successful capital raise of $X in the future. And if that event doesn’t happen, the loan is paid back by the company, simple as that.

The huge advantage with this form of raising is that you don’t really need to know what your company is worth to get the funds in your account—you simply agree that when your company does eventually do a raise, and your equity is valued, the lender will be provided shares at that value (with any discount that might be agreed).

We say this from experience. Cake has used convertible notes in its early stages, and can vouch that a convertible note can be the perfect solution to keep you charging ahead. And this is one of the reasons why a convertible note agreement is baked into Cake's capital raise solution. Lawyer-approved and expert-reviewed, our convertible note agreement template has been useful to many startups to negotiate close funding rounds. See for yourself. Sign up today.

Other equity raising strategies

Equity raising is simply selling shares of a company's stock in exchange for capital that can be used for growth and expansion.

Angel investments and venture capital (as discussed above) are typical equity financing strategies. Though we won't discuss each of them now, there are heaps more ways to raise money in exchange for equity:

• Crowdfunding where you can offer shares to hundreds of smaller shareholders online
• Accelerator funding where you can get both funding and business support in one neat package
• Employee equity where employees are offered the opportunity to purchase shares in return for their services

Cake is passionate about employee equity sharing, which is why we to built a platform that helps startup founders run their own employee stock option plans. While employee equity is not often considered as a primary investment strategy, they can actually be seen as a good way to have employees invest their time and effort into your company instead. You got it, invest sweat rather than money!

I’ve picked the capital raise strategy for me – now what?

When you’re thinking about a raise, whether with family or a venture capital fund, it is really important to make sure you have structured your equity properly, and that all of your documentation is sorted.

In our experience, the company that is most prepared for a capital raise ends up with the best deal. The last thing that the investor wants to be doing is having to drag the start-up along, and subsequently losing faith from the get go.

Here are a few key things to consider:

Share structure

How many shares does your company currently have on issue? Have you structured it to allow you to retain the right percentage of ownership after any investment made? Have all share issues and share transfers been updated in your share registry and to the regulators?

Disclosure

To be clear, you can’t go out and ask for money in return from shares from anyone and everyone—there is a strict legal process to follow. In Australia, a company is unable to raise funds from any investor without first issuing a detailed disclosure document (often referred to as a prospectus).

However, start-ups are able to raise funds from specific investors by applying exemptions to the disclosure requirements under the Corporations Act. For example, the most common exemption we see used is the 20/12/2 rule – where a company can raise up to $AUD2 million, from a maximum of twenty investors, over any 12 month period (as long as the offers are personal offers).

To be safe, we always recommend checking what exemptions you will be applying.

Term sheets

Whether you’re offering 3% ownership to Uncle Joe, or 49% ownership to the silky-suited VCs, you want to know how this will affect the way you run your business.

What rights will the investors have? Will they get a seat on your board? Can they sell their shares?

These are all issues which can be set out in a Terms Sheet. While not all companies will use a Terms Sheet for straight forward investments, any big investment will often involve some negotiation.

Capital raising tips from experts

Understand short-term and long-term financial needs of the company

Showing investors that you’ve got a clear grasp of the company’s financials is an important step in raising capital. Make sure you’ve set up your accounting software correctly, have your cap table ready, and have a full set of financials per year since the first day of trading that include the Profit & Loss (P/L), Balance Sheet and Cash Flow.

It’s one thing to have a great idea and another to have a sustainable business model. Investors are looking for founders who understand their financials and key metrics.
^{—Meryl Johnston, Founder of Bean Ninjas, former Chartered Accountant at Xero}

Provide accurate forecasts of revenue, market share, and margins

A forecast that sounds ridiculously ambitious might cause investors to question the accuracy of the rest of your pitch, but a forecast with small expected growth isn’t going to excite investors. Presenting forecasts that sound reasonable helps to build trust.

You should be able to articulate your thought process behind the assumptions in your financial model and respond thoughtfully when investors push back on those assumptions.
^{—Meryl Johnston, Founder of Bean Ninjas, former Chartered Accountant at Xero}

Other important legal stuff

The way a company is run is governed by their Constitution and Shareholders Agreement (if they have one). These company documents will set out how the company can issue new shares, what rights shareholders have, and how the general business will be managed.

These documents should always be reviewed prior to getting started on any raise, and should be amended if necessary to save you headaches down the track.

Larger investors will also want to see these documents, and may request changes before they invest – for example, a VC will often want all the terms from their Terms Sheet built into a Shareholders Agreement.

Time to raise capital!

The perfect path to growth is not the same for any two businesses. You need to consider your personal goals, your business goals, your risk appetite, your financial situation and much more.

Cake makes this easy – Cake can set up your share registry in a user friendly cloud-based platform (see-ya later spreadsheets), manage share splits and issues, and definitely will help facilitate the sending and execution of offers and investments.

Simply click a few buttons, get the money in the account, and shoot that spiffy new share certificate off to your newest shareholder.