How Do Companies Decide Between Self-Funding and External Funding?

In the startup ecosystem, it is common to secure external funding and scale expenses, with the ultimate goal of achieving massive profitability. Many startups such as MailChimp, Atlassian, and 37signals choose to be self-funding startups, proving that there’s more than one path to success.

Bootstrapping allowed these companies to retain control over their vision and operations and navigating the challenges of limited resources built resilient teams that showed impressive adaptability in adverse situations.

In this article, we explore what bootstrapping is, why founders chose this route, and when it makes sense for a startup to be self-funded. Read on to know more!

Why do startups choose self-funding?

When entrepreneurs come together to form a startup without relying on external funds, we call it bootstrapping or self-funding. The term bootstrapping comes from the phrase ‘pulling oneself up by the bootstraps,’ which used to mean attempting an unachievable feat but now means initiating or achieving something independently, particularly when the venture would normally require external help.

Thus, bootstrapping is a fitting term for self-funding, as it highlights the difficulty of achieving success without external support. This is a practice that can push a startup’s founders to the edge as failure means loss of lifetime savings. The scarcity of resources forces them to constantly come up with creative solutions and make tough decisions about which initiatives to prioritize. Furthermore, bootstrapped startups also experience slower growth than their externally funded counterparts.

On the flip side, bootstrapping allows founders to pursue their vision without external interference. Founders of self-funding startups have the creative freedom to make bold decisions, innovate, and shape the startup as per their own values and goals.

Another benefit to bootstrapping, from a purely financial perspective, is that it preserves the founders’ equity and helps avoid unnecessary dilution. However, the most lucrative benefit of bootstrapping remains the creative freedom it offers. Some startups that went down this path and achieved great success include Hewlett-Packard, SurveyMonkey, and RxBar. Check out this article to learn more about them!

How should you choose between self and external funding?

Answering the following key questions will provide clarity on your financial strategy and help you determine whether to pursue external funding or opt for self-funding.

What are your growth aspirations? 

Self-funding startups often look up to bootstrapped startups such as 37signals that evolved into a successful business with products such as Basecamp. Today, we would like to compare 37signals with one of its competitors, Trello, which, unlike 37signals, relied on external funding.

37signals started out as a web design consultancy firm in 1999. The founders realized that as the company grew, took on more projects, and added new people, the existing tools were inadequate for tracking progress, organizing client feedback, and setting up timelines for deliverables. Out of sheer necessity, 37signals developed its own project management system and launched it as Basecamp in 2004.

37signals boasts of being profitable in each of its financial years and has generated profits of over $10 million every year for the last 10 years. In December 2023, they had more than 100,000 paying customers.

Trello, on the other hand, took the venture capital funding route. It was launched as a mobile and web application for project management in 2011 by Fog Creek Software, a consultancy company. In 2014, Trello broke away from Fog Creek Software to become its own company and raised $10.3 million in a Series A funding round. These funds allowed Trello to expand into new markets like Germany, Spain, and Brazil in the following year, and by 2017, it was acquired by Atlassian, a project management solutions giant.

When we look at the journeys of the two startups, we can see that venture capital allowed Trello to grow much faster than 37signals which was a self-funding startup. So, the pace at which you wish to grow plays a key role in your financial strategy.

What is your financial situation?

Typically, startups opt for self-funding either at the pre-seed stage or at a much later stage when it has already received Series B or C funding. While these are both forms of self-funding, in early stages, self-funding refers to relying on one’s own savings while at a more mature stage, it may refer to sustaining operations and expanding via the revenue generated.

Due to the lean nature of operations in the early stages, founders may be able to keep the lights on with their personal savings. In the pre-seed or even at the seed stage, the startup’s operations are limited to developing a product prototype and researching if there is a market for it.

Self-funding seems more viable when a startup has multiple founders. However, aligning expectations is crucial if you opt for self-funding with multiple founders. Each founder may have varying financial needs, savings, and aspirations. In such cases, transparent discussions about these differences are essential to reach a consensus on investment timelines, financial commitments, and ownership distribution.

As the startup grows, its operations grow beyond its core functions and it adds more departments as many functions like digital marketing, payroll, and legal and compliance support can no longer be outsourced completely. This is a stage where startups must rely on external funding. Such startups have found evidence of product-market fit and developed a prototype but do have stable revenues. Hence, the extreme need for funds, inadequacy of personal savings, and lack of revenue combine to force the founders’ hand toward external funding.

All startups aim to reach a point where they can sustain themself through their revenue and can secure loans and other forms of debt to pursue expansion projects.

What do the market conditions look like? 

Currently, private equity investors are showing a lot of enthusiasm about opportunities in the artificial intelligence (AI) space. Since building large language models (LLMs) for generative AI requires immense computing power, it also led to a considerable spike in NVIDIA’s stock price. Over the past five years, the chipmaker’s stock price increased by 2,300%!

So, it is safe to say that the current market conditions favor AI startups and businesses that are essential for AI development. Conversely, we could also argue that startups in other sectors may be getting overlooked.

Before AI captured the private equity market’s attention, investor enthusiasm was focused on fintech and software-as-a-service (SaaS) startups such as Stripe, Zoom, Slack, and Coinbase. However, in August of 2024, we saw Tally, an automated debt manager, shut down its operations after failing to raise funds. One can speculate that such a company may have secured the necessary funding back when investors were focused on fintech companies.

The success of a funding round also depends on macroeconomic conditions. In recent times, we have seen the valuations of many unicorns like Checkout.com fall significantly in 2022 due to the economic slowdown brought on by the COVID-19 pandemic.

Thus, as a founder, you must accept that your financial strategy is largely dependent on market conditions such as investor preferences and economic conditions. If market conditions are not favorable, your startup may have to stay self-funded.

Eqvista- Empowering Innovators to Shape the Future!

Self-funding or bootstrapping is a challenging path that requires resilience and creativity from the founders and necessitates lean operations. The lack of resources often leads to sluggish growth for such startups. However, many founders would argue that the freedom to create something truly unique and unprecedented outweighs such cons.

When you are deciding between self-funding and bootstrapping, in addition to your and your startup’s financial health, you must consider how fast you want to grow. Venture capital funding would instantly provide access to the funds as well as the network necessary for growth. In contrast, building a network of comparable strength and accumulating the necessary funds independently would need substantially more time.

Additionally, in some cases, market conditions may force startups to be self-reliant.