Boiling down a startup's path to a "typical" or "standard" route is impossible. Whether it's an overnight success or a decade-long trek toward the top, every single startup takes a different path that results in either sustained success or an untimely demise.
If you are thinking about starting a business or have just started one, it's no secret that the path ahead will be a difficult one. Common logic may lead you to try to game-plan the path of least resistance – say, between equity financing and bootstrapping – but in many instances, trying to choose one over the other is futile.
"Once you're into the realm of the challenge of starting a business, I don't know if the differentiation of one [path] being a little harder or a little easier matters, because it's going to be hard no matter what," said Cliff Holekamp, co-founder of Cultivation Capital, a VC firm that works with several incubators and accelerators in the St. Louis area.
An understanding of the typical paths for growth can serve as a loose road map, but experts say a startup's greatest strength is its agility, so stay open to new opportunities and routes for growth.
Traditional equity financing
From a basic idea to a business's ascent to prolonged success, there are roughly four traditional equity financing steps a startup can take. Funding usually comes from friends and family, angel investors, early-stage investment firms (accelerators, for example), and venture capital firms.
Once startup founders successfully develop a product or service that solves a demanding real-world problem, it's time to canvas what Holekamp calls "friends, families and fools" for your first round of financing. This group is an equity partner getting in on the ground floor – they're betting more on the co-founders than on the actual business or idea, because it's still so early in the company's growth.
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"Your first investors are going to be people who believe in your brand and believe in you," Holekamp said, "because there's [rarely] anything to believe in a company that hasn't really been started yet or is in the very early stages."
Next, startups usually look for angel investors. Holekamp said most angels are looking to invest in businesses within their own community. They crave the human element of being inspired by a business and helping an inexperienced founder grow their business.
"They're often motivated by the relationship of getting to know an entrepreneur, being inspired by them – wanting to support and help them," he said. "It's very personal."
After angel investment, many startups look toward early-stage investment firms, which include accelerators. These firms offer higher-level financing and advice than angel investors but aren't quite at the venture capital level. VC firms come in after accelerators and early-stage investors. VC funding is organized into stages, starting with A and extending through the rest of the alphabet for later-stage funding. Netflix, which was founded in 1997, received five rounds of funding from series A through E before its initial public offering in 2011.
Bootstrapping vs. debt equity
The other pathway for growth is bootstrapping. The traditional equity financing pathway outlined above involves selling portions of your company in exchange for money to grow your business. It's a way for startups to efficiently go from a small operation to a powerful company. The trade-off is that the co-founders don't own as much of their business. Bootstrapping, or funding your business through financing you receive from your customers, is equivalent to how any small business grows. Instead of hunting for financing, the startup focuses on building revenue through sales and growing its business organically.
Holekamp said there are advantages and disadvantages to both. While bootstrapping allows a founder to maintain more control over their company, it can take significantly longer for the business to get up and running – sometimes upward of five years. This is not ideal in fast-moving industries like software. For other startups, this may be the best way to grow while retaining ownership. The story of Basecamp, a popular productivity management platform, is an outlier from the traditional software startup path. The bootstrapped and has since preached the wonders of this technique. It took a long time, but all the co-founders still own just about all the equity in their business.
Holekamp said the decision to either bootstrap or pursue equity financing is both a personal and business decision. It's a personal decision for the co-founders, because they need to decide what kind of lifestyle they want and how much autonomy they want to give up in exchange for funding. The business aspect of the decision involves analyzing the industry a startup is entering and weighing the risk of slow growth.
"How responsive is that market to change, and how competitive is that market?" Holekamp said. "There's a reason most tech firms are venture-backed – that's because in a fast-moving industry like software, for example, the bootstrap approach is probably not going to give you the war chest to be able to move quickly enough to capture market share in a quickly evolving and rapidly changing market."
While financing is an important external challenge to grapple with, the internal hierarchy of a startup can also help set it on the path to success. Veijo Komulainen, a counselor of trade at the Finnish Consulate in New York City, currently helps foreign startups get started in the U.S. As an experienced entrepreneur and businessman, Komulainen said internal challenges are startups' biggest hurdles. He wrote a book about the topic called Growth and Scaleup Enablers for SMEs.
Komulainen argues that one of the biggest challenges startups face as they scale is balancing internal structure and organization with output demands. As companies grow and add members to their teams, natural complications emerge. He said that focusing on culture and analyzing and simplifying processes can help a startup avoid what he's coined the "capability gap."
"A very important thing for a startup and growth company is really what kind of culture you can develop and nurture," he said. "The culture of a company is something that can be formed and modified that just needs conscious actions by the leader or leaders to make it fit for the situation of the company."
It's important for businesses to build hierarchical internal structures as they grow. This framework will make it easier to hire people, take on more projects and organize the company. While it may not be ideal for every company to establish some form of internal bureaucracy, Komulainen said rethinking current structure can remove growth impediments.
There is no traditional path for startup growth. What makes startups so exciting and unique is the ability to change direction or paths on a dime. Komulainen said that keeping internal processes in mind and trying to simplify things can keep startups lean.
Holekamp said many companies employ a combination of bootstrapping and equity financing to strike the right balance toward growth. As a business grows, however, it's also crucial for the co-founders to transition the company's reputation away from themselves.
"The goal as you're raising outside capital is to grow it, so you grow out of your personal reputation as the entrepreneur and start building the reputation of your company as one so it stands on its own," he said.