Approaches to scaling small software companies without investors


Master's Thesis, 2020

98 Pages, Grade: 1,3


Excerpt

Table of content

Table of figures

List of abbreviations

1. Introduction
1.1 Relevance and current situation
1.2 Motivation and problem
1.3 Objective and structure

2. Theoretical principles and considerations
2.1 Context and definitions
2.1.1 Scaling
2.1.2 Small software companies
2.1.3 Investors
2.2 Does it make sense to scale?
2.2.1 Why should companies strive for growth?
2.2.2 Why do some companies prefer to stay small?
2.3 The company's growth options and challenges
2.3.1 Bootstrapping vs. external funding
2.3.2 Barriers to Growth

3. Bootstrapped companies: Case studies
3.1 Companies that started without funding
3.1.1 Secure Software Solutions - The Hybrid approach
3.1.2 Dell - Pay-in-advance approach
3.1.3 GitHub - The Visionary approach
3.1.4 Atlassian - The Acquisition approach
3.1.5 Exactech - The Bartering approach
3.2 Companies that scaled without funding
3.2.1 Basecamp - The Minimalist approach
3.2.2 JotForm - The Branding approach
3.2.3 Sipgate - The Agile approach
3.2.4 Mailchimp - The Freemium approach
3.2.5 Zoho - The Culture approach
3.3 Findings

4. Lessons: How to scale a small software company
4.1 Cash Flow: Keeping growth affordable
4.1.1 Calculation of the self-financeable growth rate
4.1.2 Measures to reduce the Operating Cash Cycle
4.1.3 Creating a customer-funded business model
4.1.4 Considering alternative possibilities to VC
4.2 Sales and Marketing in a growing organization
4.2.1 Scaling the sales team
4.2.2 Professionalizing marketing and branding
4.3 Non-monetary factors
4.3.1 Key management factors at every growth stage
4.3.2 Strategy and vision
4.3.3 People and delegation

5. Results
5.1 Is it possible to scale a software company without investors?
5.2 How can a small company scale without investors?
5.3 Conclusion

Bibliography

Table of figures

Figure 1: Volume of global venture capital investments in 2018 ordered by region

Figure 2: Content

Figure 3: Difference between scaling and growing

Figure 4: Ideal company size

Figure 5: Technology Ecosystem

Figure 6: Elements to calculate the self-financeable growth rate

Figure 7: The Sales Learning Curve

Figure 8: Management demands at different growth stages

Figure 9: Composition of the company's vision

Figure 10: Translating vision and strategy into action: Balanced Scorecard

List of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1. Introduction

1.1 Relevance and current situation

When founders and entrepreneurs consider methods of funding to start or to scale their business, it is common to think of venture capital as one of the most evident and most widely used options. This type of funding is omnipresent in people's minds thanks to TV series such as “Dragons' Den” where founders pitch their busi­ness idea with the hope to receive funding from one of the investors. In addition, people are very aware of famous venture capital funded companies such as Apple, Facebook or Google in everyday life.

The fact that venture capital funded companies are more present in the media than organically grown companies, and that this type of information is more available to our brains, makes us erroneously assume that the normal way, or even the only way, to building a successful company is by raising venture capital. This is, how­ever, a typical availability bias.1 The truth is that only a tiny fraction of all small businesses obtains venture capital in the course of their life span. In fact, from all the companies aspiring to receive funding through venture capital, 99% will never achieve this objective.2 Those few companies that achieve the goal to be funded, however still have a long way to go.

In a study from the economists Hall and Woodward, 22,004 venture capital backed companies were examined over a period of 20 years. They found that only 9% of those companies reached the common goal of a VC backed company, namely they went public, while the rest of companies was acquired (26%), died (34%) or had unknown outcomes (31%).3 The researchers' most important finding was “that the reward to the entrepreneurs who provide the ideas and long hours of hard work in these startups is zero in almost three quarters of the outcomes, and small on av­erage once idiosyncratic risk is taken into consideration.4 The conclusion that the researchers state at the very end of their study is quite pessimistic: even though the payoffs for entrepreneurs are small considering the high risk, they consider that “no other arrangement [than venture capital] is much better at solving the problem of getting smart people to commercialize their good ideas.5 6

Apart from the low possibilities to raise venture capital, also the geographic disper­sion of VC volumes is noticeable: The amounts of money invested in young com­panies in North America or in China are five times higher than the volumes invested in Europe, as figure 1 indicates.

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Figure 1: Volume of global venture capital investments in 2018 ordered by region[6]

While it is true that Northern America has a three times higher percentage of its adult population becoming entrepreneurs (14.2%)7 than in Europe (5.1%)8 and that the entrepreneurial activity in China (9.9 %)9 is twice as high as it is in Europe, the high amounts of venture capital granted in North America and in China are still overproportionately higher than in Europe.

These observations testify the relevance of the research topic. Not only are the efforts of raising VC immense for a mostly mediocre outcome, but also is the availability of venture capital funds not the same all over the world: In European countries, for instance, VC is less available than in the US and in China. It is there­fore relevant to investigate the alternative possibilities of young companies to scale their business without external funding.

1.2 Motivation and problem

According to Verne Harnish, a consultant who is specialized in helping companies to grow without VC, and to manage the difficulties of growth, the engines of the economy are neither very small businesses, nor big corporations. The former ones only create a small number of new jobs and the latter ones are often even cutting jobs. The real growth, both in job opportunities and in innovation, mostly comes from the companies in between.10 Harnish calls these companies “gazelles” and he defines them as ventures that can maintain a yearly growth rate of at least 20% for four years. According to his calculations, only two to three percent of all com­panies can be classified as “gazelles”.11 This type of companies drives the eco­nomic growth forward, positively contributes to society by creating new jobs and develops new solutions to the world's problems. For these reasons, it is relevant that these companies do not run out of cash and successfully manage to keep growing.

However, a typical problem of venture capital is that amounts are too high and make companies lose their focus, or as Harnish says, companies are more likely to die from indigestion than from starvation.12 A recent example that large invest­ments can destroy a growing company, is the nine-year-old coworking start-up WeWork. The venture had received in total $18.5 billion from its investor Soft- bank.13 In August 2019 WeWork planned their IPO and was the United States' most valuable start-up with a private valuation of $47 billion. They filed their regis­tration for an IPO, however, while doing so, they disclosed several conflicts of in­terest and mismanagement by the co-founder Adam Neumann. Investors, report­ers and analysts lost their trust in the company and its valuation decreased im­mensely, leading nearly to the company's bankruptcy.14 Analysts say that the big­gest problem of WeWork was that it had too much money. It used its high funding to strengthen its commitment in unproven and money-losing business models. The venture capitalist Roger McNamee says that WeWork, but also Uber, who experi­enced a similar drop of valuation, have been run with the following conviction: “The explicit assumption is if you get enough growth, it doesn't matter how much you lose”.15

The CEO of the project management software company Basecamp shares the same opinion. He says that raising more money than necessary can destroy a company, in the same way as pouring too much water on a freshly planted seed will kill the plant rather than grow it.16 Apart from this problem, he describes well one of the main motivations from a founder's perspective not to seek financing: “One of the reasons you get into entrepreneurship is to control your own destiny to some degree, to not have to go work for somebody else, to not have to collect a paycheck from somebody else. And so the thing is, when you go take money, you're working for someone else again, instantly.” The founder and CEO of the software company Zoho shares that point of view. He says that venture capitalists “necessarily have different priorities and different motivations than people who cre­ate and operate businesses.”17 The main differences he sees, for instance, is how both parties see the “exit”. While this is the goal of any venture capitalist, the goal of a funder is usually “to run a business, not to run away from it”.18

Growth companies need cash in order to scale but raising and even receiving it can distract the company. Also, entrepreneurs and investors often have incompat­ible goals. Therefore, growth-oriented founders of software companies wonder

- whether it is possible for them to scale without investors and
- how they can approach to do so.

This thesis aims to provide answers to these two questions, primarily by investi­gating companies that have already scaled successfully and by extracting the main lessons from their growth journey.

1.3 Objective and structure

“By three methods we may learn wisdom: First, by reflection, which is noblest; Second, by imitation, which is easiest; and third by experience, which is the bitter­est.”

— Confucius

The objective of this thesis is to provide answers to the above stated questions, namely if and how small software companies can be scaled without investors.

The most obvious element that is missing without investors is funding. Therefore, the main objective is to show alternative possibilities of funding and what aspects owners should know and pay attention to when growing organically, without exter­nal funding.

The other, less obvious elements that companies must pay attention to when scal­ing, especially when they work without investors, have a non-monetary character. Contrarily to private organizations, a funded company usually pursues the goal of going public or being acquired, in order to give investors a quick return on their investment. Thus, in many cases the founders will eventually be replaced in their position as CEO and main decision makers of the venture. Even if they remain in that role, they will have at least experienced investors at their side, who scaled other companies before and can share valuable advice and recommendations. The owners of self-funded companies, however, face the challenges of their growing organization themselves. Since the skill set needed to establish a firm and to make it survive is very different from the abilities needed to scale it, the second objective of this thesis is to uncover the fundamental non-monetary elements that are nec­essary to successfully scale a company.

In the first place, the theoretical concepts around scaling will be defined in order to have a clear understanding about what the object of investigation is. Whether it makes sense to scale or not will be weighed up against one another because own­ers should determine first why they want to scale their business, before figuring out how to do it. The last theoretical part compares the advantages and disadvantages of bootstrapping versus raising external funding. Also, the typical barriers that pre­vent companies from growing will be presented.

The method of research used to answer the leading questions is by gathering evi­dence of companies that have already successfully scaled, either entirely without investors or up to a certain point. The companies will be examined in order to find out how they were able to scale and what challenges they faced on their journey. As these companies are private, official financial data is not available. Neverthe­less, many of them share insights into their strategies and share their personal lessons learned. The experiences of the founders and their companies will be used in order to identify patterns and extract lessons that can help other companies grow.

Finally, advice from scaling and growth experts will be gathered and compared with the experiences from the sample companies in three parts: Insights around man­aging finances, about sales and marketing and the non-monetary factors strategy and people. A graphical structure of this thesis can be found in figure 2.

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Figure 2: Content

2. Theoretical principles and considerations

2.1 Context and definitions

2.1.1 Scaling

2.1.1.1 Scaling vs. Growing

One of the most common misbeliefs around the term “scaling”, in the economical meaning, is that it is synonym to growing. However, there's a differentiating factor to be aware of:

“Growth means adding revenue at the same pace you are adding resources; scal­ing means adding revenue at a much greater rate than cost.”19

This definition implies that, when a business is growing, it will generate higher revenues while the cost of operations will grow proportionally. In the case of scal­ing, the business will generate higher revenues, too, but the operations costs will remain at the same level or only increase slightly, as Figure 3 outlines.20 21

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The consultant Jon Kandiah, who helped transform large-scale businesses such as EE, T-Mobile, Orange or Virgin Mobile adds in his definitions the lever that can make the difference between growing and scaling. He says that “Growth focuses on increasing revenue with the current business model” while “Scaling focuses on increasing revenue while adapting the business model to maximise profit”.22 Ac­cording to Kandiah, scaling is all about developing a business model that is not only sustainable but that also maximises profits.

This concept of investing one unit of resources in the business but gaining more than one unit back, for instance augmenting production by 80% but increasing total costs only by 60%, is also known as “Economies of Scale ”: the average produc­tion costs decrease or remain while the number of units produced increases.23 24 When the company reaches a certain size, this effect disappears, and eventually even reverses, as figure 4 shows. Therefore, there is typically a span of ideal com­pany sizes, that change depending on the industry.

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2.1.1.2 Economies of scale in the software industry

In the traditional software industry, after the significant initial cost of producing the “first copy”, any further cost of generating a duplication of the software is usually close to zero. Thanks to these negligible variable costs, software companies can take advantage of huge economies of scale.25 These low variable costs, in combi­nation with software's typical characteristics of network effects26, contribute con­siderably to the fact that the software market is considered to be an oligopoly, con­sisting of a few large software companies that dominate the markets, such as Mi­crosoft, Oracle or SAP.27 In addition, the fixed costs that a software company usu­ally has, e.g. marketing, payroll or rent, do not necessarily go up, as revenue in­creases. The less costs each new customer generates, the higher are the econo­mies of scale the company will take advantage of.

However, as researchers from the IEEE found out, this does not apply in the same way for SaaS companies. In fact, they seem to exhibit diseconomies of scale in their operational performance, because the vendor does not only sell software, but also the associated IT infrastructure management services. This means, that the costs associated with IT infrastructure, such as electricity bills, data communication costs, installing more servers, renting larger spaces or hiring more IT managers, shifts from customers to vendors.28 The more customers, the higher these costs will be, because of the augmenting necessity for servers. However, SaaS compa­nies can take advantage of other aspects that are beneficial for scaling, such as time savings in sales and installation as some of the case studies will show.

Another aspect that is especially relevant when it comes to the scalability of soft­ware companies is the immense internationalization of the industry. Software is often designed and developed on a global basis to be distributed then at low cost via the internet. This effect is so immanent to software companies, that the home field advantage that many other industries experience is secondary here: software companies often gain more revenue from foreign countries than from their own29. All in all, software companies are more easily scalable than companies of other industries, provided that they are able to find their niche market or to gain market share from the few established vendors. Therefore, they should make sure to im­plement characteristics, that make their business model more scalable.

2.1.1.3 Characteristics of scalable business models

Technology

Typically, companies from technology or research and knowledge intense sec­tors tend to grow quickly or have a huge growth potential.30 This also becomes evident when researching in which sector most VC-backed start-ups can be found: In Europe, from 2007 to 2015, the sector with the most VC-backed companies was the ICT sector. 40% of all European ICT companies in that time were backed by VC compared to the services sector (22%), life sciences (17%), manufacturing (11%) and green technologies (8%) sectors.31 This comparably high percentage provokes two questions:

- Could these ICT companies take advantage of their huge growth potential to scale even without investors?
- Or does the high percentage indicate that small ICT companies that want to scale have no other choice than working work with investors?

One of the very first definitions about growth companies and their characteristics came from the American economist Peter Bernstein who said that true growth com­panies do not depend on external factors, such as the increase of population or capital, but rather, he says, that true growth comes from within. According to his definition, internal growth is only possible through technological progress, which enables companies to produce more with the same input, or to develop new or better products.32 Most of the growth companies that Bernstein identified in 1956 were in the chemical and electronic industries. Some of them, such as IBM and General Electric are indeed established companies today. Others that he men­tioned however, do not exist anymore, which indicates that working with new tech­nologies is a valid success factor for growth, but it is not the only one.

Considerable added value

One logical way to understand if a business model is scalable or not is to ask a VC company, because this type of institutional investors will only fund businesses that they consider to be highly scalable. According to Jason Goldberg, the founder of the VC firm Edge Growth, the most relevant factor to look at, is the value that is being delivered: The bigger the problem that a company solves, the more scal­able is their business model. The solution to that problem however, shouldn't be a “vitamin pill” but rather a “headache pill”, which means that the customer must feel a true relief thanks to the product, and not only perform better. Another metric that Goldberg uses to detect the scalability of a company, is to the difference be­tween the value a company delivers to the value that its competitors offer. If the product can be considered as ten times more valuable, Goldberg considers the company to be highly scalable.33 Another aspect, that companies should consider in this regard is the identification and acquisition of strategic partners. Working with partners who can perform activities in the business model or add resources to it can further improve the value proposition to customers.34

Not selling time

The Polish venture capitalist Ryszard Szopa observes that there are a lot of soft­ware houses in Central and Eastern Europe that are developing custom-built soft­ware on “Time & Materials” contracts35 and that are struggling to scale. He says that this type of business, where customer-specific software development projects are sold, is a great way to start in countries where venture capital is not available but technical talent is. However, as in other agencies, the business model is not scalable at all, because it is an exchange of money for time: If the size of the de­veloper team doubles, revenues can double, at the most. In fact, revenue per em­ployee is likely to even decline when more developers are added because more time will be needed to manage the additional employees, so diseconomies of scale materialize.

Szopa proposes two ways how this type of companies can become more scalable and both ideas consist of not selling people's time directly. One approach is to stop billing the exact hours spent on a project but rather switching to fixed price contracts. Hiring the best developers that can quickly deliver the desired outcome will now increase profits rather than declining them. In the end, this approach is also more beneficial for customers, because they can be sure to receive their prod­uct as quickly as possible.

One step further in the process of decoupling time from revenue is to sell a prod­uct rather than services. A good indicator for a gap in the market can be if cus­tomers are asking for the same thing over and over. Payroll will become just an­other operational cost and it will not be any more a “cost of goods sold” (COGS) that is directly linked to a certain project. The transformation from a software house selling bespoke solutions to a software company selling of-the-shelf-products is not trivial. Prices for the latter will be much lower because the intellectual property stays within the company. In the case of software service companies all the intel­lectual property created is usually sold to the customer. Therefore, significantly more customers will be necessary which requires a very different marketing strat­egy than service companies have.36

2.1.2 Small software companies

The protagonist of this thesis are small software companies that are striving for growth. In order to have a clearer understanding of this term and how it will be used in this paper, it will be defined in the following.

A company is a system, where people collaborate in order to generate a value and maximise the company's profit.37 The object of investigation of this thesis are uniquely this type of organizations, in contrast to non-profit institutions.

The companies that will be analysed in this thesis are uniquely technology compa­nies because they tend to scale easier than other types of companies. Technology companies are businesses that develop and sell new products or innovative ser­vices and therefore usually have high expenses in R&D or a high number of em­ployees working in R&D.38 39 Among all technology companies, this thesis focuses on retrieving lessons mainly from software companies, whether they produce cus­tom or commercial off-the-shelf software and whether they sell their software in a traditional way on the customer's premises or as a service in the cloud, as figure 5 indicates.

Abbildung in dieser Leseprobe nicht enthalten

Figure 5: Technology Ecosystem[39]

Regarding the management, a company can either be led by its owners or by ex­ternally hired managers.40 This thesis focuses on companies that are led by their owners and founders, because this specific group faces special challenges when it comes to scaling due to the changing demands to the managerial skill set.

Even though the concrete size or age plays a minor role, this thesis will focus on companies that are not yet considered as established corporations, but rather small companies, who have successfully passed the stage of survival, and have committed to further growth and expansion. The reason for this limitation is that young companies are not smaller copies of established companies41: They face different challenges, have different success factors and growth has a different im­pact for them.

2.1.3 Investors

The last term that must be clarified for the further course of this research is “Inves­tors” and what is meant by scaling without investors. Founders who decide to start and grow their venture without raising any external funding, use the method of bootstrapping.

Bootstrapping

The Swedish researchers Winborg and Landström, identified six methods how small companies can use financial bootstrapping42:

- Using personal savings and resources from friends and family
- Minimizing accounts receivables by speeding up invoicing or using interest on overdue payment
- Sharing and borrowing resources with other ventures, for instance office space and equipment, or even employees
- Negotiating with suppliers for later payments or using leased items rather than purchasing
- Negotiating with suppliers to minimize inventory
- Securing subsidies from government or research-granting programs43

External funding

Companies that chose to accept outside funding through investors, have several options, depending on their current stage of growth:

Angel investors are wealthy individuals who seek to invest their personal funds in (very) young businesses with mostly under $500,000 and sometimes up to $1 million. They also share their entrepreneurial know-how and, in exchange, receive a part of a start-up's equity.44

Incubators and accelerators do not only provide funding for young companies, but also help with the implementation of a business idea, providing ideas, teams, processes and coaching. They often provide even services such as searching fur­ther funding, controlling, administration, recruiting, marketing and providing infra- structure.45

Venture Capital is a form of funding where investors chose companies that they consider having high growth potentials and invest high amounts of money. In return they get equity and the right to participate in decision making. Investors take a huge risk of losing their entire investment, but they also have the chance of high returns. In contrary to business angels and incubators, this form of funding is not only used to finance the early phases of a start-up, but also to finance growth in more established companies.46 Apart from venture capital companies there are two other types of VC institutions:

- Public Venture Capital is provided by public or partly public institutions that often have a political mandate. This type of fund is mostly used for the early stages of a start-up.47
- Corporate Venture Capital is capital from established enterprises that do not have their principal business activities in the financial sector. These are often subsidiaries of big companies focused on making strategic invest­ments for the parent company. CVC firms use this possibility to integrate innovative business models and solutions without developing them on their own.48

Private Equity is a type of funding for rather advanced stages of growth. Compa­nies can sell their equity to investors without the need of going public. Private equity organizations collect capital from wealthy private individuals and institutions and use it to buy equity from the fund-seeking company.49

As this short list of financing possibilities shows, typical start-up funding is usually connected with the premise that a part of the company will be sold to the investor. Before the further exploration of the question whether growth and scaling are pos­sible without selling the company, owners should evaluate whether it is a good idea to scale their company and why.

2.2 Does it make sense to scale?

2.2.1 Why should companies strive for growth?

Venture capital funded companies are forced to scale their business up in order to be able to pay the investors' money back. Public companies do not have another choice neither than seeking growth every year in order to augment value for their shareholders. For private companies, there is no such external party requiring steady growth. Why is it a good idea anyway to strive for disproportionate growth? First, thanks to economics of scale, companies can recover fixed costs, as initially discussed. But growing also brings a set of further benefits: bigger companies are taken more seriously from suppliers, channel partners and customers which helps them to negotiate better, for instance, volume discounts with suppliers.50 In addi­tion, scale can work as a competitive factor that can help the company strengthen their market presence and raise the barrier to entry for competitors trying to copy their business model.51

In a McKinsey research, the life cycles of 3,000 software and online services com­panies had been analysed between 1980 and 2012. Their findings were that growth is indeed relevant because fast growing companies have higher returns and growth predicts long-term success. The right growth rate, however, also de­pends on the sector. While the investors and managers of a healthcare company would be happy about a yearly growth rate of 20%, software companies that are growing at that rate, have a 92% chance of going out of business within the next years, according to McKinsey's research.52

2.2.2 Why do some companies prefer to stay small?

There are profitable, bootstrapped companies who do not agree that scaling a busi­ness at all costs is a good idea. One of the most famous companies that intention­ally seeks to stay small is Basecamp. The CEO Jason Fried says: “We work really hard not to hire people.53 It is not only the number of employees that he keeps as small as possible, but also the marketing cost and the office space. Large offices are not necessary for Basecamp because most employees work remotely, and their only marketing investment are employees who take the time to write articles for the company's blog.54 Basecamp was started in 1999, employed 55 people in 2019, counts 100,000 enterprise customers55 and generates an estimated annual revenue of $25 million.56

The co-founders Jason and David say that size does not equate with success for them. They are convinced that every business is unique and quickly hiring a lot of new employees is not the right choice for every type of business. Basecamp's strategy is to hire “only when it hurts”. This slow growth has allowed them to stay lean, to maintain a low complexity of communication, realize ideas quickly and keep an intimate and intellectually stimulating environment.57

In this context, it is also relevant to consider that given a certain size, diseconomies of scale will appear: decision-making processes are getting more bureaucratic, the organization becomes less flexible and might react too slowly to technological shifts or changes in the market.58

Whether a company decides to scale quickly or slowly, it should consider in both cases the advantages and disadvantages of financing the growth themselves and make sure to eliminate barriers to growth.

2.3 The company's growth options and challenges

2.3.1 Bootstrapping vs. external funding

“I am a bootstrapper. I have initiative and insight and guts, but not much money. I will succeed because my efforts and my focus will defeat bigger and better-funded competitors.”59

— Seth Godin, “The bootstrapper's manifesto”

Why chose bootstrapping?

Receiving high amounts of capital is not always a decisive and sometimes not even a helpful factor for leaving competitors behind. A good example for this is the com­pany Social Annex. It started with a comparatively modest capital of $3 million while its direct competitors raised $30-$40 million of VC funding. These competitors ex­perienced something that can be named “death by overfunding”. They lost their focus on customers, revenues and profits; an error that Social Annex could not afford to commit. While the competitors wasted money and eventually went bank­rupt, the company with a considerably lower start capital still exists today and con­tinues to grow slowly.60

However, the danger is not only to lose focus after receiving funds - the actual process of raising capital is a full-time job and will, especially in the starting phase of a business, distract the founders from building the actual company.61

Verne Harnish expresses this as follows: “Attracting angel investors or VCs can be a distraction, plus they'll want a piece of you, and bank loans may load you up with debt that can later bury your firm.”62 The Basecamp founders Jason and David, who turned down multiple VC offers, add that the danger is not only in losing the focus on building a great product and delighting customers, but spending other people's money can also turn into an addiction: once they money runs out, found­ers go back for more, every time giving away another part of the company.63

Apart from this, the founders of private companies can choose to follow certain core values that are not necessarily in harmony with the core values of large cor­porations, for instance environmental or social responsibility, or doing good in the world. When young companies reduce their dependency on outside capital, they are more likely to stick to their core values as they grow.64 Private companies also have the liberty to decide to develop a product only for a small, but loyal niche market, while investors often prefer to build products that appeal the masses. Boot­strapping gives the founders the security that they will not one day be ousted from what used to be their company. Maintaining the autonomy to decide how fast to grow can also prevent the company from building a bigger team than the customer base requires.65

Why choose to work with investors?

Bootstrapping usually takes a lot of time to build a stable business. Venture capital can help to skip several parts of that process. Especially for business models that can be copied easily, this speed is often a decisive factor in order to gain market share. In this scenario, it is favourable to receive funding to be able to go to the market earlier than potential competitors.66 Accepting funding permits to use the additional cash for a variety of assets that can help accelerate the company's growth. For instance, big orders, that require new resources, can be accepted and executed or sales, marketing and key managers can be hired. Also, in some cases, personal funding is just not enough to get the business off the ground, especially in capital intensive industries.

In contrast to bank loans, venture capital does not have to be paid back and there is a shared interest: if the company is successful, the investors will be successful, too.67

However, there is also an important non-monetary support that investors provide. Since they invested in the company, they become personally interested in its suc­cess and use their experience and contacts to help the venture move forward. If the investor knows well the industry in question, he or she might be able to make introductions that could be a game-changer and open new doors. Apart from this, many investors have special expertise in growing a certain type of business and therefore might have already gathered experience in scaling similar companies. Their expertise can be helpful not only to overcome the pitfalls of growth in general, but also the obstacles that are related with growing specific types of companies.68 Many investors have already achieved great successes in their careers, so they can also serve as a source of inspiration and motivation to make similar achieve­ments. Once the message is spread that a company attracted a certain investor, this might also raise its credibility and give additional confidence to customers, po­tential customers and other stakeholders. Last, but not least, an investor can also provide the moral support necessary to push forward, to build on the progress and to achieve further goals.69

Resuming overview

At the end of the day, the answer to the question whether it is better to apply for venture capital or to bootstrap a company is: It depends. As a recent study from the European Investment Fund revealed, VC can make a huge difference for cer­tain companies, while it can be useless for others. They compared similar start­ups with comparable growth potential. One half of the companies received VC whereas the other half were eligible for VC but rejected it. The research revealed that start-ups that were exhibiting high growth would have been much less suc­cessful if they had not received a VC investment. Entrepreneurial and innovative ideas with high potential for success performed better than non-VC-backed-com- panies and scaled much quicker. However, for companies with “non-extraordinary growth profiles” with a yearly revenue growth of 25% and less, a VC-investment had much less impact.70

2.3.2 Barriers to Growth

Companies that have decided that they want or must grow and that have figured out if they will raise capital or not, also should consider and overcome the typical barriers to growth that impede companies to scale successfully. The main chal­lenge that comes with growing a business is the increasing complexity. In fact, complexity increases exponentially with every new employee, not linearly. This ad­ditional complexity cannot be managed if the following elements are missing:

- Leadership: Lack of leaders in the organization with the ability to delegate and predict.
- Scalable infrastructure: Old systems and structures cannot handle new complexities in communication and decisions.
- Market dynamics: Increasing competitive pressure cannot be handled, so margins decrease.71

To each of the barriers that Harnish observes in growing companies, he gives some lessons on how to overcome them.

Leadership

In order to know where to lead the organization, these individuals should always be a little bit ahead of the market, by predicting the competition and their employ­ees. This can be reached by spending time frequently with customers, competitors and employees. Another aspect that leaders must embrace in a growing organiza­tion is the ability to delegate.72

[...]


1 Cf. Tversky, A., Kahneman, D. (1973), pp. 207-232.

2 Cf. Carey, R. (2014, June 25), online source.

3 Cf. Hall, R. E., Woodward, S. E. (2010), p.1168.

4 Hall, R. E., Woodward, S. E. (2010), p.1163.

5 Hall, R. E., Woodward, S. E. (2010), p. 1184.

6 Cf. Preqin (2019, Jan 7), online source.

7 ((18.75* 23.52) + (13.64* 191,418)) / 214,938 = 14.2. The Canadian population between 18 and 64 in 2018 were 23.52 million (Cf. StatCan 2019, online source). The US population between 19 and 64 in 2017 were 191,418 million (Kaiser Family Foundation 2018, online source). 18.75% of the Canadian and 13.64% of the US popu­lation were entrepreneurs in 2017 (Cf. The World Bank 2017, online source).

8 Cf. Bosma et al. (2005), p. 3.

9 Cf. The World Bank 2017, online source

10 Cf. Licht, G., Nerlinger, E. (1998), p. 1005

11 Cf. Courtenay, A. (2013, Sep 9), online source.

12 Cf. Courtenay, A. (2013, Sep 9), online source.

13 Cf. Loizos, C. (2019, Oct 24), online source.

14 Cf. Campbell, D. (2019, Sep 28), online source.

15 Cf. Bercovici, J. (2019, Sep 25), online source.

16 Cf. Johnson, E. (2019, Jan 23), online source.

17 Vembu, S. (2010, June 7), online source.

18 Vembu, S. (2010, June 7), online source.

19 Carucci, R. (2014), p. 3.

20 Cf. Gyton, H. (n.d.), online resource.

21 Cf. Gyton, H. (n.d.), online resource.

22 Kandiah, J. (2019, Jan 4), online source.

23 Cf. Münter, M. T. (2018), p. 227.

24 Cf. Münter, M. T. (2018), p. 231.

25 Cf. Schmidt, K. M., Schnitzer, M. (2002), p. 6.

26 Cf. Popp, K., Meyer, R. (2010), p. 22.

27 Cf. Katz, M. L., Shapiro, C. (1994), p. 112.

28 Cf. Ge, C., Huang, K. W. (2014), pp. 610, 620.

29 Cf. Popp, K., Meyer, R. (2010), p. 22.

30 Cf. Licht, G., Nerlinger, E. (1998), p. 1005; Claas, S. (2006), pp. 170, in: Voll, L. (2008), p. 21

31 Cf. European Investment Fund (2019, Dec 5), p. 5.

32 Cf. Bernstein, P. L. (1956), p. 88.

33 Cf. Brown, M. (2019, May 29), online source.

34 Cf. Nielsen, C., Lund, M. (2018), p. 68.

35 The exact time that is necessary to develop the software, and the materials used, will be billed.

36 Cf. Szopa, R. (2018, Dec 28), online source.

37 Cf. Hutzschenreuter, T. (2015), p. 8.

38 Cf. Pleschak, F., Werner, H. (1998), p. 1.

39 Own illustration.

40 Cf. Hutzschenreuter, T. (2015), pp. 12, 13.

41 Cf. Kessell, A. (2007), p. 50.

42 Cf. Winborg, J., Landström, H. (2001), pp. 243, 244.

43 Cf. Robak, P. (2010), pp. 60, 61.

44 Cf. Hahn, C. (2018), p. 46.

45 Cf. Hahn, C. (2018), pp. 56, 57.

46 Cf. Hahn, C. (2018), p. 59.

47 Cf. Weitnauer, W. (2016), p.10.

48 Cf. Hahn, C. (2018), p. 61.

49 Cf. Martinek et al. (2016) § 48, marginal no. 29, in: Hahn, C. (2018), p. 63.

50 Cf. Bamburg, J. (2009), p. 5.

51 Cf. Canalichio, P., Di Somma, M. (2018, Feb 2), online source.

52 Cf. Kutcher, E., Nottebohm, E., Sprague, K. (2014, April), online source.

53 Gruber, F. (2014), chapter 14: Bootstrapping.

54 Cf. Gruber, F. (2014), chapter 14: Bootstrapping.

55 Cf. Davis, K. (2019, April 23), online source.

56 Cf. Forbes (n.d.), online source.

57 Cf. Dermendzhiyska, E. (2019, Mar 28), online source.

58 Cf. Bamburg, J. (2009), p. 6.

59 Godin, S. (1998), p. 10.

60 Cf. Mitra, S. (2017, Nov 3), online source.

61 Cf. Mullins, J. (2014), p. 24.

62 Harnish, V. (2002, June 1), online source.

63 Cf. Dermendzhiyska, E. (2019, Mar 28), online source.

64 Cf. Bamburg, J. (2009), pp. 2-7.

65 Cf. Tank, A. (2018, Jul 10), online source.

66 Cf. Terpitz, K. (2016, Sep 8), online source.

67 Cf. Tank, A. (2018, Jul 10), online source.

68 Cf. Kramer, M. (2015, Oct 6), online source.

69 Cf. National Federation of Self Employed & Small Businesses (2018, April 17), online source.

70 Cf. European Investment Fund (2019, Dec 5), pp. 14-35.

71 Cf. Harnish. V. (2014), p. 25.

72 Cf. Harnish. V. (2014), p. 27-29.

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Details

Title
Approaches to scaling small software companies without investors
College
University of Applied Sciences Kaiserslautern
Grade
1,3
Author
Year
2020
Pages
98
Catalog Number
V594368
ISBN (eBook)
9783346198877
ISBN (Book)
9783346198884
Language
English
Keywords
Scaling Investors Bootstrapping Venture Capital Startup
Quote paper
Carolin Nothof (Author), 2020, Approaches to scaling small software companies without investors, Munich, GRIN Verlag, https://www.grin.com/document/594368

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