Startups, lifestyle businesses, bootrapping, indie businesses and small businesses: What are they and how you fund them

Startups, lifestyle businesses, bootrapping, indie businesses and small businesses: What are they and how you fund them

I find myself returning frequently to the concept of (tech) small businesses versus startups. A lot of that is because it seems like everyone in the ecosystem – founders, businesses, suppliers, partners, investors and larger stakeholders (government) – seems to forever be confused about the differences.

At the same time, we’re seeing a huge rise in tech businesses who are looking to take a non-traditional pathway, and often struggle to both understand what they are and what they want to become – and how to navigate challenges like funding (including whether they should take it at all!).

It can also be hard to understand your role within a sector that celebrates funding rounds above practically all else (see also: growth of revenue over signs of profitability).

I’m not going to rehash my views on the basics, that’s covered in my old post on the small business vs startup differentiation. I guess this is my ‘next step’ on that view.

Caveat on this post: here I’m talking about tech or tech-enabled businesses – sometimes the same description is used for other industry segments and can vary!

Defining different business styles

Small business and startups are already covered in the post I mentioned above – essentially, startups:

  • Are high growth. In the early days, you expect huge growth month on month.
  • Are high risk. Most of the time, they die. They don’t struggle along, they just die.
  • Go big or die. If successful, a startup becomes Facebook or Google (or exits along the way). If not successful, it goes to zero and everyone is unemployed.

Small businesses don’t have that profile – they usually grow at a smaller rate, have a lower risk profile, and aim for comfortable profitability and growth over time rather than growth-at-all-costs. Lifestyle, bootstrapped and indie businesses are kind of subcategories of small business.

Lifestyle businesses

One of my most hated terms is ‘lifestyle business’ because people seem to use it interchangeably with ‘bootstrapped business’ or ‘indie business’.

A lot of people see any not-multi-billion-dollar valued profitable tech company as a ‘lifestyle business’, and I actually consider that an insult unless that’s what the business actually is/wants to be.

I define a lifestyle business as one where the founder(s) are building a company to have a small profit (in relative terms) that pays for them to work as little as possible on the business. It’s realistically a subcategory of small businesses.

It’s the quintessential dream of the person who wants to travel the world and not need to do much work.

Typical ‘lifestyle businesses’ are things like dropshipping eCommerce companies or affiliate sites, where once the flywheel is spinning they usually need minimal intervention to run and operate.

A lot of the people I know who are into this kind of company will often have 5 or 6 different revenue streams, where they might add up to $100k in annual profit and have some volatility but they have ‘spread their bets’ a bit in case a big Google algorithm update wipes out one of their companies or something.

I hate the term because people often say I run a lifestyle business – yes, I have flexibility in how I work and operate, but I like working! I am an unashamed workaholic and I’m generally not very comfortable with any level of success, as there’s always an opportunity to do better for us as a business and our customers. We also on a technical level aren’t exactly the kind of thing that involves no work or intervention…

Bootstrapped businesses

A bootstrapped business is one that funds itself mostly out of its own revenue. This is increasingly common in software-as-a-service, where (if you charge enough…) you can grow organically alongside your customers. Typically these are more ‘small business’ (in growth and risk profile) than ‘startup’.

Initially, a bootstrapped company was also seen to be one that never raised any funding, but in reality many of the celebrated bootstrapped businesses actually have taken funding (Buffer, Wistia, Basecamp for example). Others of course don’t (Atlassian and Mailchimp famously at the big end, but also Envato in Australia) – at least at the start.

The reality is though that on the whole, a bootstrapped businesses will take a relatively small amount of capital (if any) upfront, to get the revenue flywheel spinning and then self-fund from there.

Indie businesses

In a lot of ways the ‘indie business’ term is an iteration bootstrapped business. Indie businesses in tech often are the ones that will do an early seed round, and then fund growth from revenue. Their growth profile is usually a lot smaller than a ‘traditional startup’ and their expectations are never to swing for the fences – instead to produce a stable profitable company.

Typically indie businesses don’t need a lot of capital to get going (like a bootstrapped company) or operate. You don’t see (m)any of these businesses who are launching hardware products or doing ‘deep tech’, but there are tons of opportunities in software for example.

Equally it seems we’re already starting to see confusion as to whether an indie business is more lifestyle oriented or not. In my view, they aren’t even if they have some similarities.

Understanding how venture firms work

We love to celebrate big capital raises from businesses in tech (mostly startups). The bulk of the capital comes from venture firms, but I often have to explain the business model of a venture firm to founders.

Venture firms are the petrol on your business’ fire: they are the fuel for growth (at pretty much all costs) and the ultimate aim is that your business either blows up and is written to $0 or smashes a home run and returns 100 or 1000X the money that they put in.

This is necessary because of two things:

  1. Most venture funds have a 10 year lifespanA typical venture fund (in Australia or elsewhere) has to both invest and return all its capital in a 10-12 year lifespan. That means that they spend the first ~3 years of the fund finding investments, then the remainder following on investments or getting companies to the point that they can exit (IPO/M&A/etc).This means that you will need to have some kind of exit pathway for them. Unlike what some say, I don’t think you need to have an ‘exit plan in mind’, but they need to be able to see how the company might return capital – and a lot of it.
  2. Venture firms are illiquid and high risk, so have high return expectationsVenture firms have their own investors, and those investors have their money locked up for (up to) that 10-12 year period. They (practically) can’t pull their money out even if they want to. As a result of that illiquidity, venture firms have to return a lot of capital.The typical internal rate of return (IRR, essentially the amount per annum in ‘interest’ that the investor should expect on their investment) promised is 25%. Imagine putting your money in a deposit account you can’t touch for 10 years, but it goes up at 25% each year.Combined with the fact that startups are high risk (many go to $0), a typical fund with say 15 companies it has invested into will have 1-3 who return the bulk of the fund (100X money back), 5-7 who return roughly what they put in or a small multiple (1-5X), a few somewhere between 5 and 100, and then probably 7-8 will return $0 or cents on the dollar.

The business of venture capital is to find those 1-3 investments that can both return a lot of capital and do so within that timeframe, and then keep focussing on doubling down to get the best result from them. Everyone who they invest into needs to have the potential to end up like that.

Over time, more information is gathered (e.g. how the market responds to the company), and the level of confidence of whether you will be one of those companies is adjusted. If it looks like you aren’t going to be one of those companies, you’re pretty much dead to the firm – they need to focus their resources mostly on those big home runs, as while a 3-5X return might be life changing for you1If you have any equity left at that point…, it won’t help the fund much (those smaller returns usually balance out the ones that return 0X).

Understanding how angels work

Some angels have similar views to venture capital firms: they want to find the investments that swing for the fences.

After all, given it’s illiquid and high risk, you may as well play in smallcap listed equities (high risk but at least vaguely liquid) or put your money into index funds for a 5-8% p.a. return that is (relatively) ‘safe’ and liquid.

Others are a bit different, and invest because they just like the journey or the fun – a 100X return is of course welcome, but a smaller return is still great and they enjoy the journey. Investors who are previous founders usually are more about the journey than (just) returns.

A small number of angels take this to the extreme – they actively look for lower risk investments that are still illiquid (e.g. early stage tech small businesses/indie businesses) but will slowly pay them back over time via dividends from company profits.

When you talk to an angel, ask them about their investment strategy. They may not have as clear an answer as a venture firm, but they should be able to tell you the types of companies they look for and their typical return expectations. A good question is always “what other companies have you invested into?”, and Google them afterwards.

There is nothing worse than having an angel who thinks you are trying to smash for the fences but you instead want more of a bootstrapping or small business profile. There is good friction (investors/boards should challenge founders, not just be ‘yes people’), and bad friction (they are trying to force you to be what you don’t want to be).

New models are starting to evolve in the space between angels and venture funds, like, “venture debt” and a whole lot of weird and wonderful instruments to give downside protection for investors along with upside, but retained optionality for founders. I suspect we’re going to see a whole lot more soon.

Know what you are and what you want to be

The biggest thing I say to founders is that you need to know what your business currently is, and also what you want it to be.

The ‘current state’ isn’t changeable, but you should know if you are growing like mad or just growing along at a low rate, or struggling to grow and still trying to find any kind of early product/market fit.

The future state you do have some choice in.

I say ‘some’ because one of the saddest things is when you meet a founder who wants to have a big venture-funded startup journey, but the company (/market/product) won’t support that.

Sometimes they manage to raise a ton of money anyway and grow like crazy, but at the cost of profitability and it all ends up coming to a sad end when instead they could have instead chosen to grow slowly and have a smaller top line revenue, but profitability and optionality (not to mention longevity).

Talk to your prospective (and current) investors about what it is you want to be, and ask them if they think that’s reasonable: is the total addressable market really $1b? It’s fine if the answer is no, but don’t delude yourself or your investors about it all.

It’s okay to not be big

The final comment I’ll make is that it’s okay not to be a big startup raising money all the time. I feel like I have to keep repeating this as founders (myself included) increasingly get a sense of jealousy (?) at times about people announcing these huge rounds or growing at a crazy rate.

But with that money comes strings. Sometimes the strings are big (liquidation preferences can often wipe out any cash returned to founders or employees even at a 3-5x multiple…).

Slower growth is still great – the business is still getting bigger every year! Profitability is great – you have options for what you want to do and aren’t reliant on a revolving door of investment rounds to survive!

While big venture funded startups can make you and your investors a ton of money, they also have their own challenges. Hiring like mad is actually not something that many founders enjoy, and as the company gets bigger it becomes more and more of your time rather than the things you want to do. Fundraising is soul destroying. Missing that quarter’s targets is potentially life-threatening for the company. You’re statistically more likely to walk away with nothing than you are with a yacht in the French Riviera – no matter how hard you work.

Small businesses have their own challenges too. In a venture funded startup you’re always hiring for 12-18 months in the future (ie senior people to rapidly build out teams), while in a small business you’re hiring for 6 months in the past (ie you’re always under-resourced). You usually don’t have a cushion of millions of dollars to fall back on if situations change and you fall on hard times. You can’t front-run the cost of acquiring a customer that much (and have multi-year payback periods), because that’s just not sustainable.

Both are incredibly hard work. I know literally zero founders who do not have at least some time of the business’ life where they are working 18 hour days 7 days a week – venture funded, bootstrapped or otherwise.

At one point in the life of every company – tech startup, bootstrapped business or even café – the company will ask you to write a cheque for your soul2I mean this pretty literally. It will ask for every bit of energy and time you have – and quite potentially destroy all of your personal and professional relationships in the process. It will take everything you have, and more. I applaud the focus on how we improve founder mental health, but the reality of why not everyone starts businesses is that they are risky, stressful and at times an insane amount of work (NB this also applies to your employees too!). Being a founder is not for everyone and that is totally okay.. You need to be willing to immediately sign that cheque and hand it over, because that is (IMHO) a necessity for the company to survive.

What I’d like to see though is more celebration about the diversity of businesses, because it’s not fair to suggest that anyone who is not venture funded doesn’t work hard (has a ‘lifestyle business’), or that fundraising is a success metric (you’re kicking the can down the road, so it’s great that you’re not dead yet and have shown progress but that’s not the goal).

All that does is make people think everyone should raise and that they’re a failure if they don’t or can’t – which often forces companies into trying to become what they simply cannot be.

The number of people I’ve met running companies that pump out consistent profits every year and have done it for quite some time (common in family businesses) is starting to go up. But you don’t see them in the press often – they have no need or want to be. Historically many of these companies are in places like manufacturing, distribution, franchising or travel, but we’re starting to see more and more tech companies like that. A lot of people just have no idea that they exist.

Notes   [ + ]

1. If you have any equity left at that point…
2. I mean this pretty literally. It will ask for every bit of energy and time you have – and quite potentially destroy all of your personal and professional relationships in the process. It will take everything you have, and more. I applaud the focus on how we improve founder mental health, but the reality of why not everyone starts businesses is that they are risky, stressful and at times an insane amount of work (NB this also applies to your employees too!). Being a founder is not for everyone and that is totally okay.

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