Rethinking Startup Funding: What Entrepreneurs Should Do Before Raising Cash

Can you start a business without outside investments such as venture or angel funding?

“Without question,” says Saras Sarasvathy, a professor at the University of Virginia’s Darden School of Business and a leading authority on the cognitive basis for high-performance entrepreneurship. “Many aspiring entrepreneurs believe they need formal funding lined up before they can build anything, but that’s simply not true.”

Research shows that, contrary to popular belief, nearly 80% of companies that go public do so without raising a single dollar of venture capital. And two-thirds of the companies on the Inc. 500 list of the fastest-growing private companies in the U.S. have never raised money from outside investors, an approach referred to as bootstrapping.

So, how do those ventures get off the ground without an infusion of capital? Sarasvathy says entrepreneurs who’ve founded multiple companies start with a mindset she’s dubbed effectuation.

“Effectual entrepreneurs view money as an unnecessary and expensive ‘middleman’ in the early stages of creating new ventures,” she says.

Rather than seeking funding to pay for services and employee salaries, effectual entrepreneurs focus on building relationships within a network of stakeholders including customers, suppliers, mentors and others. They secure the services and capabilities they need by working with those who want to help and shape the fledgling business. This collaborative approach reduces upfront costs.

Why Relationships Drive Startup Success

Although entrepreneurs have a wide range of funding options, most typically rely on only a few. For example, 75% of small-business owners fund their ventures through personal savings combined with some form of debt, such as bank loans, credit cards, home equity loans, and government loans.

Even among high-growth startups, few attract venture capital. Most rely on Small Business Innovation Research program grants, credit cards and savings, Sarasvathy notes.

Regardless of how and where entrepreneurs secure external funding, Sarasvathy highlights the importance of relationships even in the fundraising process. Multiple studies have shown that relationships are crucial when seeking financing from formal sources such as angel investors, venture capitalists and banks. There’s evidence that having strong relationships with lenders can increase access to credit and lower interest rates.

Interestingly, research also shows that older, more educated and experienced owners of small and medium-sized enterprises (SMEs) are less likely to seek external financing than their younger and less educated counterparts.

What Expert Entrepreneurs Know That Novices Don’t

Sarasvathy’s own long-term study of expert entrepreneurs confirms that. In her influential book, "Effectuation: Elements of Entrepreneurial Expertise," Sarasvathy describes expert entrepreneurs as individuals who have dedicated at least 15 years to starting and running multiple ventures. At least one of those ventures achieved significant financial success, such as an initial public offering (IPO) or being acquired for a price that was many times greater than the original investment.

Expert entrepreneurs stand apart from novices not just in the depth of their experience, but also in the way they think and make decisions. Instead of relying on prediction and market forecasts they act effectually, choosing to work with things within their control. This flexible, relationship-driven mindset focuses on making the most of the available resources and collaborating with stakeholders to co-create their ventures.

Launching OpenQ: A Lesson in Bootstrapping

When it comes to funding their ventures, effectual entrepreneurs follow the Affordable Loss Principle — they never invest more than they can afford to lose. “It’s the first rule of effectual funding,” says Sarasvathy. “And zero is an affordable loss for everyone. That’s why effectual entrepreneurs become masters at bootstrapping.”   

Take Jim Zuffoletti (MBA ’05) and Otavio Freire (MBA ’05), serial entrepreneurs who co-founded SafeGuard Cyber and OpenQ, a cloud-based software and data platform tailored to life sciences and medical industries.

Zuffoletti and Freire’s startup journey with OpenQ didn’t begin with a fat wallet but with a rough sense of a problem in the world of pharmaceutical marketing — and a lot of sweat equity.

“In the early days, it wasn’t the investment of monetary resources that kickstarted our venture, but rather the commitment of time and the development of relationships,” says Zuffoletti, who was a first-year student at Darden when he launched OpenQ with Freire.

Instead of pitching to investors, Zuffoletti and his co-founder focused on developing their idea, writing a business plan to enter a business-plan competition at UVA, and connecting with people who believed in their vision. “Otavio and I did a lot of networking with alumni and classmates for free work and advice,” says Zuffoletti.

When it came to building their software, traditional routes were out of the question. “Eighty thousand dollars a year per developer? That was fantasy land,” says Zuffoletti. Instead, they negotiated with an unlikely software partner: a company better known for air conditioners than coding. They managed to cut the initial quote from $20,000 to $8,000—payable in arrears. “We didn’t need perfect software. We needed something we could demo,” says Zuffoletti. That deal gave them breathing room: four months to make a sale before the bill came due.

Zuffoletti and Freire epitomize a kind of entrepreneurship that’s not fueled by external capital but by creativity, bootstrapping and partnerships. “It turns out, what you really need isn’t money,” says Zuffoletti. “It’s the things money buys. If you can get those things through relationships with people who will often provide them at low or no cost, you’re ahead of the game.”

This article is based on the technical note “Doing Without the Middleman: A Primer on Funding for Entrepreneurs” (Darden Business Publishing) written by Saras Sarasvathy, Paul M. Hammaker Professor in Business Administration, and Jim Zuffoletti (MBA ’05).