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How to get your customers to fund your business start-up

October 10, 2014

While “entrepreneur” may occasionally be a euphemism for “out of work”, there are more and more individuals working in earnest to start a business of their own. Indeed, statistics show no fewer than 400 million such individuals globally, with over 2 million in the UK and 20 million in the US.

Sadly, many of these ventures will never get off the ground at all. Of those that do, the majority will fail. Of those who submit business plans to venture capital investors, less than one percent will get the funding they seek.

Those elite few who do raise finance have to give away large portions of their company and control in return. Worse still, many business founders who do receive venture capital money get fired within a year of the investment.

Despite the challenge of raising money, and the serious potential downsides, there is a widespread notion that if you are an entrepreneur looking to build a successful, growing business, you need to write a business plan and raise a few million pounds. But this vision is essentially wrong.

You don’t have to raise large amounts of capital to grow a business

Many companies that have grown successfully never raised any venture capital. So why are we so focused on raising money, putting the investor at the center of this entrepreneurial phenomenon?

The customer is the focus of any successful business, not the investor, or even the entrepreneur!

There are numerous examples of large, successful companies that have grown using their customers’ cash, like Airbnb, Banana Republic, and Dell. They may have raised money, but they did it later, once the business model was proven and generating revenue. Those conditions make it easier to attract funding, giving the entrepreneur a lot more control over the terms of the deal.

So, there are a lot of reasons why not to raise capital early and use customer funding instead. “OK, but how?” you ask.

Five ways to build a business funded by customers

There are five different types of customer funded models – each surprisingly familiar – that creative founders use to get their customers to fund their start-ups.

                                    Customer Funded Business Models – Five Types
 Type  Category-Defining Examples  Today’s Examples
 Matchmaker models  Real estate brokers, eBay,   Expedia.com  Airbnb, Dog Vacay, Wonga
 Pay-in-advance models  Consultants, architects  Via, EasyFairs, Studenterbolaget
 Subscription models  The Wall Street Journal, Sky TV  TutorVista, Massage Envy, Yammer
 Scarcity-based models  Zara  Vente Privée, Gilt Groupe, Privalia
 Service-to-product models  Microsoft  MapmyIndia, Vera Solutions, GoViral

 

What is most striking about these models is that each gives the company what accountants call negative working capital. That is, the company has customers’ cash in hand before having to produce or pay for the good (or service) it sells.

A customer funded model that has worked – TutorVista

TutorVista’s founder, Krishnan Ganesh, was a successful entrepreneur, having started and floated a customer-funded computer repair company in the 1990s that he built on $5,700 of founder funding.

His next company powered outsourcing, again, funded by early customer contracts, and was sold for $19.3 million just two years after launch. So Ganesh had some great experience and an enviable track record when he launched TutorVista in 2005.

This time around, he tried another powerful model for harnessing customer cash to fund the business: subscriptions. Ganesh had seen first hand the dismal state of public education in America and the resulting hunger for supplemental academic help.

His background in outsourcing gave him the confidence that he’d be able to use qualified, English-speaking Indian labour to help meet this demand at a fraction of American tutoring rates. Furthermore, he’d be able to predict required capacity based on the number of subscribers at any given time and contract tutor labour accordingly.

Indeed, TutorVista had 500 student customers in just 6 months, and raised an A round from investors to scale the model 18 months after launch. As though Ganesh’s track record and TutorVista’s negative working capital weren’t enough, investors are also known to love the recurring revenue of subscription businesses.

Before you launch your own start-up funded by your customers

So, take heart. The seven domains model articulated in, ‘The New Business Road Test: What Entrepreneurs and Executives Should Do Before Launching a Lean Start-Up‘ offers a clearer way to answer the crucial question: “Why will or won’t my idea work?”

The model is comprised of four market and industry domains, plus three additional domains that address the central elements in the assessment of any market opportunity:

  1. Are the market and industry attractive?
  2. Does the opportunity offer compelling customer benefits as well as a sustainable advantage over other solutions to the customer’s needs?
  3. Can the team deliver the results they seek and promise to others?

Test your business idea with the New Business Road test app

You can even ‘Road Test’ your business idea – from the road, if you like, using the New Business Road Test app – before you even think about launching. Then work out how to get customers to pay earlier, and more, to help fund the early stages of your business.

Once you have proven your business model and attracted paying customers, you can approach investors from a much stronger position, giving you a higher chance of success, keeping more equity and making it more likely you will be able to keep your job!

About the author

John Mullins is an associate professor of management practice at London Business School. He has also been a senior executive and two-time founder, and took one of his companies public. His latest book, The New Business Road Test, Fourth Edition, and app has been published in response to a growing need for practicable, research-based insights into efficient entrepreneurship.

More help on funding your business

For more tips on financing your business, try some of ByteStart’s other guides;