More than two generations ago, the venture capital community – VCs, business angels, incubators, and others – convinced the entrepreneurial world that writing business plans and raising venture capital constituted the twin centerpieces of entrepreneurial endeavor. They did so for good reasons: the sometimes astonishing returns they’ve delivered to their investors and the very large and valuable companies that their ecosystem has created. But the vast majority of fast growing companies never take any venture capital.
Related: 4 Alternative Funding Sources
The customer-funded alternatives. Michael Dell, Bill Gates, and Mel and Patricia Ziegler have something in common. Each started and grew their company largely with their customers’ funds. Here’s how they and other inventive 21st century entrepreneurs have done it:
1. Matchmaker models. Matchmaker models are those in which the business, with no or limited investment up front, brings together buyers and sellers—without actually owning what is bought and sold—and completes the transaction, earning fees or commissions for doing so. Good examples are the U.S. companies Airbnb and DogVacay.
2. Pay-in-advance models. Pay-in-advance models like the USA’s Threadless and India’s Via and Loot convince customers to pay something up front, such as a deposit or even the full price, to get started building or procuring whatever it is that the customer has agreed to buy. Michael Dell did this to start his eponymous company from his University of Texas dorm room.
3. Subscription models. In subscription models, the customer agrees to buy something that is delivered repeatedly over an extended period of time, such as newspapers, a box of organic veggies delivered weekly straight to your door or a service like a cable TV subscription or your monthly Netflix fix. India’s TutorVista and the USA’s H.Bloom use this model successfully.
4. Scarcity models. In the scarcity model, what’s for sale is severely restricted by the seller to a limited quantity for a limited time period. The seller pays the supplier after the sale is made. Spain’s Zara, France’s venteprivee and the USA’s Gilt Groupe do this.
5. Service-to-product models. Service-to-product businesses like Denmark’s GoViral and Puerto Rico’s Rock Solid Technologies begin their lives providing customized services and eventually draw on their accumulated expertise to deliver packaged solutions that stand on their own. Bill Gates transformed Microsoft from a services business that wrote operating systems for early PC makers into to a product business that sold application software – Word, Excel and more – in shrink-wrapped boxes.
The Zieglers of Banana Republic fame got their start selling military surplus apparel (the short-armed Spanish Paratrooper Shirt was their first hit) at flea markets, then by mail order, then in their own retail stores. They financed growth by collecting cash from their customers before their suppliers had to be paid. Rocket science, no, but ingenious for sure!
Why raising early VC is a bad idea. Too many entrepreneurs believe that the best way to start and grow a thriving business is to come up with a great “idea,” write a great business plan, raise capital from angels or VCs, flawlessly execute the plan, and (Voila!) get rich!
It hardly ever happens that way. The vast majority of successful businesses don’t ever raise venture capital. Instead, at least at the outset, and sometimes for the entire journey, they get the cash they need from their customers. They don’t do so because it’s easier, though. It’s not. They do it in large part because of the unwelcome drawbacks entailed in raising capital too early:
Distraction. Raising capital requires full-time concentration. So does starting an entrepreneurial business. One or the other will suffer when investment capital is sought.
Tough term sheets. The terms and conditions attached to venture capital can be (for good reason) onerous, as investors seek to protect themselves from downside risk. The further along the path, the less onerous the terms.
Advice and support. Just how good is the “value-added” advice and support that investors provide? Most of their investments don’t pan out.
The entrepreneur’s stake. The further you progress in developing your business before you raise funding, early uncertainties become more certain, risk is lowered, that translates into a higher valuation and a bigger stake for the founding team.
Bad odds. VC today is an all-or-nothing game. Is that the game you want to play?
A viable alternative is to let your customer be your VC. A customer-funded approach offers the most sure-footed path to starting, financing or growing a business, regardless if you’re an aspiring entrepreneur lacking startup capital, an early-stage entrepreneur trying to get your cash-starved venture into take-off mode or a corporate leader seeking to grow an established company.
In the words of Shanghai’s entrepreneur and angel investor, Bernard Auyang, “The customer is not just king, he can be your VC, too!”