Three alternative ways to finance and grow your start-up

Most entrepreneurs take for granted that to start their venture, they’re going to need venture capital (VC). This is false. Some of the biggest and most successful companies in the world – Dell, Microsoft, Banana Republic and many more – have been created with little or no outside investment. Raising capital too early, in my view, is a very bad idea. “Why?” you might ask. 

Two big reasons. Firstly, raising capital and running a business are both full-time jobs. So if you’re trying to raise capital for your venture and also trying to run it – gain customers, develop your supply chain and everything else – one of those jobs is going to suffer. What inevitably happens is with all the attention paid to financing, the other issues don’t get the attention they deserve.

Secondly, there’s a widely held view that raising VC equals success. “I just got a bunch of angels to come together and give me half a million pounds: I’ve made it!” so many say. Or “Hallelujah, I raised a series A to take the business to the next level: the world is ours!” What people don’t realise about VC-backed businesses is that the vast majority of them are not successful. The research says that more than three in four firms that attract VC investments don’t repay the capital that goes into them. We simply can’t say that VC equals success. On the contrary; it’s just the start, and a tenuous one, at best.

The rest of the stuff you have to do – refine your product, please your customers and hire the right people – is much harder than raising VC.

Is there a better way?

Entrepreneurs who don’t focus on VC, and instead ask whether there other, alternative ways to fund their business – whether that’s at the start-up stage or at the growth stage – have a much bigger chance of success. And, like Michael Dell, they’re likely to be able to retain control of their business over time, which cannot be said for their VC-funded cousins.

“What about banks?” is a common cry. Banks are out, at least for start-ups. They’re only going to loan money when they’re darn sure they’re going to get repaid. Your early-stage venture is highly uncertain, whether you think so or not. Later when your business is generating cash flow, banks may be an option, typically by financing inventory and receivables so they have some security other than your (and your spouse’s!) house and assets. So once you’re at the growth stage, try banks. As you’ll soon discover, most fast-growing businesses don’t generate cash. They consume it.

So where does that leave you, at the start of your entrepreneurial journey? If you need cash for your venture, forget the PowerPoint slides. Spend time on your customers instead. Because in addition to being your most important focus, they’re your best source of funding, too.

Customer funding: Nothing new

Customer funding isn’t a new model. It’s the mindset by which many entrepreneurs have lived for decades. Airbnb and Zara are just some of the globe’s most successful recent examples of this relatively ignored phenomenon. Here are three of the best ways to do it:

1. Pay in advance: Via.com

In 2006, in India, the burgeoning middle-class was going places, and they wanted to go to those places on planes. The only problem was they had to wait until the day of travel to know the time and price of their flights. Enter Vinay Gupta, whose business had recently become a member of the International Air Transport Association (IATA), giving him access to real-time ticketing and flight information. In exchange for a rolling deposit of US$5,000, Gupta promised travel agents a computer, an IATA connection and the real-time ticketing information that would revolutionise the way they did business, and give them better commissions, too. In less than two months’ time, the 180 customers he initially signed up provided some $800,000 in deposits – do the maths! – to fund the business. By 2007, his company Via was issuing 5,000 tickets a day. Next, VC investor NEA IndoUS Ventures came on board. But Gupta didn’t really need its money, which sat in the bank while the rolling pay-in-advance deposits from his customers funded Via’s inexorable growth. Today Via is the “Intel Inside” of the Indian travel industry.

2. Subscription: Petals for the People

Sam Pollaro always wanted to start and run a business. When the 2008 recession lost him his job, he and his wife, Sarah – a florist – decided to combine the power of the internet and her expertise and launched PetalsForThePeople.com in Washington, D.C. Customers created their own bundles of flowers and had them delivered via a weekly or biweekly subscription. Because the Pollaros knew how many customers would want which flowers and when, customers got their flowers fresh and considerably cheaper than a one-off delivered bouquet. And because customers paid in advance, the Pollaros were able to get started and grow with essentially no capital. By 2010 and with hundreds of subscribers, the business was running on cruise control, and Sam was hungry for something new. So he made a deal with Bryan Burkhart, the founder of H.Bloom, a New York-based flower delivery subscription company. H. Bloom bought PetalsForThePeople’s customer list and hired Sarah as its creative director. By that time, Sam had realised that his passion didn’t lie in flowers, but after the deal, he had enough money, and more, to fund his next venture.

3. The scarcity model: Zara

If we know something won’t be around for long, we all want that something more. That’s not news. But the way the Spanish fashion chain Zara has used that concept and turned the “sell as much as you can, as quickly as you can” mantra on its head, is.

It’s been the key to Zara’s success. Zara has trained its customers to buy what they like when they see it because it could be gone tomorrow. By rotating its styles very quickly Zara has convinced its customers to buy now. It typically doesn’t pay its suppliers for that item for 60 days, while it already has its customers’ cash in hand. It’s not rocket science: sell the goods now and pay for them later. Zara has made the scarcity model into a fine art: the seller restricts what’s for sale to a limited quantity for a limited time period, and the supplier isn’t paid until after the sale is made.

The scarcity model was really popular after the global financial crash in 2008 because manufacturers had made too much of too many things they then couldn’t sell. Along came merchants like Vente Privee, which sold the clothes the apparel makers hadn’t managed to, discreetly, off the Champs-Elysees. It said, “Why don’t we do this on the internet so we can reach all of France, not just Paris?” And the notion of flash sales was born. Vente Privee would show a three-to-five-day fashion event online, and people would watch and order the clothes, paying with a credit card. Vente Privee, with its customers’ cash in hand, would then deliver the clothes and pay the vendor for the apparel, typically weeks later.

Sadly, though, most flash sales models have not worked out so well as in Vente Privee’s early days and Zara’s long-running success, as the manufacturers got their closeouts under control and raised their prices in the face of booming demand. However, scarcity models – though perhaps not the flash sales variety – can turn up in many variants. Zara is evidence of their immense potential.

Customer funding: A well-kept secret

Why don’t more people talk about customer funding? Because it’s not sexy. Facebook, Apple, Google and many more have led us to believe that a start-up is nothing without millions of pounds of investment behind it before it barely exists. But if you look at the league tables of the fastest-growing businesses, what you’ll find will surprise you. The vast majority of these rock-star businesses got their early funding from the most hospitable source available: their customers. Not VCs.

Whatever type of entrepreneur you are, if you don’t yet have the start-up capital you need, customer funding will give your business the most solid grounding you could ask for. When you start your customer-funded – and customer-focused – journey, you’ll follow the path of some of our bravest and most astute business pioneers. Once you’ve done so, and demonstrated that customers actually want what you have to sell, then that’s the time when you might consider VC or PE. That’s what Via and Airbnb have done, and on favourable terms, too, thanks to their already proven track records.

But be careful when you do. As I tell my students and executives in Financing the Entrepreneurial Business, “The day you take a pound or euro of outside investment is the day you’ve agreed to sell your business.” Many entrepreneurs don’t realise that this is what they’re signing up for. Many fall for the bright lights of VC and think they need it, but what most of them actually have to figure out is how to win a customer and get that customer to fund their business.