By John Mullins
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 incredibly large and valuable companies that their ecosystem has created. But the vast majority of fast growing companies never take any venture capital.
Why raising early VC is a bad idea
Too many of today’s entrepreneurs have come to the belief 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! But it hardly ever happens this way, and the vast majority of successful businesses don’t ever raise venture capital. Instead, at least at the outset, 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. (See the table)
The drawbacks of attempting to raise capital too early
|Raising funding||A distraction||Raising capital often requires full-time concentration, but so does starting an entrepreneurial business. One or the other will suffer when investment capital is sought. Why not raise money later when the business is less fragile?|
|Pitching vs. proving merit||Nascent entrepreneurial ideas, however promising, always raise numerous questions. Proving the merit of your idea, based on accumulated evidence and customer traction, is much more convincing than using your own wisdom and charm to pitch its merit.|
|The term sheet giveth; the shareholders’ agreement taketh away||The terms and conditions attached to venture capital are (for good reason) somewhat onerous, as investors seek to protect themselves from downside risk. The further along the path, the less onerous the terms.|
|Building the business||Advice and support||Just how good is the “value-added” advice and support that investors provide?|
|Outcomes||The stake you and your team get to keep||The further you progress in developing your business before you raise funding, the lower the risk. Less risk translates into a higher valuation and a higher stake for the founding team.|
|Bad odds||VC today is an all-or-nothing game. Are these the odds you want to play?|
But is there an alternative?
What do Michael Dell and Bill Gates have in common? Each of them started or grew their companies largely with their customers’ funds. Here’s how they and many others have done it:
- Matchmaker models (for example, Airbnb and DogVacay)
- Pay-in-advance models (Dell, India’s Via)
- Subscription models (SaaS businesses everywhere)
- Scarcity models (Spain’s Zara)
- Service-to-product models (Microsoft, Puerto Rico’s Rock Solid Technologies).
Whether you’re an aspiring entrepreneur lacking the startup capital you need, an early-stage entrepreneur trying to get your cash-starved venture into take-off mode, a corporate leader seeking to grow an established company, or an angel investor, mentor, or business accelerator or incubator professional who supports high-potential entrepreneurial ventures, a customer-funded approach offers the most sure-footed path to starting, financing, or growing your business or those you support. In the words of Shanghai’s entrepreneur and angel investor Bernard Auyang, “The customer is not just king, he can be your VC too!”
About the Author:
John Mullins is a two-time entrepreneur and an associate professor at London Business School. He is the author of three best-selling books on entrepreneurship. His newest book, from which this article is adapted, is The Customer-Funded Business: Start, Finance, or Grow Your Company with Your Customers’ Cash, Wiley, August 2014.
Follow John Mullins on Twitter: @John_W_Mullins
Interested in reading this article in spanish? Click here.