Corporate venturing models assume that the path to launching a business begins with writing a business case and then seeking funding. But this overlooks perhaps the most important source of capital: your customers.

John Mullins – London Business School professor and author of, most recently, The Customer-Funded Business – has studied the launches of successful companies and has found that the more money you raise at the start of a venture, the less likely that venture is to succeed.

This seems counterintuitive. If the investor is smart and can pick good ideas, the ideas that attract more investors should be better, right? Mullins has found there are three key reasons why your venture is less likely to succeed when you raise more money at the start:

  1. You get sloppy: When you have capital early, you get lazy and sloppy.
  2. You give up agility: You will probably need to pivot because your Plan A will not work and you will need to shift to Plan B (Mullins’ prior book, Getting to Plan B, showed that success depends on your ability to abandon Plan A and move to Plan B quickly). Once you have taken capital, however, you will feel pressure from investors to flawlessly execute Plan A. You lose agility.
  3. You get distracted from what matters: Raising capital can quickly become a full-time job, robbing time from what really matters: understanding your user, and executing and improving your business model.

Perhaps then it is no surprise that the vast majority of fast-growing businesses never raise venture capital. Nor do they even write a business plan!

I got a chance to speak to Mullins last week at Verne Harnish’s Fortune Growth Summit. He laid out five ways to get your customers to fund your business instead:

  1. Matchmaker models: Uber and Airbnb don’t do the work that requires capital investment. They connect people who have invested capital (in cars and houses) with people who want access to the assets.
  2. Service-to-product models: Take your service and turn it into a product. Microsoft, for example, took a service (the operating system) and turned it into a product, converting payment from being spread across months or years into one upfront payment.
  3. Scarcity-based models: Zara, for example, limits inventory, which creates scarcity, which drives customers to buy now … because they know it may not be there when they return. Gap, by contrast, tries to prevent stock-outs.
  4. Pay-in-advance models: Michael Dell convinced his first customers to pay in advance for PCs he was going to produce for them. Steve Blank suggests you sell your product before you make it. This principle works with vendors as well. Costco, for example, does not pay vendors until after products are sold.
  5. Subscription models: Get your users to subscribe just as magazines, telephone companies and cable companies do. Costco, for example, gets a significant portion of revenue from subscription (membership) fees. Netflix can guarantee a steady stream of revenue because it’s selling memberships, not downloads.

When engineered well, each of these models move you toward the nirvana of “negative working capital” in which the faster you grow the less capital you need!

Another way to think about this is that you want to optimize and prove your business model BEFORE you fuel it with capital. Research shows that fast-growing profitable companies start out first achieving profitability then later add growth. If you pursue profitable growth the other way around – seek to grow fast and later extract profits – your success is statistically less likely.

In an interview I conducted recently, the man behind innumerable large private M&A deals leaned forward after my flurry of questions and said, “Do you want to know my secret?” The secret that summarizes all of the advice he had shared came down to this: first engineer the terms of the deal so that you risk a little to gain a lot, so that you get upside without much downside, and then “go all in.”

Ask yourself five questions:

  1. Could you get your customers to pay you sooner?
  2. Could you become matchmaker?
  3. Could you switch to a scarcity model?
  4. Could you get your customers to subscribe?
  5. Could you bottle your service and turn it into a product?

To build a customer-funded business, that could remove your dependence on funding, I suggest you pick up Mullins’ book, The Customer-Funded Business.

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