Scaling fast doesn’t have to dilute your equity
101 hard lessons in raising capital that created my love for customer-led funding
One of the common misconceptions in the tech community is that raising venture capital should be celebrated. In truth, it is a dilution event for the founders. It creates potential upside in the future if everything goes well, but also amplifies potential risks.
VCs often have the loudest voice and are usually able to shape the narrative in the tech community. Many of the largest tech companies in the world are (or were) backed by VCs, which provide great proof points to the argument. The reality is that venture capital is like rocket fuel, and for the right company at the right time*, it can be tremendously valuable.
One of the key milestones on the journey as a founder is becoming financially secure. Whether your company is early stage, growing rapidly or established, becoming financially secure allows you to take on a lot more risk in your company. You can sleep well at night knowing that your basic lifestyle is looked after and you can focus your time, energy and effort on giving your company a shot at greatness.
Being venture funded typically provides a founder with 18 to 24 months of runway, which creates short term comfort (aka salary and certainty) but usually requires more funding within a year or so.There is also massive downside if the company doesn’t execute to plan or new funding isn’t achieved.
Today, there are more choices than ever before for founders to build a company and access funds to accelerate their growth, without giving up control (or having meaningful dilution). Many great companies** have benefitted from customer-led funding, with customers paying upfront for the product or service and that payment providing working capital or growth capital for the company. This works especially well if you’re selling or marketing your product online.
It isn’t easy, and certainly isn’t for everyone, but my view is that founders should focus on creating value for their customers and community, and as part of that process, create value for themselves. Any external funding should be thought of in that context.
A few ideas for funding (in a rough hierarchy):
Pre-sales of products: selling your product before it is developed or ready to be shipped, either on your own site/landing page or via a crowd-based platform
Direct product sales: where the customer pays upfront, your product is then delivered online or, if it is a physical product, it is bought from the supplier or manufacturer and delivered, paying the supplier later
Sale of future products: gift cards, signup to a premium version of today’s products and also get upgrades in the future or access to additional items as they are released
Partnerships or performance based arrangements: where you pay a third party to sell or promote your product using the revenue or profits generated from the relationship or, a supplier can pay to promote their product or service to your customers or audience
Sale of product related tokens: core or additional product functionality, proof of product ownership e.g. NFTs
Limited sale of future revenue: could be a token, share or other right that gives access to future revenue, profit or specific return. Ideal if it can have some kind of limit either time or value related
Other funding alternatives that can have a bigger potential impact on founders are:
Security over business: many different forms of debt are available now. These include: venture debt, growth finance, revenue finance, bank debt etc. It could be debt over stock or debt with the company or other assets as security
Equity with limited control: could be bringing on passive investors or doing an IPO and listing your company on a securities exchange
Equity with negative control of business: right to veto business plans or other operational, board or shareholder controls. Including funding from venture capital, growth equity or strategic investment from a company
Equity with control: change of control of business through sale of a controlling interest to a specific investor, trade sale to another company or sale to a private equity firm
There are many choices for founders. Sometimes, the most obvious choice isn’t the best solution. Once you’ve taken outside capital, you have two masters, the customer and the investor. It is a real challenge to keep both masters happy (investors usually have a louder voice than your customers). Two of the biggest reasons companies fail are:
They scale prematurely: they spend time, effort and money on marketing or sales to acquire customers before the product meets or exceeds customer expectations. This often results in positive short term customer or revenue metrics but has associated high costs or customer churn rate, which can end up killing or severely limiting the company); or
They focus on today’s sales and revenue rather than tomorrow’s customer delight (product enhancement or development): this can happen at any stage of a company’s life and is often evident in larger companies where the company or product may once have been great, but over time the experience has gotten worse
I’ve learned the above lessons (unfortunately), multiple times.... Now they are both front of mind for me.
I’m not arguing that you shouldn’t take external investment or that investors shouldn’t have controls in place. In many situations there is merit to having external investors, and those investors need appropriate protections to manage their risk.
I think the optimal path for most founders who can sell their product or service online is to start by focusing on customer-led funding. There is a real opportunity to connect directly with customers to get feedback or make sales, especially given the rapid rise of technology adoption over the last year. Once that is fully explored, if more funding is needed, then I’d consider other options including taking on external investment, so long as it clearly propels your business forward and helps both your business’ success and your personal financial security.
Notes
* Different investors have different criteria. Many early stage investors are looking for at least 3x year on year growth. For later stage investors, especially for SaaS companies, the rule of 40 is often used
**Australian companies like: Atlassian, Campaign Monitor and Envato. Global companies like: Basecamp, GitHub, Lynda. Some of these companies eventually raised external capital, but it was well after they had already achieved meaningful scale
Acknowledgements
Thanks to Kevin Brennan, Paul Mills, Curtis Minasian, Rey Vakili, Garry Visontay and James Whalley for comments, inspiration, and feedback.