Asked the other day, having witnessed the success of WhatsApp, “how are these companies getting funded when they don’t have paying customers?”
It’s a good question, but frankly too, one that for many of us, actually doesn’t make sense. Most innovation gets funded without revenue so I’d ask in return, what makes you think you need revenue to get funding??
Given the decline in early stage venture capital and the increasing risk aversion that traditional capital sources seems to be experiencing, it’s not unreasonable to conclude why entrepreneurs increasingly believe that they have to have customers. The popularity of Lean Startup practically preaches that you need customers and revenue to validate what you’re doing and as Angel investors, not just startup founders, read those same books, naturally, they’re going to default to such a response when they, having just heard your pitch, are unsure. I’m sure you’ve heard such a reaction from potential investors, instead of simply saying no or not right for us, you get the, “Do you have any customers yet? I’d advise you to focus on revenue and securing some customers; come back and let’s talk some more when you’re further along that track.” These trends in the startup economy are causing entrepreneurs to think (believe) that they must have customers and revenue to get funded. Think about how innovation works though, MOST investment is in developments in which there are no customers nor revenue: real estate development, medicine, R&D, energy.
Most Investment is the Result of Marketing, not Product
The reason famed economist Peter Drucker famously quipped that the only things that create value in business are innovation and marketing is that it’s true. And yet unfortunately, most entrepreneurs are being taught that marketing is a cost for which the return is leads/customers. Marketing is an investment. Marketing is the reason there is so much investment in those companies without customers. How do I mean? Consider those examples:
Real estate investors/developers are incredibly savvy investors. They know how to work the system, they play the politics, and strategically plan their developments such that real estate still delivers the highest return on investment in the world. Sure, that ROI is because of the unending appreciation of property value as demand will forever increase but appreciate that there are never (okay, rarely) failed property development investments. How on earth is that possible? They don’t have customers and revenue until the investment in the development is done! Surely, they need paying tenants to know that they should build an condo tower. Right?
Imagine being a real estate developer and starting a new project (your new startup) when you can’t get customers and revenue. How would you possibly justify that the investment be made? That it’s worth chasing your dream?
Real estate developers don’t just develop property where ever they can, for the sake of building it and hoping people will move in (as long as they can find the skilled technical resources to develop the land); so why would you?? But that’s what many startups are doing these days; as long as we have the developers, we can build the skyscraper and then get the tenants… why won’t anyone fund us!? Real estate developers do market research, study demand, evaluate infrastructure (roads, utilities, etc.), and consider the nearby “partners” (think businesses and companies that can employ people and/or attract people to occupy their development).
Having determined that there is a reason to develop, they fund it and get to work. All of that validation is marketing.
The same is true of medicine, R&D, energy, and other verticals wherein there are no customers until you’ve built the product or service. “Hey, let’s drill on the side of this granite mountain! I have a dream of making oil more accessible and cheaper by drilling in every mountain in America. We have the tools, and the drillers, and, I’ve been told, once we pull just one barrel out of the mountain, we can sell it and bootstrap our success!” Seriously??
How Startups Get Funded without Revenue
Are you just building something hoping to get customers who will pay you (move in to your new building) in order to convince investors to give you money?? Put yourself in the shoes of the investor hearing that pitch, “Sounds good. Come back when you have some of those customers and let’s talk some more when you’re further along.” Rats. But that’s how you’re pitching the company! Why would any investor take a risk on you when you’re selling a dream as though it can be sold?
I love this chart to the right as it simply conveys what we’re talking about here. If you’re an investor looking at 5 different startups, in which one of those would you prefer to invest? Most demanding use is determined by customers but disruptive innovation requires knowing how to be disruptive.
Instead of building something customers can buy, shouldn’t you first do market research to understand how big is the market in which you’re working? Who are the competitors? How much market share you can achieve and at what cost? Wouldn’t it make sense to make sure there’s demand for what you’re thinking and figure out from where and how you can capture that demand? Does the infrastructure exist – does the media cover your industry/market, do the technologies and APIs exist to simplify what you’re building, and are the marketing channels significant enough that you can get people TO what you’ve built? And what of Partners? Not the BS, “we could partner or get acquired by Netflix, Google, or P&G!” Sure you can. Let’s understand who the real, potential partners are; those with whom you can foster an industry, customer adoption, PR, and share resources.
If you have’t done that marketing, you can’t raise money without revenue because you don’t have a business any more valuable than selling something. Businesses that sell something get loans. Startups that understand their potential to redefine and own markets, get funding.