Some startups are fortunate enough to fund their operations through actual customers.
Some startups are fortunate enough to fund their operations through actual customers.

This post continues our Financing a Startup Company Series with the topic of customer funding.  Many startup companies begin using just a small infusion of cash from the founder and the money that they earn from their first sales.  Airbnb’s founders, for example, started the company by renting floor space to conference goers in San Francisco, before realizing the potential for growth in linking all kinds of travelers to accommodation.  To keep expenses low, they brought on founders who could do the coding work to create the website, and they were off.

While many of the startups that can utilize a customer funded strategy will be ones with low initial costs, however, even companies that must invest more in R&D or product development can utilize variations of the customer-funded model.  The key, of course, is finding a customer, or customers, who will pay in advance for a product or service that is delivered later.

The advantages of customer funding are:

  • It can be non-dillutive
  • Your customers may help beta test and refine the product
  • The existence of a large (and happy) customer can provide product validation when turning to find new customers

The disadvantages of customer funding are:

  • It is not always possible to find a customer (or group of customers) willing to fund the development of a new and untested product
  • Sometimes, a large first customer will want equity in exchange for fronting the money for product development
  • Designing a product for one large customer might lead to design choices that end up making the product less appealing to a wider market

Your company may end up as a service provider, building one customized product for a customer, then building another product for another customer and so on.  This model is not the same as the scalable model for growth that companies that sell a standard product to many different customers follow.