In a world of complicated finance, the idea of building a business without capital, raising money from your customers seemed expensive and retro. Although mentioned as an example in every business text book, in reality, entrepreneurs have focused on debt financing or outside investors rather than looking to their customers.
With the credit crunch and housing collapse eliminating many small business loans and home equity loans as a source of business capital, many entrepreneurs are returning to the historic source of capital, their customers. Money magazine shares the anecdotes of several business owners, owners who have sold stock, pre-sold gift certificates, and otherwise took action to raise capital from their current or potential customers, both raising capital cheaply and increasing customer loyalty.
In some ways, however, this capital is cheap, and in other ways it is very expensive. The capital is cheap in that it lacks personal guarantees, protecting the downside, and may not have the warrants and other “teeth” that angels and VCs may want. However, selling $1,500 in gift certificates for $1,000 to raise money is a 50% rate of return and will likely be redeemed within 3 months, potentially charging you a 200% rate of interest. If that customer would have spent $1,500 with you anyway, that’s real cost in opportunity cost. To the restaurant owner, if they run at 50% margins, that $1,500 costs them $750, so from a cash flow point of view, the money is cheap. As most small business owners will remind you, cash is king, and cash flow matters a lot more than the traditional finance metrics, because cash means survival. The Fortune 500 finance guy is worried about NPV (Net Present Value), but the local coffee shop needs to pay the rent and cover payroll.
As a rule, I open my business bank account with the first check from a customer. If I invest in the business, it comes later, but by always opening the account with a customer check, it serves as a reminder that you aren’t in business until you have a paying customer.