Bypassing the VC: Funding Your Business with Deferred Revenue | Hacker News Reader

Bypassing the VC: Funding Your Business with Deferred Revenue

markenomics.com

35 pointsmediaman11 comments

This may seem like an obvious point, but encouraging prepayment is often overlooked by typical struggling startups when designing billing options. It's definitely something to consider if you haven't already.

I used this for financing a new landscaping company. 15% of my customers prepaid their maintenance fees for the year at a 10% discount. Purchased tools, equipment and paid lease downpayment on a truck with the money and still had some leftover for hiring two helpers.

Isn't this just taking the risk from the venture capitalist (who is in the business of taking risks) and giving it to the customer (who isn't)?

Who better to bet on you than your customers?

This is exactly the method taught to me by my mentor, who affectionately referred to our first customer in any business as our "sugar daddy".

Not saying they aren't, just that the article glosses over the fact that the customers are taking on the risk that a VC normally would and not getting the reward. If the customer needs your product enough that they are willing to take that risk, it doesn't seem like such a bad idea.

(I worked for a company that got started this way. Although they went on to take VC money, they were in a good position by the time they needed it.)

Part of it is because of the cost of capital. It's very high for startups and much lower for others, particularly busines customers, although the concept also applies to consumers who buy things like magazines. Clever startups can capitalize on this difference in capital cost by discounting the price enough to incentivize the customer to take the prepay, but not so much that it's not worth the boost in liquidity.

But yes, it means the customer takes the risk and doesn't get paid for it the same way a VC would, which in my book is a good thing for the startup.

The important word here is : liability.

Once you take the customers money up front you better deliver them the service. If you take 12 months worth of money, you need to be around for 12 months at least. If you stop delivering the service 6 months in, the customer may pursue the unused money.

This is an interesting specific example but the broader message is to concentrate on your cashflow conversion. Bad businesses are ones where you hold a lot of inventory for a long time, either paid up front or using borrowed money, and then try to sell at a profit. Good businesses are ones where you take the cash, then deliver the product. Dell was so successful principally because they built on demand, using the customers money to purchase the parts, and needed little working capital.

This works great for B2B consulting or custom products. That's actually how my previous startup managed to survive for more than a year without raising VC funding, and we were able to develop a hardware product on our spare time (and dime).

It won't work for consumer/web applications, unless you have some Pro version that you can sell to businesses first, but that's unlikely.

We are using this model of financing at our business. Up until reading this, I didn't know there was a name for it. This method will probably only work for certain types of businesses though, especially one's that can't get customers to prepay for service, or are not subscription based.

Even large corporations do this, when developing a large project for a "lead customer".

The actual sale itself takes time... drafting proposals, speaking to the right people, etc. I think the author down played that a little bit.

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