Recently, I taught a webinar on Funding your Small Business Startup. One tactic that I shared that I think does not get nearly enough attention is the idea of getting the customer to fund a startup. Rather than following the traditional path of writing a business plan and using it to get a loan from a bank, by the way, this hardly ever works, or convince early-stage investors to give you money, I tell my clients to look for ways to get the customer to provide the money you need to fund a startup.
Have you ever been to a private country club? Let’s face it, the real estate where you will find a country club is often some of the most valuable property around. It costs a fortune to buy the 75 acres that it takes to build an average golf course. But who owns the property? The members do.
I live in a neighborhood that was built around a private country club. To become a member of the country club, you have to buy in. At the time, over 30 years ago, one share went for about $ 10,000. To put that into perspective, our home sold then for about $ 120,000. If you do the math, the country club membership was more than 8% of my home cost. A typical 18 hold country club may sell 400 to 500 shares. That translates into four to five million to cover the cost of the land. Then there are the monthly dues to maintain your membership. It is not hard to see that the country club was not bought with private money but by selling memberships and from monthly dues to cover operational costs.
In another example, when it was clear that my mom, who suffered from Macular Degeneration and could no longer drive, needed to move to an independent living facility, she chose a community in a Denver suburb with approximately 1,700 units at the time. When it came to the construction of the facility, rather than think about building the facility like it was some kind of large apartment complex which would have required the builder to come up with several hundred million dollars to build it, they sold each unit like it was a condo. As a result, residents bought their own apartment rather than renting it and this money was used to pay off the loan principal used to build the facility. At the time she moved in, it cost my mom about $ 250,000 to buy her apartment. When she moved out some six years later, the facility bought back her unit for the original price, spruced it up, and resold it at the new market value. Here again the customer, in this case, my mom and 1,700 of her neighbors, paid the capital expense that covered the construction cost of the facility. Then, there were the monthly maintenance fees that covered the facility’s operational costs.
For over a decade, we owned a class A motorhome. As we traveled the US for about two months each summer, we discovered many membership RV resorts that used a similar scheme to get their customers to pay a large part of their startup costs. One RV resort that comes to mind is Cutty’s. A typical resort like Cutty’s might sell 3,000 units for a one-time membership of $ 400. That would generate $ 1,200,000 in initial seed money that could be used to buy the land for the resort. The land, owned free and clear, acts as collateral for a development loan to further develop the property. Members are also charged about $ 600 per year in dues to cover operational costs that include the interest on the debt used to develop the property.
Rather than following the traditional routes of getting a loan or selling business shares to investors, I encourage many of my clients to think about ways that they can offer some kind of membership or discount program to their customers in exchange for membership benefits.
Say you want to start a self-serve carwash and you need $ 125,000 to buy the lot and build the carwash. When you consider that on average, you wash your car every 2 weeks or 25 times a year and that the average household owns between two to three cars, if you assume that the cost per wash is $ 15, that is over $ 900 per year that a household spends to keep their cars clean. Now let’s say that you sold 250 one-time carwash memberships for $ 500 each. That would generate the $ 125,000 you needed to start your carwash business. You could then offer these members a steeply discounted price of say $ 3 per wash, which would be more than enough to cover the cost or water and soap and would represent a significant lifetime saving to the member compared to paying $ 15 per wash. The startup cost of the car wash becomes zero since it was paid by your 250 members.
Say you want to start a much more modest lawn care service and you need $ 10,000 to buy that large commercial-grade zero-turn mower. Consider selling 20 discount lawn care annual memberships for $ 500. 20 memberships at $ 500 each would be enough to buy that new mower altogether. While at retail you might charge the client $ 50 each time you cut their acre of grass, with a membership, you would charge members only $ 30 for each cutting which would be enough to cover labor and fuel to cut the lawn. Assuming each member received 30 lawn cuttings per year, the membership would save the customer $ 100. While you would lose $ 100 in revenue from 20 memberships, totaling $ 2,000, the customer’s membership would have paid for the mower that you would likely use for several years. Startup costs were zero as the customers, with the first year’s annual membership, paid for the mover with the discount program.
Another way to get customers to fund a startup is through what I call strategic partnerships. One of my business mentors, Ron Muns, used a strategic partnership when he started his company Bendata. It was in the early 1980s and the personal desktop computer was just making inroads into businesses. Companies needed a way to track the location of all their computer-related assets since they were no longer all located in a central computer lab. Ron built a strategic partnership with three customers to develop a software application to track all their computer-related assets across their businesses. Each strategic partner contributed technical specifications for the application and provided one-third of the capital needed to develop the first version of the asset tracking database product. In the end, for making the deal happen, Bendata owned the rights to the underlining software while the strategic partners got their application for a fraction of the cost of doing it themselves. What did it cost Ron to develop his first product? Nothing, his customers paid for it.
In addition to simply raising the necessary seed money to fund a startup, several additional benefits come from getting your funding covered by your customers.
One of the main benefits is customer loyalty. When you own a country club or RV resort membership, bought into a carwash or lawn care discount program, it is very unlikely that you will take your business elsewhere.
Secondly, as we discussed in the post “A Simple Pricing Hack to Increase Customer Satisfaction” when you separate the payment from the consumption of the product, it drives up customer satisfaction.
Thirdly, by getting the customer to pre-pay, you have validated that customers are willing to exchange money for your product or service.
Finally, all this adds up to social proof, making it much easier to sell to additional customers and minimizing the risk to lenders and investors that may be needed to fund a startup’s further growth.
Regardless of the type of business, you plan to start, getting your customers to help you fund a startup has some significant advantages over the more traditional ways of selling stock or taking on debt and is too often overlooked by most startups.
How can you get customers to fund a startup?