Source: London Business School
by John Mullins,
07 Mar, 2016
Starting up? Five ways to dodge the trap of venture capital
[dropcap]T[/dropcap]he venture capital industry is celebrated as an economy-driving powerhouse. In the early days of the venture capital boom, in the 80s and 90s, superstars like Arthur Rock and John Doerr were immortalised for the parts they played in creating today’s computer industry, and the investing knowledge that came as a result.
The world soon became enamoured with writing business plans and raising venture capital. Today, the (sometimes) astronomical investor returns and massive companies that the system has generated are evidence of its success.
But let’s examine the facts: the vast majority of fast-growing companies never take any angel or venture funding.
John Mullins, bestselling author and Associate Professor of Management Practice at London Business School, says that automatically going down the venture capital route is risky and needless. “Sadly, VCs and the rest of the entrepreneurial ecosystem hijacked the financing limelight a couple of generations ago in Silicon Valley and Boston and now most everywhere else. They convinced entrepreneurs that writing business plans and raising start-up funding were the only ways to start a business. Dead wrong.”
Mullins says that almost all fledgling business should be looking to another source of funding first: their customers. His research has found numerous businesses – young and old alike – that have found inventive ways to get their customers to pay for their earliest stages of development. More importantly, there are patterns in what they’ve done. Five of them, to be exact.
Matchmaker, matchmaker, make me a company: The matchmaker model
DogVacay
Rambo and Rocky aren’t really the types to enjoy staying in a kennel. Like other dogs, they love to take walks, run, or play with others, whether dogs or people. In 2011, Rambo and Rocky’s owners, who were planning yet another short trip away from their dogs, found a dog trainer who was watching dogs and had a big garden. Aaron Hirschhorn recalls how much better that experience was for him, for his wife, Karine, and for their two rambunctious dogs. “It was great. I loved it, the dogs got socialization and were in a social environment. They are, at the end of the day, pack animals. We thought to ourselves, this would be a great idea to try out on our own.” With no marketing spend, the couple earned $30,000 in customer cash in just eight months. Venture capital then followed, and today DogVacay dog-sitters are found in nearly all 50 states. Plans for a Hamstervacay, Birdvacay and Snakevacay (really) are in the offing.
I’ll take the cash, please: Pay-in-advance models
Threadless
When Jake Nickell and Jacob DeHart started out designing t-shirts in 2000, it was a hobby. But it wasn’t just them who enjoyed creating and wearing their own designs – their friends did too. So the pair of web-developers and designers launched a competition and judged the best, printing the winning entries. The first batch would cost money, though, so they each threw in $500 to cover the printing and t-shirt costs, and to pay a lawyer to incorporate the fledgling business. They—actually DeHart’s aunt, a screen printer who did the printing—printed two dozen of each of the five winning designs, and offered them to the Dreamless.org community for $12 each. They sold out quickly. Do the mathematics. Two dozen each of five designs, sold at $12 each, or $1,440 in total, enough customer funding to more than cover the $1,000 in initial costs. A customer-funded business was born, and by 2004, sales were at $6.5 million. Threadless was named the “Most Innovative Small company in America” by Inc. magazine in 2008.
Subscribe, rinse, repeat: Subscription and SaaS models
Tutor Vista
In 2005, a cartoon showed an irate American father telling his son, “No! You can’t outsource your homework to Bangalore.” Outsourcing the homework hasn’t happened just yet, but outsourcing some of the learning has, thanks to the power of the Internet and Krishnan Ganesh’s observation in 2005 that education—particularly in mathematics—was suffering in the United States and elsewhere. With three Indian schoolteachers, who began tutoring American students more than 9,000 miles away, some headsets, a webcam at each end and a VoIP connection, TutorVista was born.
Ganesh soon discovered that a subscription model—$100 per month for all the tutoring you could want —enhanced customer adoption and retention, not to mention cash flow. Six months after launching TutorVista, he had enrolled 500 students, served by 50 tutors working from their homes in India. It wasn’t long before he had a $600,000 run rate revenue-wise. With customer traction proven, he was ready to raise serious capital so his business could grow faster. In 2011, UK publishers Pearson acquired a 76% majority stake in TutorVista for $127 million and fully acquired it by buying the remainder in 2013.
Buy me now or lose me forever: Scarcity and Flash sales models
Zara and vente-privee
Scarcity models are perhaps the cleverest of them all. They’re also the hardest to pull off and sustain. One of the most established, successful and famous examples is Zara. A knockoff of what was on the catwalks at London Fashion Week can hit the stores in as little as a couple of weeks. But Zara won’t reorder that same style. Its young clientele know how shopping at Zara works. If they see something they like, they’d better buy it now!
The transience of fashion makes the industry fertile ground for the scarcity model. Vente-privee used flash sales not to start its business, which already existed in another format, but to grow it. In 2001, Jacques-Antoine Granjon and his team came up with a simple idea. For years, they had been performing the delicate task of moving unwanted excess inventory of Parisian fashion designers, through a variety of events that would not disrupt the carefully honed brand images of their upscale suppliers. From time to time, an e-mail would sent to the ‘members’ of vente-privee (the French phrase vente privée means ‘private sale’ in English), giving them 48 hours’ notice of an upcoming ‘sale event.’ The sale would last for just three to five days, with the goods priced 50 to 70 percent below what they would have sold for on the Champs-Élysées. Vente-privee has been so successful at establishing itself as a luxury brand in its own right that more than 600 exclusive brands, including Dolce & Gabbana, Cacharel, and Givenchy have supplied merchandise to vente-privee. Before long, vente-privee was ranked as France’s fifth most popular brand, ahead of the ultimate French fashion icon, Chanel.
Build for one and sell to all: Service to product models
GoViral
When the number of views for Claus Moseholm and Balder Olrik’s first online video campaign hit 20 million, the pair realised they might be on to something. It might seem like the invention of the colour TV to us today, but in 2003, very little conscious effort was being made to create video content that would spread organically and virally. In 2004, GoViral sold two more campaigns to the same client, under an arrangement where they were paid based on the sales directly generated from the campaign. Though both campaigns spread widely, GoViral earned only modest revenues, as the number of actual sales that were closed was modest.
In February 2005, YouTube launched just as the duo had developed cost-per-view pricing. Web-based video had begun to appear on the radar, and by the end of the year, they saw enough promise to register the company and officially open for business. Happily, GoViral soon secured an attractive contract—more customer funding, paid in part in advance, as the team had by now come to expect—through the creative agency Leagas Delaney in London. The agency would create the videos, and GoViral would manage the distribution, placing the videos on websites that would reach the intended target market for the client, Goodyear Europe. After talking their way into the Cannes Lion Advertising Festival and sticking a 30-page booklet into every delegate’s gift bag, it wasn’t long before they were leading the new market. Two years and a few challenges later, the group had revenue of $2.5 million.
However the real game-changer for GoViral was their decision to offer a product, rather than just a service. Moseholm, Olrik, and new addition Jimmy Maymann recognized that though all three of them had strong backgrounds in advertising and media—and could sell!—they lacked expertise in the technology underlying their offerings. When they finally brought tech-savvy Rene Rechtmann on board to create a tech platform in 2008, GoViral was also able to provide detailed data reports and analysis for the client. This success became a huge validator of the firm’s capabilities, and made for a compelling case study in pitches to other global brands. At Cannes in 2010, AOL bought GoViral for $96.7 million, a multiple of five times the company’s 2010 annual sales.
The best time to start your customer funded business is now, according to Mullins. Why now? “Somebody down the street or around the world is probably working on pretty much the same idea as you are. If he or she is busy chasing investors and you’re focused on customers, my bet is on you to win the race. And I’m betting you’ll have more fun, too. Would you rather spend your time solving customer problems or pandering to investors?”
