Customers first. Angels second.

Should business angels be an entrepreneur’s first port of call?

This article is provided by the Deloitte Institute of Innovation and Entrepreneurship.

More than two generations ago, the venture capital community convinced the entrepreneurial world that writing business plans, raising angel funding, and then following with venture capital constituted the holy triad of entrepreneurial behaviour.

They did so for good reasons: the sometimes astonishing returns they’ve delivered and the incredibly large and valuable companies that their ecosystem has created.

But the vast majority of fast growing companies never take any angel or venture funding. Are they on to something that most of today’s entrepreneurial ecosystem has missed? Indeed, should a business angel be seen as the first port of call for getting your nascent entrepreneurial venture off the ground? Perhaps not.

Why raising angel funding early is a bad idea

Fortunately, there exists another approach. Most fast-growing companies, at least at the outset, and sometimes for the entire journey, get the cash they need from revenue – not costly equity from their customers. They don’t do so because it’s easier, though. It’s not. They do it in large part because of the unwelcome drawbacks entailed in raising capital too early. Here are just a few: 

• Raising capital is a distraction: Let’s face it. Trying to get a fledgling venture off the ground is a full time job! But so is raising capital, which demands a lot of time and energy on its own. If you try to do both, one or the other will suffer.
• The stake you’ll get to keep: Who kept the greater share of the value he created, Steve Jobs or Michael Dell? It was Dell, hands down. When you raise angel or venture capital early, as Jobs did at Apple, you start giving away a portion the company – often a substantial portion – in exchange for the capital you are given. And that portion typically grows over time. Dell, on the other hand, used his customers’ pre-payments for their PCs to fund his startup and its early growth.
• Advice and support: Many angels haven’t actually built an entrepreneurial business from the ground up. They’ve been highly-paid I-bankers or consultants, hardly the best platform to learn what it takes to survive the long and tortuous entrepreneurial path. You would be forgiven if you wonder just how helpful their support or “value-add” is likely to be!

But is there an alternative? Yes, five of them!

There are five time-tested but largely unknown approaches that scrappy and innovative twenty-first century entrepreneurs have ingeniously adapted from their predecessors – like Michael Dell, Bill Gates, and Banana Republic’s Mel and Patricia Ziegler. What Dell, Gates, and the Zieglers have in common is that they all started and grew their companies largely with their customers’ cash. Here’s how they and many others have done it: 

• Matchmaker models (the USA’s Airbnb and DogVacay)
• Pay-in-advance models (the USA’s Threadless, India’s Via)
• Subscription models (India’s TutorVista, the USA’s H.Bloom)
• Scarcity models (Spain’s Zara, the USA’s Gilt Groupe)
• Service-to-product models (Denmark’s GoViral, Puerto Rico’s Rock Solid Technologies).

Do business angels have their place?

If you are an angel investor I suggest you ask those seeking your capital to put one or more of these models to work. “Come back when you’ve got customers (even before producing the first product),” you should say, “and I’ll then help you grow.” Customers first. Angels second.

If you’re an aspiring entrepreneur lacking the startup capital you need or an early-stage entrepreneur trying to get your cash-starved venture into take-off mode, a customer-funded approach offers the most sure-footed path to starting, financing, or growing your business. In the words of Shanghai’s entrepreneur and angel investor Bernard Auyang, “The customer is not just king, he can be your VC too!”