Startups: Vai-Thee-Fuss?. Start-up funding: Raising money from customers is the litmus test

Fundraising is the glamorous aspect of starting up, thanks largely to the media going gaga over entrepreneurs raising huge amounts of capital and rapidly turning their firms into not-so-rare unicorns, despite massive losses. This has spawned a bunch of entrepreneurs who believe the goal of their start-up is raising money, rather than making money.

The reality is that raising money is less important than building a great product or service that attracts repeat paying customers. Customers will fund a start-up by using the brand regularly and paying for it, but this is hard to achieve. Hence entrepreneurs choose the easier option of raising money from investors.

When raising money, it’s important for an entrepreneur to ask a few questions: When should I raise the money? Who should I raise the capital from? How much should I raise? And the most important of all: Why am I raising the money?

A start-up should raise money primarily for growth. This means that a basic product or service has been developed, and enough customers have tried it and use it regularly. More importantly, every time a customer purchases the product or service, the company makes money. This proof of concept is the foundation on which an entrepreneur can create a growth-based business plan and subsequently raise capital to fund such growth.

Unfortunately, most entrepreneurs end up raising money to pay bills. Suppose you open a cafe and, after two years of toil, the monthly revenue is ₹5 lakh and costs are ₹7 lakh. If you raise external capital now, the money will be used to fund the monthly losses, which is a bad idea. However, if the costs are also around ₹5 lakh, then one can plan to open 25 more cafes in the city over the next couple of years, and leverage scale to control costs and improve margins.

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The other distraction entrepreneurs fall prey to is valuation. Many founders are more worried about the valuation at which they can raise money than focusing on how best to deploy the funds and drive growth. In fact, the only sensible way to improve valuations is to drive sustainable growth.

It is also important to observe that a great business can be built without raising equity from investors. Most traditional companies have done this. Recently we have examples of start-ups like Zerodha and Zoho. My good friend Manjunath has built a nice little profitable digital marketing business, Kenscio, without raising external capital. So, while fundraising is important, building a smart business is a lot more critical. In the next column, we will look at some of the other aspects of funding.

(The writer is a serial entrepreneur and best-selling author of the book ‘Failing to Succeed’; posts on X @vaitheek)

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