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Sunday, July 24, 2016

Using customers' money for your startup

Beijing has the world’s costliest rental housing, according to a survey of 15 global cities, with average prices more than 1.2 times average salaries, says a report by the Global Cities Business Alliance, a UK-based not-for-profit organization. The rise in rent, in developing countries like China, India, and Pakistan, has provided developers an opportunity to make money out of thin air.

What they do is to purchase a piece of land and then announce construction of residential plaza or shopping mall over it. Advance booking is announced for residential and commercial units. The advance money collected is then used for completing the project. Unheard in many developed countries, realty development is one of the most lucrative areas for investors.

The use of customers’ money for growth isn’t limited to realty sector only; entrepreneurs can use this method to grow their startups in other areas as well. Take the example of TutorVista, which successfully leveraged this customers’ money model of financing. It started when Krishnan Ganesh hired three teachers and provided them with VoIP internet connection, PC displaying a digital whiteboard along with webcam. It quickly became a 100$ per month tuition service.

Dell is another example of customer funded business. Michael Dell, founder of Dell, started by selling customized PCs to small businesses. The core percept in his business was to collect cash before having to lay out money on chips and computers to be sold. 

Customer funding provides many benefits to the startups. Usually, startups receive higher valuations if they performed successfully for an extended period of time, without external funding. Additionally, strong cash inflows, from customers, allow entrepreneurs to focus on proving business model rather than wooing investors.

In this model of business funding, balance sheet shows more current liabilities than current assets. In accounting term it is called negative working capital. Ironically positive working capital is assumed to be good as it poses less insolvency risk to the business.

Not every startup can be run using customers’ funding. Capital intensive projects need to rely on traditional way of financing. 

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