Customers are your best source of funding

As an impact investor in education, I’ve talked to talk about 2,000 edtech startup entrepreneurs over the last four years and I often get asked investment advice. Questions such as, “What do you look for in an investment?” and “How do I raise a seed round?” are common. These are good questions to ask an investor whether you’re currently raising funds or not.

In return, I typically ask something along the lines of, “How have you funded the company to date?” Responses like “We’re self-funded,” or “I’ve raised some money from friends and family,” or “We’re not paying ourselves yet” are common and they all make sense, but I’m surprised at how often the answer is not “We have paying customers.” Now, to be fair, many entrepreneurs do look to customers for early funding, but I think nearly everyone should and here’s why:

1. Paying customers are proof points. If you’re looking to raise money from investors, we all want to know if you have paying customers already. You’re going to need to figure out how to get them to pay and that takes time, so why not get started from the outset? When you have an initial cohort of customers who are paying you, then you get past a key initial hurdle in an investment conversation.
2. It de-risks your product development efforts. I went through many product development cycles as a startup operator and it took me longer than I’d like to admit to learn that the objective is to get customers to commit to paying you even before you build a product. Not only will the funding help you finance your product development efforts, but you’ll have critical initial thought-partners who will help you build a product from the ground up that better fits the market.
3. It’s likely a signal of broader market demand. If you’re able to convince a cohort of customers to pay you based on a problem statement and your proposed (but not yet built) solution, you’ve increased the probability that you’ve found a need that many others are likely to pay for as well. Think about it for a moment from the customers’ point of view: If this is a pressing enough problem that a customer is willing to pay before you’ve built a product, that’s a high-priority problem, right? Your Minimum Viable Product (MVP) at this stage could be a slide deck or a very basic prototype. I worry about entrepreneurs who settle for prospects who say, “If you build it, then I’ll consider paying,” and then go ahead and build it anyway. I’d be suspicious that most if not all of those prospects don’t really value your solution enough to pay.
4. It’s non-dilutive. Early-stage financing is expensive and whatever amount you raise dilutes ownership. Why not raise early capital from customers and keep more of the business in the hands of the founders?
5. It’s capital efficient. There’s nothing wrong with using funds you’ve raised from investors to build your product. It’s often necessary to build a robust product. My point here is that you’ll use your capital more efficiently and stretch your fundraising dollars out over a longer period of time if you can get customers to pay for your product development efforts.

This approach isn’t right for every startup entrepreneur in edtech. If your first product is a freemium offering, this isn’t practical, but for most everyone else I think it makes a lot of sense. It’s certainly not easy, but if you set a high bar (e.g., sign up six committed customers before building) then you’ve found product development financing and de-risked your product development efforts in a major way. In addition, you differentiate your company from so many other startups, which should impress investors.