Creative Business Financing Options: Customer Financing

In trying to come up with startup capital, many entrepreneurs overlook what may be their best source of creative business financing: their customers. Both parties can benefit if the deal is put together correctly.

Of all the ways to bootstrap your new business, getting a customer to help finance your startup might be one of the most difficult. But because of how it bonds your customer and you together, this business financing method can pay some of the biggest dividends.

There are all sorts of reasons that you might be able to persuade an existing or potential customer to help you get started. And there are a number of ways to arrange their involvement.

Customer business financing “may take a lot of different forms,” says Richard Scruggs, director of the Center for New Ventures and Entrepreneurship at Texas A&M University. “And it spans most industries that you can think of.”

Create a win-win scenario

While you can play on your emotional connections with family and friends, most customers or potential customers will look at your proposition with an icy view of the bottom line. So to get them interested, you need to present a good case for how financing your startup is going to benefit them just as much as, or even more than, it will benefit you.

For the customer, the incentive might simply be the chance to invest some money with the promise of higher returns than conventional investments. A customer may be smart enough to realize the business potential of your new company and want to get in on the ground floor. Or they may just figure that you’re going to be a player in their market, and if they help you, at least you can deliver them better pricing or terms than the competition does.

For example, when Randi Payton launched the nation’s first weekly magazine aimed at African-American automotive consumers several years ago, African-Americans on Wheels, he was able to obtain advances from General Motors and BMW of North America to pay for printing the first issue. That’s because both automakers recognized the importance of strengthening their marketing to ethnic Americans and how Payton’s startup based in Marlboro, Md., might be able to help them.

Leverage familiarity

In your quest for startup financing, you should leverage every personal relationship you have – and that can apply to customers as well.

If you’re leaving an employer on good terms to start your company, maybe that employer could be your first customer – and an up-front financier. Or if you have established good relationships with customers, vendors and other business associates during your time in the corporate world, target them as your first potential customers and suppliers of initial capital.

To get their Avalon International Bakery in Detroit off the ground several years ago, for example, Ann Perrault and Jackie Victor asked friends, associates and strangers to pre-purchase bread – and then come in and pick up the goods once the bakery was open. “We raised $30,000 that way,” Victor says.

Explore format options for the deal

Focus on the bottom line of customer business financing: to get a customer to help reduce your need for initial capital. This means that you should be open to receiving assistance in a variety of forms. Don’t necessarily insist on a loan or give away too much by allowing a customer to insist on an equity investment.

Other possibilities are advance payments on goods or services that you will deliver, a retainer arrangement, the promise of the first production run or preferred pricing, or underwriting of the cost of development of your product – you get the idea.

“The common denominator and the most important thing here,” says Scruggs of Texas A&M, “is to reduce your overall need for capital.”

Don’t leave anything on the table

When approaching your customers for business financing, Kennedy notes, it’s important that “you sound like you’ve got all your numbers figured out, and you know what you’re doing, and you’re very confident in the results. You don’t want to appear in need, and customers don’t want to hear about that anyway.”

At the same time, Kennedy urges, if you’re going to bother asking customers to help finance your startup, make sure you ask for enough assistance to make the whole troubling exercise worthwhile. “You might as well ask for a lot of money,” he says. “Swing for a home run.”

Our Bottom Line

Obtaining business financing from a customer can be a difficult exercise, but a very worthwhile one. The best approach is to create an arrangement where both you and your customer emerge as clear winners.

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