How about having customers provide all the necessary capital.

While this scenario may not be realistic for most startups or existing businesses, within the concept resides a nugget of truth that can find practical application for many companies in their approach to capital and customer acquisition.

The primary question is:

How lean can a company start and operate in order to attract paying customers with an early version of its products or services, thereby demonstrating viability, scalability, and fundability?

After a business has demonstrated these characteristics, it’s a lot easier to get funding, because the investment is a lot less risky.

This idea is not new or uncommon.  For many years 3-M has fostered a culture of intrapreneurship whereby small teams of technical and business people come together on a limited budget to develop and market new products.  Some industry experts estimate that 30% of all large companies provide seed funds to finance internal entrepreneurship today.

Many entrepreneurs could take a page from this playbook for their own companies.  In other words, start making money from a small investment in product development and marketing, consistently improve the product based on market demand and reasonable economics, and raise growth capital after establishing a respectable product, delivery and support team, customer base, and growth plan.

One of the key elements to this lean approach is focusing on the creation of “minimum viable products,” and then building a base of paying customers.  This approach has also been around a long time.  In the automotive industry, both Honda and Hyundai came to market in the United States with cars that could easily be classified as minimum viable products.  They sold a lot of these cars at low prices, which provided revenue and a growing customer base on which they could continuously improve.  Both car companies have a much better reputation today than they originally did, and they are still going strong, even amid global economic challenges.

I’ve worked with many startups that wanted to hit the market with a knockout product or service from the very beginning.  Few have achieved their fully realized vision out of the starting gate.  Many find that the perfection curve can be a real business killer for tender young companies with limited financial resources.  I’ve experienced this brand of misery firsthand with one of my own startups, and don’t recommend it to anyone!

Venture capitalists and other investors are coming around to this way of thinking again – spend less upfront to develop products and customer bases, and then fund the winners that emerge.  It’s a simple lesson with major implications.  It’s also a mindset and a strategic approach that can help you quickly and economically sift through many good business ideas to find a really great one customers love to pay for.

1. Customers buy from you and perceive value

The question professional investors often ask is, “Will the dogs eat the dog food?” If you have an existing business where customers pay reasonable prices for your products and services and perceive value in the exchange, you have the foundation for a successful business. The absolute best source of capital for your business is satisfied customers. But if your company has strong proven customer demand and you need expansion capital to meet that demand, you’re in a highly attractive position to investors. For start-ups, the question is more difficult to answer until customer traction is achieved, and we’ll address this issue in a future post.

2. Your business generates strong earnings

Many start-ups launch with strategies to attract customers with free or low-priced goods and services. Of course, the company eventually has to generate profits to be successful, so prices usually escalate and more revenue streams are established. Most start-ups lose money for a while, and even well established companies lose money occasionally. If your business is not currently profitable, you need to demonstrate a clear and credible path to profitability. Investors are looking for proof of your company’s ability to maximize earnings while keeping the customer value equation in balance.

3. Your business is scalable

How much realistic growth potential does your business have? Is there a way to double or triple your revenues within a year or two? What will it take to make it happen? If you can demonstrate the scalability of your company, you’ll find more investors willing to talk to you. However, if you have a $1 million business today and can grow it to $5 million within the next 3 years, your deal won’t appeal to venture capitalists or angel investors, but it may be attractive to informal investors or commercial lenders. The type of investor will depend on how much your company can reasonably scale. Proof of scalability enhances your strength in the eyes of investors, even if it is on a limited or trial basis.

Start-up companies generally don’t have much evidence of these issues, but are often able to achieve it after a period of bootstrapping with a focus on generating the necessary proofs. Both investors and lenders respond well to business owners who have taken this approach.