Funding – an input or an output?

The startup quandary: ‘Give me the money and I will make it happen’ or ‘Show me the solution and I will give you the money’

Starting a venture requires many resources which are captured by the five Ms of machines, materials, methods, manpower and money. Mobilising the first four resources also require money. Many new age enterprises are asset light or are in the service sector and hence, the need for machines and materials is minimal. Methods are created by the manpower employed by payment of salary or money. Hence, money becomes the most important resource for a startup.

For an entrepreneur, digging into the personal savings is an emotional decision which may not be difficult to take. However, the quantum of such funds could be small. Raising money from the family can be an emotional and a rational decision. Parents and relatives would ask pertinent questions before agreeing to fund the venture, although they may not really understand the technicalities of the idea or the venture.

The questions would essentially revolve around the team, the idea, the problem being solved, the size of the problem, the ability of the entrepreneur and the team to create a practical solution, customer acceptance of the solution, the ability to deliver the solution and the subsequent scaling of the venture beyond the comfort zone.

The information and techniques available to the family to assess the venture would be different and less sophisticated from the ones available with seasoned investors. Nevertheless, the prospect of raising funds from the family is difficult, and even more difficult as the entrepreneur seeks funding from relatives or friends.

The prospect of funding has a direct correlation to the probability of success of the venture, which is a function of the insights the financier would get from the answers to the pertinent questions.

The entrepreneur would do well to deep-dive into the problem, interact with potential customers, co-create a solution at a prototype or pilot level and then, with this story, get people and organisations on board to deliver the solution.

Unfortunately, many entrepreneurs spend a lot of time to raise funds, a domain alien to them, instead of utilising the time and available resources to create an acceptable solution to a genuine customer problem. Let’s consider two typical scenarios of entrepreneur funding.

Scenario 1

An entrepreneur thinks that he has a wonderful idea, very innovative, nobody has thought of it, first of its kind, no competition, and when introduced, it will capture the market. All he needs is funds to develop the idea and launch it in the market.

Such entrepreneurs often have little idea of how to develop the idea and limited domain skills to convert it into a prototype or pilot. In addition, they are far away from ground reality of how things work and the practical aspects of creating a solution. They have a fuzzy vision of their customer segment and think that virtually everyone is their potential customer, waiting to grab the solution when launched.

From a financiers’ perspective, the entrepreneur needs to develop the idea first, go through the rigour of solution development and its testing for robustness, followed by a prototype or pilot for customer acceptance. The impression that the solution is unique is often due to insufficient research.

The monopolistic vision is transitory as competition would spring up, in the absence of a technological barrier to entry, the minute the solution is introduced in the market and gathers some traction. This is a typical case where the entrepreneur does not have domain expertise, and is detached from the marketplace and the customer.

The entrepreneur would do well to dig in his heels, deep-dive into the idea, understand how to develop the solution, recognise the resources required to convert the idea into a prototype or a pilot, do a lot of secondary and primary research on the marketplace and get a real feel by interacting with potential customers before starting to develop the solution.

Scenario 2

An entrepreneur has developed an innovative solution to a problem, having integrated the technical or engineering aspects into a digital solution which nobody has thought of, it’s a first of its kind, a patent application has been filed or is in process, potential customers have seen the prototype and love it, there is no competition and when introduced, it will capture the market.

His love of technology and the thrill of developing a patentable solution drive him to include more and more features into the solution. He wants funds to further improve the solution and incorporate customer feedback in it before the commercial launch.

Such entrepreneurs create a solution based on real-life experiences but have little idea of the commercial aspects of doing business, of cost economics and marketing. They seem to have a clear idea of their customer segment but find it difficult to obtain confirmed orders from them.

From a financiers’ perspective, the real-life story behind the solution creation and the commercial affordability are very important. The digital solution could be a capital investment for the potential customer, the cost of which would be recovered by higher per unit revenue from the customer or by savings in their operating cost.

With too much features and technology put into the solution, the unit costing could make it prohibitive to charge more from the end customer due to competitive pressures or the savings in operating cost may not be sufficient to adopt the technological innovation. Innovative entrepreneurs must realise that customers pay for actual and perceived benefits and not for features only.

Hence, while the innovation is acknowledged, cost economics may not be attractive enough to generate sales. Substantial effort and cost in marketing the solution to create awareness, differentiation, positioning and acceptance could be required to generate sales. A credible third-party endorsement of the solution would help reduce the marketing effort, accelerate customer acquisition and give greater comfort for financiers to consider funding.

In both the scenarios, the entrepreneur is seeking funds but is politely turned down by investors. Entrepreneurs must appreciate that funding is an outcome of a commercially viable solution and is not an input to create solutions, the market of which is uncertain.

A commercially viable solution, in simple terms, implies that the potential customer is willing to buy the solution at a price which provides a reasonable margin for the entrepreneur to meet expenses and the sales are scalable. It makes sense to focus on providing one or two key benefits to the customer instead of developing an integrated solution with multiple features at the initial stage.

As customer acceptance increases, more features or versions could be introduced based on specific customer feedback. This also helps to keep the initial solution development cost, effort and time lower while creating the sales funnel earlier in the life cycle of the venture.

In summary, if the solution is backed by a live story, addresses and focuses on a key pain point of the potential customer, has been demonstrated to work effectively in real-time and is attractively priced, it would make customer acquisition that much easier.

Entrepreneurs must create solutions on which they have domain expertise, are able to create a prototype or pilot with their available resources, including funding, and are focused on solving a real customer problem in a simple and effective manner without too much frills in terms of features.

It makes a lot of sense to consider baby steps, introduce a base version in the market, gain acceptance and then build additional features to stay ahead of the competition. Entrepreneurs must understand that funding is an output of the solution they have created and not an input to create a solution.