Part 1: One of the Toughest Questions Start-Ups Need to Answer for Funding

December 1, 2009

One of the toughest questions entrepreneurs need to answer when looking for funding is how you know your product concept will attract paying customers. While today’s investors know that it’ll be years before they will see any returns from the start-up, they are impatient and want market validation in less than 12 months. What investors are seeking is a way to reduce the market risk. Experience has shown the technology risk to be minimal, not many start-ups have failed because they couldn’t develop the product. Investors don’ want to fund a development effort for 4 or 5 years only to find out there aren’t any paying customers. So how do entrepreneurs show market acceptance and customers in the early stages of a start-up? This is a series of blogs of how some start-ups have addressed this issue.

STRATEGIC PARTNERS CAN BE A WIN-WIN FOR ALL

Strategic partners are external companies whose product lines can be expanded or are complimentary with the product of the start-up. Strategic partners are a potential source of funding for a start-up project. These partners are motivated to solve their own problems. They may be your future customer that’s looking for a way to reduce development costs or indirectly address a customer desire. I’ve seen start-ups receive funding from multiple partners. The key is to know the strategic partners’ product line well enough to know what will be complementary and to know what the strategic partner’s business goals are. You can expect the potential partner to quiz you on your knowledge of their product line. As in any sales process, it’s not what the start-up wants to sell the partner; it’s about what the partner needs or wants to buy.

Here are a few real life examples of how strategic partners have funded start-ups.

(1) A graphics company wanted to extend its product line into digital video, but didn’t have the internal resources needed to do so and was therefore willing to fund a digital video start-up.

(2) A Fortune 100 company wanted to offer their customers a hardware option but the volume was too low for such a large company to develop the product efficiently. The company was willing to fund a start-up to develop the product, which was in turn sold into the Fortune 100 company’s customer base with a guaranteed minimum volume as a reference sale.

(3) A company wanted to reduce the bill of materials costs by reducing the cost of a component that was used across their product lines, and were willing to fund a start-up to develop a cost reduction and create future competition for their current supplier.

(4) A lead investor wouldn’t proceed with the funding of a start-up until at least one strategic partner would provide $100K of funding. The lead investor knew that $100K was enough money to go through a corporate approval process with an established company. The theory was if the start-up could get a strategic partner then the lead investor had an indication that there were potential customers for the start-up product.

The trick to developing strategic partnerships to address the start-ups need for funding with its long-term vision of what the start-up wants to become.