Self-financing through customers

What is self-financing?

In general, there are two types of financing for a company: financing by external capital (borrowing, fund raising...) and financing by equity. This last method is called self-financing. 

More concretely, it consists in using exclusively your own financial resources or cash flow to ensure the creation of your company, its development and your investments. You use your own resources to launch your business without financial assistance from others. Most entrepreneurs use their savings and draw on their personal savings to finance their business. However, it is possible to rely on your customers to finance yourself and to use the initial sales revenue of your business. 

This type of business model is structured so that cash advances from customers help fund growth, making your business less dependent on early external funding. This is a strategy that many new businesses consider: receiving money from customers before having to pay for the product or service to be sold (this is the principle of negative working capital). Relying on advance payments as a financing mechanism is not new, yet it is striking to see its growing use. 

This self-financing entrepreneurship is not uncommon. It is also known as "boostrapping". 

Customer self-financing models

There are five main models of customer-funded businesses. 

1. The matchmaker model: this involves bringing buyers and sellers together. This strategy can significantly reduce capital requirements, as these businesses have no inventory (see our article on how to finance inventory) and the cost of goods sold is extremely low. Examples of such businesses include consignment shops, real estate brokers, or eBay and Airbnb. Matchmaking models became particularly popular when businesses discovered the power of 'collaborative consumption' - the sharing of underused resources, a practice increasingly encouraged and coordinated by web applications and social media.
2. The deposit model: relying on upfront payments for funding is a common practice. By requesting deposits up front, the company can secure crucial initial funding without having to turn to outside sources.
3. The subscription model : because customers pay a predictable monthly fee in advance, the company is highly capital efficient and enjoys steadier revenue growth than most start-ups. Newspapers and cable networks have used subscription models for many years, and newer companies such as Netflix have grown dramatically by relying on fixed monthly fees. 
4. The standardize-and-resell model: the strategy of winning a contract to create a product for a customer and then reselling a variant of that product on a larger scale can be effective for small companies. One of the best-known examples goes back to the early days of Microsoft, when Bill Gates won a contract to supply an operating system to IBM; the resulting software was the basis for the Windows systems subsequently sold on most PCs.
5. The scarcity model: Other businesses still use scarcity to entice customers to buy (and pay) up front. This tactic, particularly useful in retail, takes advantage of the fact that retailers often do not have to pay their suppliers upfront. Vente-privée, a French flash sale site that offers high-end fashion items available from stock.

The advantages of self-financing 

While boostrapping allows you to slowly and organically grow your business while ensuring that the model is financially viable in the process, it offers other benefits such as: 

• Less costs: self-financing avoids the need for loans that are often very expensive in the long term because they require interest payments. 
• More independence: This practice also allows you to gain financial independence and enjoy more flexibility in investments and financing. You have full control over the management of your company.
• Non-dilutive: this independence and management stems from the non-dilution of your share capital in favor of your investors. You have full control over decision making and are the only one in charge. If in the case of external financing, shareholders or investors can have a decision-making power and interact in the development of your company (sometimes towards a different objective than yours), thanks to self-financing, you are not accountable to any investor and you can thus define your own development strategy.
• Less risk: self-financing encourages the entrepreneur to develop his business model and commercial strategy in a profitable way as quickly as possible. This method limits unnecessary expenses and allows the entrepreneur to focus on the essential: the user and his needs.

One of the main advantages of this approach is thatit allows company founders to focus on creating, testing, refining, and demonstrating their business models rather than on the investor market. In addition, companies that wait longer to accept outside funding are generally better valued. 

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Partoo's success story

Partoo develops the online visibility and e-reputation of its clients to attract new consumers to their establishments! It is a B2B SaaS that generated in November 2020 an ARR of more than €6M, for a total financing need since the creation of the company in 2014 of €500k. Thibault Renouf and Benoit Cotte's start-up is a good example of a self-financing success. 

The pillars of its success story echo the benefits of self-financing. 

Frugality as a state of mind

By choosing frugality as a state of mind (a self-funded state of affairs), the founding team spent its money only on useful things (software and recruiting screened), maximized the value of each investment (insourcing vs. outsourcing), better negotiated the prices of its suppliers (especially for software licenses), and fostered innovation. As a self-funded start-up, the constraints of time, money and tools allowed it to innovate and be more agile than its competitors.  

Business focus 

Theory versus practice. By opting for a self-financed approach, Partoo's managers focused on the operational and not the theoretical, on the concrete and not on slides. This method also forced them to opt for financial and operational rigor. Partoo has a strict policy regarding its KPIs. They must be simple, limited in number, easily measurable and adapted to the stage of development. Their mantra regarding the time to be spent on KPIs is: "20% to measure, 80% to improve - not the other way around". 

Develop a real culture 

Defining one's values and guidelines is essential at the beginning of an entrepreneurial project. Benoit and Thibault defined these values very early on because they guided the rest of their adventure, defined the type of people they were going to work with... Since Partoo's growth was slower in the first few years due to the choice of self-financing, they were able to devote the necessary time to it and lay the foundations of their building. Partoo's culture allowed them to overcome the crisis periods.

Take your time to do it right 

Self-financing allows you to avoid burning your wings too quickly. Some start-ups that have raised a lot of money, for example, find themselves unable to manage and absorb strong growth. On the contrary, by self-financing, Partoo has spent more time building up its own experience in the field and bouncing back from its own mistakes. The advantage of self-financing is to go at your own pace. Partoo has been able to slow down when necessary but also to redouble its efforts when needed.

The success of Partoo thus underlines the advantages and strengths of self-financing. However, there are also disadvantages to this type of development. 

The limits

Proponents of bootstrapping advise against "skipping steps" and recommend focusing on profitability over growth. A company can then see if a business model is self-sustaining without giving up any control or direction.

You should not abuse self-financing. Fully self-financing your investments is neither a sign of good health nor a sure way to ensure your company's sustainability. Like all types of financing, self-financing has its limits: 

• Less advice and networks: not having external investors limits access to a network of experts and specialist advice that can be there to guide you and help your business flourish. 
• No media coverage: few companies become known thanks to their 100% self-financed model. Fundraising in particular allows you to put your company in the spotlight of the entrepreneurial scene and get people talking about you. Moreover, it can act as a guarantee of confidence and success with your customers. 
• Slower acceleration: as this is done at the rate of your customers' acquisition, it can be slower than if you had invested in customer acquisition (for marketing, for example). 
• Competitive Lag: This slower acceleration and sometimes insufficient resources can leave you unable to quickly seize interesting and promising opportunities. 
• Low response to the unexpected: building your entire business model on self-financing is not necessarily the wisest approach. If something unexpected happens, you may not have the resources to deal with it.

Bootstrapping has limitations that may make it difficult or impossible to implement for some businesses. Launching a self-funded business requiresstrict financial discipline, a significant time investment, a minimalist structure, initial cash flow, and the ability to reinvest early profits directly into the business.

The fit also depends a lot on your market. For example, the start-up costs associated with a software provider are significantly lower than those of a manufacturing company.

Although self-financing can be an interesting solution, this means of financing can bring a certain amount of constant pressure and relying exclusively on it can be a risky gamble. 

Taking our examples from the previous 5 self-funding models by its customers, each of these models allowed company founders to launch with little or no external funding and use the time not spent searching for potential investors to fine-tune their businesses. In each case, the founders then found venture capitalists willing to write them checks, in part because they had already proven the viability of their business.

Customer-funded models are not appropriate for all businesses. Capital-intensive projects that require manufacturing plants or other infrastructure must almost always rely on traditional financing.

Generally, it is advisable to self-finance the short term, the activity and to borrow on the long term, the investment. 

Karmen and RBF, the alternative self-financing solution

Priming can make growth more gradual, which can be positive, as mentioned earlier. However, there is a fine line between slow growth and stagnation. If bootstrapping is consistently holding you back from reaching your goals, it may be time to consider a new strategy. Fortunately, there are many other opportunities to raise capital.

The RBF (Revenue Based Financing) system is ideal for subscription-based business models, which in the start-up world generally means e-commerce or SaaS companies. Why is this? Because this type of business generally has a monthly income. This makes it easy for RBF companies like Karmen to determine loan amounts and terms based on current and future revenues.

How does it work?

Karmen is a revenue-based financing solution for revenue-based businesses seeking short-term financing.

In less than 48 hours, Karmen can release funds to finance projects, customer acquisition costs or generate cash. 

In addition to this speed of execution, revenue-based financing is a non-dilutive and more accessible financing solution.

For start-ups, we are often their first source of growth capital to help them accelerate before raising funds. 

For venture-backed companies, we provide an additional source of non-dilutive, founder-friendly capital to help entrepreneurs achieve their growth objectives, while retaining ownership of their company. 

The benefits?

This type of financing ensures the non-dilution of your share capital (and therefore an independent management of your company), an immediate cash flow (less than 48 hours, where banks are sometimes reluctant if you are a high-growth start-up or a young start-up considered as "risky") and finally, it is a low-risk financing. 

Our service at Karmen is based on three cardinal principles: speed, non-dilution and transparency! 

To find out more, please contact us and we'll put you in touch with a Karmen specialist! See also our article on how to finance and grow without dilution.