Is Your Customer’s Money Green?

One of my readers asked me how I viewed companies raising money from customers. The traditional advice is not to take money from customers since it gives them additional leverage. I recently experienced this at a company where our portfolio company was a key supplier to the firm. The business arrangement was worked out but things got more complex when we surfaced the idea of their investing. You generically run into a couple of speed bumps:
1) the customer often wants a special term for investing such as a right of first refusal, best nation pricing, exclusives and such
2) the customer has an incentive to mess with the financing to drive the price down. This is where divergence at the customer hits when the investment arm is focused on ROI (lower price) and the business unit wants a well funded supplier.
3) this potentially complicates your exit if they are a potential acquirer. They are an insider and the only way a third party outbids an insider is by paying too much based on inferior information.
4) having a customer invest potentially messes up future sales with some of their competitors (potential customers for you). They may suspect that their competitor will have privileged information as an insider about them.

On the positive side, you:
1) potentially get affirmation in the market place about your product if a major player (your customer) in the market is willing to invest capital as well as do business with you.
2) can get a higher valuation since they are not investing purely for ROI and they also have a deeper appreciation for what you can do.
3) can get fewer restrictions and likely no board seat requirement.

All of these are broad generalizations and only one or two possibly come into play on any given deal (and often none do). But, you should be careful not to get blinded to these facts because of the higher valuation that you will likely get from them. Overall, I would say that if you can avoid taking money from customers, you should. It adds another dimension and lever point in the relationship.

2 thoughts on “Is Your Customer’s Money Green?

  1. great post

    perhaps there might be a distiction between selling securities to customers and using customer finance as seed capital

    personally, I’ve seen shops like http://www.squarespace.com/ achieve great results by preselling their product at a discount, and then using the cash to build and deliver the product to presold customers

    this approach also seems to work in property development…or any other space where contracts for future delivery are popular

  2. Spot on. The best funding is revenue. Many start-ups can defer or minimize the dilution they take on by getting advanced bulk purchase orders from customers by giving a discount. This isn’t equity, so it doesn’t create control issues or dilution.

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