There has been a great shift in the venture capital industry in recent years. Once upon a time, entrepreneurs could validate their business on an idea and investors were willing to take a risk, offer capital and, eventually, wait to find out if real customers were willing to adopt the idea.
You don't see that much anymore. Why? Too many investors have been burned.
Entrepreneurs can talk a great game to investors, but what they should be doing is talking to potential customers first.
Detroit's entrepreneurial ecosystem may be robust, but we don't have the same money to throw around as places like Silicon Valley. That's why it's so critical for entrepreneurs to go prove their ideas in the marketplace before they seek funding.
This concept is one of the main focus areas of Automation Alley's new entrepreneurship program: The Automation Alley 7Cs. We're focused on advanced manufacturing, and we have partnered with all kinds of potential customers for our participating startup clients. These potential customers are great sounding boards for how entrepreneurs should build their products or services going forward.
It is that Midwest sensibility that has driven this great "customers before capital" shift.
And here's why it makes sense:
(1) You don't know your customer until you ask them questions. If you're trying to build something before you've had conversations with customers, I can guarantee you that much of what you are building, you will get wrong.
What many entrepreneurs don't understand is that they don't have to build a prototype to go have conversations with customers. If you can get a few customers on board with your idea, then you can go back to funding sources and say "I have customers willing to pilot this product."
(2) It's all about talking to customers and learning what their pain is — and how what you are building alleviates that pain — before you actually build it. Asking for money before you have customers shrinks your business valuation. Remember: If you don't have customers, investors are taking a much greater risk. Because of that, they will most likely want the majority share of your startup.
So, right out of the gate, you will end up as minority shareholder for the company you are trying to build. Investors want to be compensated for the risks they take. If you go get customers, the value of your business will skyrocket, and you will give up a smaller piece to investors. By attracting customers and showing that you can execute with few resources, potential investors will have more confidence in you and will be more likely to back you.
(3) You will discover new features to your business you didn't even know had value. Before you go down a path where you get locked into certain engineering or software protocol, there is no better time than before you start building something to get all of that out of the way. I guarantee that customer input will lead you to discover new things about your idea.
It's much cheaper, for example, for an architect to lay out plans for a house and change the design on paper based on customer feedback than to start building, have the customer walk through and say, "I love the house, but why would you put the bathroom there? I want it over there." You're stuck.
Why don't more entrepreneurs embrace the "customers before capital" approach? Because entrepreneurs are a special breed of people. They like to invent, innovate, create and push out their ideas. They get this thick skin, and many feel they know better than the customer.
That can be very dangerous.
Remember, asking questions and having confidence upfront can make all the difference. It's better to ask customers, "What am I'm doing wrong?"
I've heard entrepreneurs say, "I really can't go to my customers and talk about what I could do because they will think I'm foolish, and they'll challenge me." Most entrepreneurs want the comfort of having their product or service built before they attempt to sell it, before even asking the customer, "Is this something you actually need?"
Tom Kelly is the Director of Entrepreneurship at Automation Alley.
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