Funding a business from start-up to profitability

Far and away the best source of finance for a business is revenue from customers. Most other sources – especially equity investment, and loans – have strings attached.

 It follows that start-up businesses should focus as hard as they can on reaching their first paying customers as soon as possible, and in the meantime keep costs as low as possible. The ‘lean start-up’ model describes how various iterations of a minimum viable product are tested with potential customers as the company develops. However, some businesses cannot avoid turning to investors for funding to prove a concept, build a prototype, or carry out trials; they cannot take a product to market without spending significant money on its development, and need to consider their entire journey from start-up to profitability.

The first step is to estimate how much cash is required to reach breakeven, when the company’s revenue covers its outgoings. This analysis is likely to involve several milestones such as completion of a prototype, appointment of key people, agreements with suppliers and distributors, and more. At each stage there is a balance between keeping costs low and having sufficient resources to reach the next goal. One tendency, often remarked upon by investors, is that early stage companies focus far more on the product or service itself than on the market opportunity, or on how the business will bring the product to market.

The more effort put into researching the market before embarking upon product development, the better. The first version of a product is unlikely to be exactly what the market requires, and concentrating solely upon completing product development before addressing market entry is likely to be expensive and ineffective. To use the terminology of electronics, a parallel rather than a serial approach is required, and this has a bearing on how the business is funded. At the outset, entrepreneurs will need to find some resources of their own; savings, earnings from parttime jobs or consultancy, or support from family and friends. There are several grant schemes for helping businesses set up and investigate proof of concept, but even these usually require some matching funds from the founder.

The objective should be to prepare a convincing case for the next level of investor, maybe a business angel group or institutional investor such as a VC. These investors will need to know how and when they will be able to realise a profit on the funds they invest, often by the sale of the business to a larger firm (a trade sale), or perhaps by way of a flotation. This will determine a demanding timescale for the growth of the company, and the investors will need to have confidence in the team assembled by the company to implement its plans.

Once the business has started to make regular sales, more funding options become available, including debt, and the company can start to depend more upon building its customer base than on further funding from its investors.

Jonathan Harris
Editor, YCF