Customer-funded development — overview
This is the first post of a short series about what I think is an underused business model among software entrepreneurs, namely sponsored (i.e. customer-funded) development. Key points include:
- If you have an invention you can’t fund yourself, having your first customer(s) pay for development may be the key to realizing your dreams.
- Likely prospects are companies that:
- Are sufficiently hard-core technically to value your bleeding-edge ideas …
- … and to be willing to invest in projects with obviously high risks of failure.
- Are sufficiently limited technically to believe that your team is significantly stronger than what they could hire and deploy themselves.
The second post in the series discusses the substantial complexities that an actual sponsored-development deal might entail.
Suppose you have a great idea for a software product that you want to develop and sell. How do you get initial funding? In some cases the answer is straightforward.
- Companies with ongoing software businesses might fund new development as normal R&D.
- A conventionally-wonderful-seeming team, possessing both business and technical credentials, might raise venture capital in the usual way.
- Individuals who made a lot of money in previous start-ups might fund a new venture themselves.
Even better, the product might be fast and cheap enough to bring to market that even a non-wealthy person might be able to self-fund. Examples include:
- A lot of things sold at consumer kinds of prices.
- A number of data center tools during the mainframe era.
If you’re in such a situation yourself, congratulations — you’re in a great situation for successful entrepreneurship.
Suppose however that you’re an inventive engineer, with:
- A strong track record in developing great software.
- Limited business skills.
- An idea that requires more person-years to bring to fruition than you can self-fund.
- No obvious choice for “business-y” co-founder.
With that kind of profile, you probably can raise ~$200,000 or so of some kind of seed/angel funding. But let’s suppose that that’s not nearly enough.
Some of your options are:
- Raise a larger amount of venture capital from accomplished VCs (or angels). But without business skills, that’s hard — not because you won’t make the right moves (although that’s a problem too), but because most halfway-choosy investors will be reluctant to fund you.
- Recruit the right business co-founder to help you get VC. That’s perhaps even harder, because you lack the skills/expertise/judgment to run a sound hiring process for this utterly crucial hire. If you get the right person, it’s just dumb luck.
- Find some sketchy VC who then recruits a sketchy CEO to take control of your company.
Each of these strategies has low probability of working out well.
Another option is government research funding, but that only works in some industry segments (commonly ones with national defense applications) in some countries, and even then only for people who know or figure out how to navigate the grant process.
What’s left is customer-funded development — find somebody in the private sector who wants the product so badly they’ll pay for it before you’ve proven you can deliver. Yes, it’s a difficult sales task — but the business skills you do have probably include the ability to do one or both of:
- Persuading people to bet on your development projects and ideas.
- Persuading people to hire you as some kind of consultant.
Getting a major project sponsored by a firm you’re an outsider of will likely be the hardest such persuasion of your life … but you just might be able to pull it off.
In general, a custom development project should be something very important that the customer can’t easily pull off themselves. That’s the sweet spot for getting something funded and for the customer taking the risk of an outside development team. So how do we match that pattern with an unproven invention idea?
- The customer must pride itself on technical excellence. If they don’t aspire to technical leadership, why would they gamble on something cutting-edge?
- The customer must believe your team is a lot better than what they have in-house or can hire themselves (except perhaps for people needed on yet-more-crucial projects). This follows from the previous point; they surely (think they) can put together a reasonably good project team themselves. Yours has to be a whole lot better than “reasonably good”.
- Notwithstanding the project’s importance, the customer must be able to tolerate the risk of failure.
That last bit is essential — because from the customer’s perspective, it’s likely that your shiny new idea will fail. Fortunately, many organizations understand that difficult software projects have large chances of failure. In particular:
- Tech companies doing R&D know that not all projects will pan out.
- Smart enterprises are always prepared for the possibility that application projects will fail, because even in cases of “zero” technical risk, implementation often goes awry.
So how does a hopeful start-up get such a crucial sponsorship deal? As an overview, I’d say:
- To a first approximation, this is like any other initial sale. However:
- In some ways it’s even more complicated and tougher.
- In some ways it’s actually easier — the product definition is (within reason) whatever customers want it to be, and the delivery timeline is whatever you need to give them what they want.
- I suggest applying much of my usual startup-vendor advice. In particular:
- My general comments about your first customers apply.
- My general comments about introducing yourself apply.
- Sales qualification is of utmost importance in sponsorship scenarios.
- If you have a super-close relationship with a particular large prospect — perhaps even a former employer — that of course can help a lot.
And finally, as I explain in a companion post, deal structure needs to be handled with great care.
Related links
- This post relates closely to my previous one Should you start a tech company?, particular the part at the end about design partnersl
- My strategic worksheet draws on and links to many other relevant posts. Some more recent links are in the comment section.
Comments
Leave a Reply