Mentoring Entrepreneurs: Customer Financing

I am passionate about entrepreneurship. I truly love it. And I deeply believe in equality in our society. And so I decided to put those two beliefs together when I sent out the below tweet:

 

Before I hit send on the Tweet, I thought that I would only get a few responses. I do not have a lot of followers. But it blew up. The response has been overwhelming. I started the mentoring yesterday and the first sessions have gone well. I wanted to share the advice that I shared because I am sure that it is applicable to other entrepreneurs.

The first mentoring conversation was with Jose who is running a SaaS business to generate customer referrals, ReferralVoodoo.com.  He has a nice start to his business. He and his partner have bootstrapped it to 80 customers and 7 employees in only 10 months post launch. Really nice growth without any outside capital! Well done Jose. He has grown his referral software company in a very crowded space by focusing on small, service providers, such as Doctor’s offices. Jose said that he wanted to discuss capital raising. He had just raised some money and was thinking about raising more.

After discussing his business in a little more detail, I suggested a different path than a Seed Round…using Customer Financing. Customer Financing is when you get your customers to fund your growth. That’s the best form of financing because you are not selling equity in your company. So how do you get customer’s to fund your growth? Sell annual licenses.

During our conversation, Jose mentioned to me that almost all of his customers were on monthly plans. Also, the ASP was about $250 – $400/month. He offered a 20% discount to purchase annual plans, but few customers took him up on it. I told him one possible reason that few customers chose that option is because it isn’t worth $50 – $80 in savings to give up the flexibility of being able to cancel the contract at any point. The savings are just not a significant enough incentive. I suggested that he run an experiment. Take a cohort of prospects and only offer them annual plans. Tell them that monthly plans are no longer an option. Do it for just a cohort as an experiment. Guess what happened…

 

At the end of the day, ReferralVoodoo was a great product at a fair price. Taking away the option of monthly plans didn’t change the customer’s intent to purchase. They chose the Monthly option because it was easier and it was given to them as a choice. But that choice was NOT required to close deals.

The real benefit of an annual plan to Jose and his team is that pre-paid annual licenses create negative Working Capital. Meaning, you have cash for a contract that has not been fully used yet. Said differently, you have a year’s worth of cash flow from a customer up front. This allows you to invest that money in growth.

I knew about this option because I did it myself at Validately. Switching to annual only licenses for my SaaS company was the single best operational decision that I made in my entire career.  We immediately went from NEEDING to raise capital (which we likely wouldn’t have been able to do given our churn metrics at the time) to being cash flow positive. We used the cash flow from customer’s pre-paying for annual licenses to grow the team. Our ARR went from ~$350k at the time of the switch to ~$4.5 million at the time of our exit only 3.5 years later. Also our cash in the bank was at its highest level at the time of our exit. It was double the cash in the bank at the time of our prior capital raise.

One word of caution is that you should focus on the word EXPERIMENT in the advice above. I am a big believer that successful startups have to constantly be experimenting. And not just with product or UX, but also with pricing, sales and marketing. Hide the monthly option on your public pricing page for a quarter. See what happens. If it works for your business, it will dramatically change your company for the better.

If you try it, let me know how it goes.