Many aspiring founders believe the first step in starting a business is raising money. They spend months writing pitch decks and meeting investors, often without a single paying customer. Most are turned down. Meanwhile, founders who focus on winning customers and proving their business model often find investors approaching them.
There is a saying in start-up circles: capital chases those who don’t need it. Investors want to back businesses that have already shown that customers want the product and that each sale can be profitable. Once that evidence exists, money becomes far easier to raise, often on better terms.
This article explains why proving unit economics comes before raising capital, illustrates the point with the early history of a large hotel network, describes ways to start with little capital, and sets out ten questions for choosing between debt and equity when you do need funding.
A case study: proving the first hotel
The founder of what became one of the world’s largest budget hotel networks has described how he spoke to many investors early on and received little interest. The idea of partnering with small, independent hotels to offer standardised budget rooms sounded interesting, but unproven.
Instead of continuing to chase investors, he focused on making the model work in one hotel. He improved room quality and photography, changed harsh white lighting to warmer lighting, added Wi-Fi and free breakfast, and improved the hotel’s listings on travel booking websites. The hotel moved from the bottom of the search results to the top. Its occupancy rose from about 19% to around 90%, and its monthly income increased several-fold.
The business earned a share of that improved revenue as a commission. After covering its own overheads and marketing, the single hotel was profitable. That changed everything. Hotel owners wanted to join, and investors could see that the model worked at the level of a single unit and could be multiplied. One venture firm invested early. Within months, after the model had been extended to a handful of hotels, other investors that had previously hesitated were competing to invest.
The lesson for any founder is to prove that the business works at the smallest scale, one customer, one location or one product, before seeking growth capital.
Unit economics: the evidence investors want
Unit economics describes the revenue and costs associated with a single unit of the business: one customer, one order, one location, one machine or one product sold. Key questions include:
- How much revenue does one unit generate?
- What are the direct costs of delivering it?
- What does it cost to acquire one customer?
- How much margin does each unit contribute to overheads and profit?
- How long does it take to recover the cost of acquiring a customer or opening a location?
When unit economics are positive and predictable, growth means multiplying a profitable unit. Investors can see how their money will turn into returns. Short-term losses from hiring ahead of growth become acceptable because the long-term model is sound.
When unit economics are negative, growth multiplies losses. No amount of investment fixes that.
Starting with little capital
Founders without large savings or investors can still start, by being creative about resources.
Partners as investors
Your first landlord, first supplier, first key employee and first customer are all investors of a kind. They commit resources to you on trust. Rather than paying for everything upfront, consider arrangements that share risk and reward:
- Revenue or profit sharing with asset owners. A restaurant, building or shopping centre owner with unused space might share in revenue rather than charge full rent upfront.
- Partnership with skilled people. If you plan a food business but are not a chef, bring in a skilled chef as a partner or co-founder with a share of profits, rather than hiring one on a full salary from day one.
- Supplier terms. Negotiate trade credit, consignment stock or deferred payment with suppliers who believe in your growth.
These arrangements require a credible plan and the confidence to propose them, but little cash. Put them in writing, with clear terms.
Customers as investors
Customers are often the best and cheapest source of funding. Pre-orders, deposits, subscriptions paid in advance, advance payments on custom work and crowdfunding campaigns all bring cash in before costs are incurred. This also validates demand: customers paying in advance is stronger evidence than any survey.
Prove, then raise
Once a first unit is profitable, it becomes much easier to attract modest investment to open the second, third and fourth. Each proven unit increases confidence, and the value of the business grows.
When you do need funding: debt or equity?
Eventually, most growing businesses need external funding to expand, enter new markets or invest in equipment. The two main sources are debt, meaning loans from banks and other lenders, and equity, meaning selling a share of ownership to investors. Ten questions help decide which suits your situation.
1. How predictable is your cash flow?
If your business generates steady, predictable monthly cash flow, debt is feasible, because repayments can be met. If cash flows are uncertain or will only come after years of development, equity is more suitable, because investors share the risk and do not require fixed repayments.
2. How profitable is the business?
High margins generate cash to service debt. Low or uncertain margins make debt risky, because a cash shortfall could make repayments impossible.
3. What does each source cost?
Debt is generally cheaper than equity. Lenders receive a fixed return (interest) and take less risk. Equity investors take more risk and expect higher returns through a share of the business’s growth. Giving away ownership in a business that becomes very valuable can cost far more than interest ever would.
4. Do you have collateral?
Banks typically require security, such as property, equipment or personal guarantees, often worth more than the loan. Without collateral, bank borrowing is difficult. Equity investors invest on the strength of your plan and team, without collateral.
5. How much risk does the funder take?
Lenders reduce their risk with collateral and priority in repayment. Equity investors have no collateral and are repaid only if the business succeeds. That is why equity is more expensive.
6. How much ownership and control are you willing to give up?
Debt does not require giving up ownership: you repay the loan and keep the business. Equity means sharing ownership, and often some control. Investors may require board seats, information rights and approval of major decisions.
7. What returns does the funder expect?
Debt returns are fixed by the interest rate. Equity returns vary: investors may lose everything or earn many times their investment.
8. Does the funder share in the upside?
Lenders do not share in your success beyond interest. Equity investors share fully in growth, which is their motivation and your cost.
9. How does the funding affect growth?
Debt repayments draw cash away from growth. Equity provides capital without repayments, allowing the business to invest for several years. As the business grows in value, it may attract further investment, and early investors may exit.
10. How much can you raise?
Borrowing capacity is limited by income and security. Lenders generally limit total repayments to a portion of your cash flow. Equity capacity depends on growth potential, so a fast-growing business can raise multiple rounds. Building an equity base also strengthens the balance sheet, making lenders more comfortable to lend.
Summary table
| Factor | Debt | Equity |
|---|---|---|
| Best for | Predictable cash flow, assets to secure | Uncertain or delayed cash flow, high growth potential |
| Cost | Lower | Higher |
| Collateral | Usually required | Not required |
| Ownership | Retained | Shared |
| Repayment | Fixed schedule | None, investors share in value |
| Funder’s upside | Interest only | Share of growth |
Preparing to raise money
When the time comes to seek external funding, preparation makes a large difference:
- Know your numbers: unit economics, margins, customer acquisition cost, lifetime value, cash flow forecasts and break-even point.
- Clean up the basics: up-to-date accounts, clear company structure and ownership, signed contracts and protected intellectual property.
- Show traction: customer numbers, revenue growth, retention, pipeline and testimonials.
- Be clear about the ask: how much you need, what it will be used for and what milestones it will achieve.
- Understand the funder: lenders focus on repayment capacity and security, while equity investors focus on growth potential, the team and how they will eventually realise a return.
- Choose partners, not just money: good investors and lenders bring advice, networks and patience. Bad ones bring pressure and conflict.
Funding mistakes to avoid
- Raising too early, giving away large stakes at low valuations before the model is proven.
- Raising too little, running out of money before reaching the next milestone.
- Taking debt for uncertain ventures, creating repayment obligations the business cannot meet.
- Personal guarantees without understanding the risk to your home and assets.
- Mixing personal and business finances, which complicates funding and accountability.
- Ignoring dilution: multiple equity rounds can reduce founders’ ownership more than expected.
Frequently asked questions
What if my business genuinely needs capital before it can sell anything? Some businesses, such as those requiring regulatory approval, specialised manufacturing equipment or long research and development, cannot easily prove unit economics without funding. In those cases, reduce risk in other ways: validate demand through letters of intent, pilot agreements or pre-orders, use grants and research partnerships, build prototypes cheaply and raise funds in stages tied to milestones.
How much equity should I give early investors? It depends on the amount raised, the stage and the valuation. Many founders aim to keep enough ownership to stay motivated through several future rounds. Get advice and compare offers.
Is bootstrapping always better? Not always. Self-funding preserves ownership and discipline, but slow growth can allow competitors to take the market. The right choice depends on the opportunity, competition and your personal goals. Many founders combine approaches, bootstrapping until the model is proven and then raising capital to accelerate growth.
Funding options in Australia
Australian businesses can access a range of funding sources, including:
- Bank and non-bank loans, equipment finance, invoice finance and overdrafts.
- Government programs and grants at federal and state level for specific purposes, such as research and development, export, manufacturing and regional growth.
- Angel investors and venture capital for high-growth businesses.
- Crowd-sourced equity funding, a regulated regime that allows eligible companies to raise capital from many small investors through licensed platforms.
- Tax incentives for investors in eligible early-stage innovation companies, and the research and development tax incentive for eligible R&D activities.
- Customer funding through deposits, pre-orders and subscriptions.
Each has conditions and costs. Get advice from an accountant or financial adviser before committing.
A worked example
Two founders plan a business offering refurbished industrial equipment. Rather than raising capital to buy a warehouse full of stock, they partner with a manufacturer that has surplus machines, taking them on consignment and splitting the margin on each sale. They refurbish the first machines in a leased bay, take deposits from buyers before completing refurbishment, and track margin per machine, time to sell and customer acquisition cost.
After twelve months, they have sold forty machines at a healthy unit margin, built a waiting list of buyers and proven their refurbishment process. They then approach a bank for an equipment finance facility, secured against stock, to buy machines outright at better prices. A year later, an investor offers equity to fund expansion into a second state. The founders compare the offer with additional debt, consider their cash flow predictability and ownership preferences, and choose a mix of both.
Summary
Capital chases businesses that have proven customers and unit economics. Prove that one unit, whether customer, location or product, is profitable before chasing growth capital. Start with little cash by partnering with asset owners, skilled people, suppliers and customers. When you need funding, weigh debt and equity against cash-flow predictability, profitability, cost, collateral, risk, ownership, returns, upside, growth and capacity. Customers remain the best investors of all: their money validates the business and costs nothing in ownership.
Sources: small-business training notes on chasing customers rather than investors, including the early history of an Indian hotel network as told by its founder, and on choosing between debt and equity, adapted to Australian funding options. This article is general information, not financial advice.
