Navigating the cash flow ebbs and flows generated by having to fund inventory orders upfront while investing continuously in digital marketing is one of the toughest challenges for all DTC brands to navigate.
That leaves brands in a position where, depending on which point of their cash flow cycle they are, they may not be able to capitalize on opportunities, whether in the inventory purchasing end or in advertising, particularly around peak demand times.
To get out of that dynamic, eCommerce brands use a variety of financing products. This article is a summary of the most popular ones.
Bootstrapping is still the number one method of financing for early-stage eCommerces, not just because it’s relatively easy to access and non-dilutive, but often because it is the only way for unproven brands to get their start.
Although in the current landscape, returns of most cash deposit products are meager, this may seem like the way to go, it comes with serious risk of losing your capital, since anywhere between 80% and 97% of eCommerce brands fail within five years.
Also, what happens if you don’t have any savings you can tap into?
Friend and Family… and fools
The old startup tradition says that your first equity round is to ‘friends, family, and fools’. Family and friends because they love you and want you to succeed. Fools because the risk-adjusted returns of seed round funds are much lower than Series A and B investors. And your loved ones are no different.
Although this may be an excellent way to access cash at a fair valuation, it can severely strain the relationship.
One of the quickest ways to access funds is credit cards, particularly if you and your partner have many. According to Gallup, the average American has 3.7 credit cards.
Now, the APRs on these credit cards are exorbitant and can put you in severe personal risk if your eCommerce brand happens to fail. Additionally, when you have into account the lag time between when you first make a down payment on inventory with your credit card and when you sell that inventory, you see that there is no chance you can cover minimum payments, which makes having to pay that interest a practical guarantee.
Small Business Association loans are widely used in the US. In Europe, you have European Union funding grants and loans. Both are designed to support small and startup businesses, with friendly conditions and relatively low interest rates.
The process of applying and getting one of these loans, however, is incredibly time-consuming. A large amount of paperwork is required, including business plans, revenue forecasts, and feasibility studies that most startup businesses do not have. Most eCommerce brand founders do not want to have to spend the time writing.
Revenue-based financing and MCAs
Interest in MCAs (merchant cash advances) in eCommerce has increased dramatically in the past few years as a form of unsecured funding for eCommerce.
Although in the past, MCAs have had high equivalent APRs (to offset the risk of unsecured financing), now, MCA providers have gotten a lot better at assessing the risk profile of the brands taking on that capital, thus being able to offer much better equivalent rates.
For example, at Wayflyer, we utilize AI, as well as your merchant (Shopify, Magento, etc.), advertising (Facebook, Google), analytics, and banking data to forecast future revenue and cash flow. That way, we can assess real risk and offer rates much lower than most lenders.
Put on a suit, go to your local bank, pitch them on your big idea for your brand, and what do you usually get? Nothing. Most banks see early-stage businesses as too risky to lend, mostly for two reasons: one, new companies are all, by definition, riskier than ones with a track record of performance, and two, horizontal lenders do not have the technology required to assess risk when it comes to eCommerce properly.
Now, even when you do come in with a solid track record, and they approve you for a loan, you can expect interest rates to be in the high teens. Not only that, but personal guarantees are also required, so weight the risk vs. the reward when engaging banks.
DTC eCommerce brands are an underrepresented part of VCs portfolios, since they much prefer to bet on tech companies that service the eCommerce space (think Klarna, Klaviyo, even Shopify) whose growth is tightly adjusted to the growth of eCommerce as a space, more than in specific brands.
Troubled IPOs like that of Casper this year have not helped increase VCs appetite for this type of deals.
Additionally, raising venture capital comes with the disadvantage of dilution, which is the last thing you want to do early in your brand’s existence, when most of your growth is ahead of you.
Sites like Indiegogo and Kickstarter have been the launching pad for many eCommerce entrepreneurs. However, the fact that they hold on to your funds long after the round has been completed is not the most efficient thing for an agile brand.
Also, crowdfunding sites charge considerable fees, between 5 and 10%, and the remainder is technically considered revenue, so you can and will be taxed on it. Additionally, you run the risk of losing the fund if you cannot meet your fundraising goals.
Regardless of the direction you choose to go, make sure you weigh the pros and cons and get an understanding of the obligations that come with raising cash.
Our opinion is that merchant cash advances are the best method of capitalizing eCommerce brands for several reasons:
- They don’t require personal guarantees
- Equivalent APRs are quite competitive with the right partner
- Time to funds is relatively short compared to other methods of financing
- DTC brands have gross margins big enough to accommodate the repayments easily
- No interest, pay as you earn
That’s all we do at Wayflyer, so if you plan to raise some debt to grow your brand, we would love to talk to you.