Revenue-based finance vs. equity financing: Why 11 eCommerce brands chose revenue-based finance
August 6, 2022
Launching your own business isn’t just difficult, it’s risky. When small business owners face a financial obstacle, 62% of them dip into their own personal funds to help them overcome it. But risking personal assets for a business venture is rarely the best option. That leaves one alternative: funding.
Deciding what type of funding is the best for your business is a big decision. One option that many young eCommerce businesses may consider is equity financing, which sees a business sell stock in the business to get capital. Increasingly, however, eCommerce is turning to revenue-based funding, a type of financing that gives businesses access to working capital.
So, why do eCommerce founders choose revenue-based models over equity financing?
We surveyed some leading names to answer that very question. There were a few recurring reasons that drove their decisions: their businesses were growing, they needed fast access to cash, and equity financing was too dilutive.
The business was ready to grow
Growing demand is a great indicator that an eCommerce brand’s hard work is paying off. And according to Daniel Richards, founder and managing director of D-STILL, access to working capital was a natural fit for accelerating this success. He says:
“Revenue-based financing just made sense for us. We are a business that is experiencing growth year on year, and our biggest challenge was purchasing stock without impacting our cash flow.”
As an eCommerce business grows, so does its customer base and demand for its products. To meet this demand, the brand needs to buy greater volumes of product. Typically, manufacturers and suppliers require their customers to pay for their orders up front, or at least pay a deposit.
Many eCommerce businesses will need to buy more stock than their current profits allow. And if products take a long time to manufacture, the brand will need to finance its purchase on an even tighter timeline to ensure products are in stock by the time a customer places an order. Brendan Copp, director at Slime Pop, explains:
“It allowed me to order more stock in advance; this is especially useful considering many of our products have long lead times from international suppliers. It’s also great for cash flow.”
An expanding business also needs to invest in efforts that support its growth, such as expanding the team to accommodate the greater volume of inventory or marketing to help drive sales. But scaling operations to match business growth requires a brand to pay for these investments before sales translate to profits. This presents a problem: how does an eComm business pay for its growth when current profits don’t match the price tag? Dan Wilkins, director at CAPO, says access to working capital helped solve this cash flow problem:
“[Revenue-based funding] seriously fast-tracked our growth by providing capital for much higher stock levels, which in turn allowed us to increase advertising and sustain much higher sales levels. Furthermore, [it] allowed us to expand the range and carry higher quantities of existing bestsellers.”
Chi Yau, CEO and co-founder of FuelRod, echoes the sentiment:
“Wayflyer provided us with the working capital to fuel the growth of our business. The funds are being used to purchase additional inventory, to launch new marketing campaigns, and to expand our operations team.”
They needed fast access to capital
Smart founders focus on learning how to best run the organisation and guide its long-term success. They actively think about ways to innovate and pay attention to what is happening in their industry. Keeping a keen eye out for circumstances that are particularly favorable to the business allows them to recognise and respond to new opportunities — but only if they can afford the costs involved.
Will Kennedy, co-founder and CEO of Sons, says revenue-based financing enabled Sons to do exactly this:
“We launched at the start of 2020. In any business, you spend the first months/years understanding market dynamics and opportunities. Wayflyer allowed us to capitalize on market opportunities as we saw them — month to month.”
When opportunities arise, a quick response is vital. A business that reacts too slowly will lose opportunities to the competition, reducing its potential for profit. And this extends beyond just online retailers. eCommerce brands can only respond quickly if their suppliers are ready for them. Manufacturers and suppliers need to respond just as quickly as their retail customers if they want to retain their loyalty.
For example, fashion trends, and consequently the items consumers want to buy, are constantly changing. As online retailers attempt to cater to fluctuations in demand, they’ll turn to suppliers, expecting products to be available and ready to ship when they place an order. The suppliers that are prepared to meet this demand are the businesses that maximise profits.
This requires suppliers to acquire stock well before any customers call. They’ll have to pay for everything up front, then wait for orders to come in before they earn a profit. Rachel Heather, CEO of Live Unlimited London, says revenue-based finance helped Live Unlimited London overcome this hurdle:
“Our biggest challenge was to fund stock when customer payments were significantly later. [Revenue-based] enabled us to stock more and grow our business quicker.”
Ongoing supply chain issues further complicate things by causing shipment delays that extend already long lead times. But eCommerce brands still need to react fast to meet customer demand. Eddie Li, director of operations at Injoya, explains that revenue-based financing enabled the brand to “buy more inventory to deal with the current highly volatile global supply chain situation.”
Along with stock, suppliers have other expenses, including labor, web hosting, and warehousing, that they need to account for to keep operations running. But covering these costs is difficult when capital is tied up in inventory. According to Dominic Day, co-founder of fourfive:
“[Revenue-based finance] is extremely useful for us to cover shortfalls in cash flow when we get big orders from retailers. We need to order bulk stock that can be expensive and dent our cash flow for a number of months.”
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Equity financing was too time consuming and dilutive
Equity financing is difficult and time consuming, delaying your access to capital and distracting from other business operations. According to Andy Fine, founder of Sartoro:
“[Revenue-based financing is] a faster solution. Raising equity capital takes significantly more time and effort. For a smaller team, we need all our effort focused on driving the business forward, not on raising money.”
Additionally, revenue-based financing allows entrepreneurs to retain full ownership of their businesses, as equity-based financing requires founders to make concessions that aren’t always worthwhile. James Higgins, founder of Ethical Bedding, opted for revenue-based financing because he felt that relying on a venture capitalist compromised the “value of the brand” by forcing him to sell equity at a lower price than it would have been worth in the future. Additionally, VCs often have additional requirements a brand must meet to receive funding.
Eddie Li, director of operations at Injoya, also has prior experience raising equity to fund his business. And in his experience, the demands of funders don’t always align with what’s best for the business. He says:
“Equity funders will always influence the company’s decisions toward more profits at the expense of the company’s long-term growth.”
That’s because once funders invest in a company, they anticipate that their investment will result in an exit. This puts pressure on the brand to succeed and grow based on the expectations of its VCs. With so much focus on earning profits for investors, the company won’t have the same level of flexibility to experiment with new ideas or take risks. Brendan Copp, director at Slime Pop, says:
“I felt access to capital without giving up ownership is a great first step; especially with an early-stage startup, if you’re validating an idea, it’s a much simpler and faster option.” Zach Manley, CFO of Braxley Bands, says retaining ownership is valuable for maximising a business’ value:
“As a small business, you cannot afford to give away large sums of equity to finance operations; it should be reserved for strategic growth in areas not yet matured. With revenue financing, we are able to expand our product line and grow revenue, ultimately increasing equity value, without selling equity.”
Drive success with financing that caters to eCommerce
eCommerce brands have unique financing needs. Without assets to borrow against, online businesses must put up their own business as security when they seek funding.
While selling equity to raise capital may seem like a good way to finance operations while minimising debt, the long-term costs can still have severe impacts on a business. Revenue-based financing is the only model that meets eCommerce’s unique financing needs to accelerate business success.
How you choose to finance your business has a direct impact on its growth and long-term success. Schedule a call to explore what revenue-based financing looks like for your business.