Finance

Why every eCommerce company should use revenue-based financing

Friday

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May

15

Tough working capital cycle

eCommerce companies have an inherently difficult working capital cycle. They have large upfront costs in inventory and marketing (typically Pay Per Click marketing costs), which they turn into revenue over relatively short cycles. This is driven by the lack of credit available from factories (especially in the Far East), with inventory requiring part payments on order, shipment, and final delivery a typical payment schedule for products.

This stress on working capital is accentuated at peak periods of the year (Thanksgiving, Christmas, Summer Season Launch, etc.), where both inventory orders and marketing spend are significantly (and concurrently) larger than at other periods in the year. These are also the times of year where companies need to back themselves and make sure they are prepared to take advantage of the increased demand.

For fast-growing companies, this working capital stress is emphasized as you are continually trying to make larger inventory orders to meet the increased demand, and we all know that the worst thing that can happen to a company is to run out of a product and leave sales/profits on the table.

Unloved from a financing perspective

eCommerce companies tend to be unloved from a financing perspective. Banks don't want to have anything to do with them as they don't typically have any assets outside of inventory, and Venture Capital funds tend to avoid investing in individual e-commerce companies. While they still invest in the sector, they tend to focus on companies that are making eCommerce easier, such as logistics, customer service, payments, analytics tools, marketplaces, and new D2C models such as renting/second-hand platforms.

Wayflyer was created to fill this white space. From our experience, most eCommerce companies rightly tend to focus on being profitable on every transaction (subscription companies having a stronger focus on LTV). They also tend to be run by business people, who have a much better grasp of the financials of their marketing machines than financial institutions give them credit for.

High Gross Margins

The D2C model, which is prevalent today, allows eCommerce companies to maintain robust gross margins. Therefore, most of these companies' main focus should be to acquire new customers and find ways to retain those customers in the long-term.

For the first part, while of course, one needs a good product, a company's marketing talent is the secret sauce, which more often than not, is the differentiator between success and failure. Pay per click channels allow companies to reach a wide range of audiences, and those who can appeal to their desires/personas can grow quickly. Marketing quality is why we see such varying levels of success between companies with almost identical products.

Why are high Gross Margins relevant

In a typical D2C company, the Gross Margin before advertising costs is typically around 60% of revenue, and advertising costs tend to make up 10% - 20% of total revenue in the company (potentially larger if the company is early-stage or focused on subscriptions).

Assuming these figures are in the ballpark for your company, you have a Gross Margin after advertising costs of 40% - 50%. So we can establish that Gross Margin percentages aren't the issue for your company. Growing revenue and meeting your business's working capital needs are the most important issues for business owners to focus on.

Given how strong the gross margins are, using debt to fund your marketing spend throughout the year makes a lot of sense, and the impact of interest in your P/L is tiny compared to the advantages of having access to that cash.

Even if, by taking on debt, the Gross Margin % after advertising costs go down to 30% - 45% (Not miles away from the 40% - 50% you were at pre interest), you're now on your way to solving your working capital issue, as that capital you were going to spend on marketing, can now be spent on additional inventory and other business costs, while you spend the capital you took on in marketing. This way, you can focus entirely on growing your revenue.

Thankfully there are lenders out there who will happily look at your historical performance, forecast your revenue into the future and take the risk that you will be able to generate $X in sales by providing debt to an early-stage e-commerce company (Wayflyer, for example).

At the end of the day, in early-stage businesses, if you can service the cost of debt (which eCommerce's margins comfortably do), then you should grab it with both hands rather than giving away equity while you are growing quickly or bootstrapping and sacrificing growth.

Be smart; just use the funding for peak periods in the year

As an industry, eCommerce has a spiky revenue profile, made up of many seasonal peaks throughout the year. And it is coming into these spikes that the working capital profile is at its worst (We have to pay for large deliveries and marketing costs in advance). We know we will sell out the stock coming in, but we need to find a way to fund the cashflow dip we are currently facing before finding ourselves flush with cash post-peak season, including the additional profits you've made during the season.

If you use debt to fund your marketing spend through just these peak periods, then you have more money for inventory and can take advantage of the peak period by spending more $'s on marketing than you had planned and grow your revenues when it matters most.

Time to lay off the lenders

Short term SME Lenders (yes, ourselves included!) get a hard time for charging what in theory are very high annualized equivalent interest rates. The main reason for this is because they are only funding you for peak periods in the year. Traditional banks love getting a customer and funding them for years and years. They are the bank's most profitable customers.

However, as those in e-commerce should know better than anyone, there are reasonably high customer acquisition costs associated with getting a new customer (Pay Per Click Marketing Costs), and then there are the additional chunky lender costs associated with onboarding new customers (bank statement processing, bank transfer fees, payment fees, and employee time for processing). Additionally, unlike a traditional lending model where these costs happen once at the start of a multi-year term, these costs are incurred every few months as these lenders move from one customer to the next.

In the long-term, that is why returning customers get better rates on second and third advances (We too know the value of returning customers – high LTV!).

The Summary (& the Pitch!)

Gross Margins aren't the problem for eCommerce companies, and marketing is the secret sauce. So stop spending your time completing application after funding application, come to us at www.wayflyer.com and get funding in 48 hours so you can focus on optimizing your online campaigns and growing your total revenue.

Oh, and I forgot to mention, our data science team is made up of marketing analytic experts/nerds who want nothing more than to provide you with advice on how to optimize your campaigns. And yes, this is all free. When you've signed up, you'll get access to our analytics platform and team of experts. We're here to help you as your success is our success, and the more efficient you are, we can better finance your growth!