Understanding Financing Options for eCommerce Brands: Choosing the Right Fit

Understand the different providers of capital

Let's make three assumptions from the outset of this article:

• You've read our previous articles, which can be summarized by the following statement: It's a combination of strong unit economics and savvy working capital management that makes a great business. You can't do one without the other.
• Your own business has established healthy unit economics and is seeing strong demand from the market, but is subject to the working capital challenge that almost every consumer brand faces: cash is tied up in inventory for the duration of your cash conversion cycle. You'd be categorized as a "sleeping giant" as per our matrix.
• You're considering external capital providers to finance your operations and ensure you're not leaving growth opportunities on the table.

The next step is to understand the financing options available to you, so you can choose the most appropriate provider. A year-long warehouse extension project has very different financing requirements to an inventory order, for instance. Key factors to consider include the intended use the funds, the duration of the project, and the expected return on investment.

A good CFO, or whoever is managing your business's finances, should understand the true cost of different capital options. There's a give-and-take with everything. Factors like cost of capital, duration, repayment terms, collateral requirements and speed of deployment need to be considered. You need to understand your own goals and see if they align with the financing sources you want to tap.

At a very high level, capital can be separated into two buckets: equity and debt.

Equity

Let's start with equity financing. This involves raising money from investors in exchange for an ownership stake in your company. It's traditionally used to fund projects with highly lucrative, but low-probability payoffs. This form of financing has been around for centuries, dating back to the days of Magellan and Columbus. These famous explorers secured funding for their voyages by convincing investors - monarchs and wealthy patrons - to finance their expeditions in exchange for a share of the potential profits from newfound lands.

To understand this model, it can be helpful to put yourself in the shoes of a venture capital portfolio manager. Your job is to make a number of out-of-the-money bets, expecting most to fail, but hoping a select few generate asymmetric returns. Entrepreneurship is inherently risky. Most startups fail. But some become unicorns and return 100x your initial investment, helping the wider portfolio generate the oft-quoted 2.5-3x net returns target.

Now step back into your own shoes. If the venture capitalist gets a lot of "at bats" to invest in a home-run company, you're only stepping up to the plate once. That's why it's so important to weigh up your financing options carefully.

An obvious advantage of equity financing is that you don't have ongoing repayments to service. But there are downsides too. You give away a chunk of your business, which could end up being an expensive decision should your valuation soar. You spend months pitching for investment and quibbling over valuations, time that could be spent on core business operations instead. And incentives are sometimes misaligned. Your investors may push you towards the "unicorn or bust" mindset, causing decisions that are at odds with healthy financials.

Historically, venture financing has been a source of funds for companies that are not otherwise good candidates for more traditional options. Think transformational technologies like search engines, electric vehicles, renewable energy, quantum computing and space exploration. More recently, venture capitalists have broadened their scope in search of a return. Think SaaS, fintech and, you guessed it, consumer brands. At the peak in 2021, VCs invested over $5 billion into brands like Warby Parker, Allbirds and Rent the Runway. Many DTC businesses have faltered since, not because of the business model itself, but because the influx of cash caused them to overspend on acquisition costs and lose sight of profitability. VC interest has waned too, with just $140m invested in 2023 - a 97% drop from the peak. This has raised a number of questions. Are consumer brands a fit for the venture-backed model? Can brands reach the unicorn scale that venture capital investments require? Is it a good idea for brands to give away a chunk of their business, just to spend that money on inventory and paid ads?

It's the latter question that this article addresses. It proposes debt as an alternative financing option for day-to-day operations like inventory purchases or marketing spend.

Debt

Think about the earliest days of starting a consumer brand. What do you spend your money on? Developing your first product. Designing your brand. Building your website. Acquiring your earliest customers. In a sense, these are speculative investments. There is no guarantee that your product will be well-received by the market. You may not recoup that investment.

But now let's assume those initial investments pay off and a viable business starts to emerge. As your brand gathers momentum, your cash flow profile becomes more predictable: Use $X to purchase inventory. Run ads with a budget of $Y. Generate a return of $Z. Let's label this an "inventory cycle".

As we've covered extensively in previous articles, these inventory cycles are cash intensive for growing brands, so how should you finance them?

Of course, you could wait for a cycle to end, claw back some profits, and grow incrementally. But if you're a growing brand seeing strong demand, you should consider debt as an option to fund this growth.

Generally speaking, equity can be thought of as risk capital, and debt as operating capital. If you're embarking on a project to develop a category-defining product, this is a speculative investment. It could indeed deliver groundbreaking results for your business, but it's not clear when it will generate cash returns, so equity financing might be most suitable because it doesn't require near-term repayments. For an established product with existing demand, more predictable returns and clearer timelines, debt might be a better option to provide short-term working capital for the duration of your cash conversion cycle. Debt works for businesses that are likely to generate near-term cash flow, enough to cover the repayments and principal amount at the very least.

Debt is a broad term, so now consider some different forms of debt that a consumer brand might opt for:

Asset-Backed Loans (ABLs)

You get access to capital, but it's secured against reliable asset collateral. The amount you can access is typically a percentage of your assets, known as your "borrowing base". Let's say you provide collateral worth $1mn, and the ABL provider extends to a facility of 50% of your borrowing base, then you have a $500k debt facility to draw on.

For a "typical" business, this is more straight-forward. For instance, a manufacturing company might secure the loan against their warehouse facility or machinery. But for a consumer brand running an asset-light business, providing sufficient collateral can be difficult. The bank may want to secure against your inventory, which creates a chicken and egg scenario. As a growing brand, you're turning over inventory rapidly, so you need cash to replenish your stock. But running low on stock reduces your asset base, meaning you can borrow less.

The collateral requirements reduce the risk profile of this arrangement for the lender. Should you default on your debt repayments, the ABL provider can seize your assets. As a result, ABLs can provide some of the lowest interest rates on the market when quoted on an APR (annual percentage rate) basis. You should be wary of hidden fees, though. Closing fees, monitoring fees, termination fees and warrants cause your blended cost of capital to creep upwards.

Term Loans

Term loans are what many would consider the "traditional" financing option. You receive a sum of cash (principal) and pay it back, plus interest, over an agreed period of time, often 18-24 months.

From an APR perspective, this can be a very good option, provided the project you're financing aligns with the duration of the loan. If you're financing an extension to your warehouse, for example, it makes sense to pursue a loan that spans a longer timeframe. However, for consumer brands using term loans to fund short-term inventory cycles, it can be worth considering more than the quoted APR alone. To finance your operations efficiently, you want to avoid paying interest on cash outside the timeframe it's needed. But term loans can sometimes create mismatches like this.

Suppose your cash conversion cycle is 6 months long and requires working capital of $200k. You secure an 18-month term loan of $200k at an APR of 14% to finance this. If you crunch the numbers, this works out to be eighteen monthly repayments of $12,383 each, and a total interest expense of $22,895.

But here's the thing. Most of these repayments happen after you've already purchased and sold the inventory, so there's a timing mismatch that could wreak havoc for your cash flow. And perhaps more importantly, your ability to secure further financing might be hampered if providers are put off by a facility that's still outstanding.

Had you opted for a shorter term (i.e., 6 months), the quoted APR would likely increase due to the tighter timeframe, but the total interest expense could reduce. For argument's sake, let's compare the above to a 6 month term loan at a 25% APR. You'd need to have sufficient cash flow to cover the six monthly repayments of $35,800, but the total interest expense would reduce to $14,830.

Another common scenario is brands taking a lump sum upfront (e.g., in Jan) to plan for expected cash outlays down the line (e.g., an inventory cycle in June). They recognise that traditional term loans can take weeks and months to secure, so don't want to endure that hassle during busy season. But in these instances, you're holding cash you don't need, and paying unnecessary interest charges as a result.

Term loans can create timing mismatches, where you either hold cash you don't need upfront or continue repaying long after the intended use case has ended. It's important to keep this in mind.

Purpose-built, fixed fee financing

A crop of purpose-built financing solutions have emerged for consumer brands in recent years. Wayflyer's fixed fee financing is leading the charge here.

Had traditional financing options been suitable for consumer brands, these alternative providers mightn't have entered the space. But traditional options have a number of shortcomings that needed to be addressed:

• It can take weeks or months to secure financing.
• Terms are often inflexible and misaligned with how your business operates.
• You need to provide extensive collateral and sign personal guarantees.
• You sometimes give up a chunk of equity in exchange for financing.
• And all of the above assumes you can access financing in the first place, which many brands can't because they're too nascent or can't meet the extensive requirements.

These shortcomings are especially pertinent for short-term operating capital. Of course, traditional debt and equity options have their place in the financing stack. But for instances where you need fast access to cash to invest in discrete opportunities with a contained timeframe and a predictable cash flow profile, it's worth turning to modern financing partners. What's a good example of this? You guessed it: the inventory cycles we've mentioned throughout this article.

This is a fast-moving space. Growth opportunities come and go. Your financing provider must be able to keep up. That's why Wayflyer is modernising how consumer brands finance their operations, with a purpose-built financing offering that:

• Can send you funds in as little as 24 hours.
• Tailors offers to align with your inventory cycles.
• Quotes a single fixed fee, with no hidden costs.
• Doesn't take equity in your business.
• Isn't secured against your assets.

Our mission is to put the best products in the hands of more people worldwide. Using the proprietary technology we've built, we can assess the financial health of brands in minutes and back those who are primed to grow with our unique financing offering. We form long-term relationships and provide ongoing access to short-term cash injections.

So to revise our statement from earlier articles: it's a combination of healthy unit economics and strong working capital management (supported by a purpose-built financing partner) that makes a great business.

Does this sound like you? The next article outlines some factors to consider when determining how Wayflyer can fit into your financing stack.