Equity Financing for ECommerce Businesses
April 25, 2023
When business owners need external financing to boost their cash flow, they often turn to loans. While loans are a good option for certain types of businesses, they aren’t the only solution out there. Loans often have difficult qualification requirements, high interest rates, and tough repayment schedules. What’s more, traditional loans are not always feasible for startups and small businesses. ECommerce businesses in particular may find it difficult to obtain loans. That’s where equity financing comes in.
Equity financing gives you access to capital in exchange for minority shares in your business. It’s a great way to raise funds without going into debit or paying compounding interest. Read on to learn what equity financing entails, all about types of equity financing, and the pros and cons of this type of eCommerce financing. Then, you’ll be able to determine if this funding option is right for your business.
In this article:
- What is equity financing?
- Why equity financing is a good option for eCommerce businesses
- Types of equity financing
- The pros and cons of equity financing
- An alternative to equity financing
Equity financing is the process of selling minority shares of your company to investors in exchange for the capital you need now. The investors share in your profits, which means that they’ll take a cut according to their percentage of ownership. This gives you access to funding without accruing debt. You also won’t have a fixed time period in which you need to pay back your investors, taking the pressure off your wallet.
It’s important to remember that while the investors receive a share of the profits, they’ll also suffer from any losses you incur. Therefore, equity investors will carefully choose which companies to invest in, and will likely demand a say in business operations. Many investors will want an active role in running your business and the decision-making process, so be careful who you decide to sell shares to.
Once the investor no longer wishes to draw shares from the business, they will sell their shares back to the owners or other investors, and no longer draw from the profits.
Due to the nature of eCommerce, online sellers struggle with traditional loans. They may not have the high credit scores needed to obtain low interest rates on loans or high-value assets to use as collateral. In addition, many newer businesses and startups don’t have the history required by many banks and lenders and haven’t yet produced enough revenue to qualify for other forms of eCommerce funding.
Another challenge that eCommerce businesses often face is seasonality and fluctuations in demand. This makes it difficult to stick to a fixed repayment schedule with high monthly payments.
Equity financing removes many of these obstacles. Equity investors are interested in opportunities that show the potential to generate profits. This often takes the form of new, innovative business ideas backed up by market research and accurate forecasting. Therefore, eCommerce businesses are often a great fit for equity investors looking for the potential for future growth and profitability.
Securing equity financing may seem like a complicated process, but with the proper planning and forecasting, it is attainable for many startups and small businesses. ECommerce businesses have an advantage too, thanks to the surge of online shopping in recent years. There are now plenty of investors who are excited about the opportunity to invest in eCommerce.
There are several different types of equity financing, from individuals with personal wealth to large investment firms looking to boost the small business economy. Different types of equity investors benefit businesses at various stages of growth, and with a wide range of needs. Here are some of the most common types of equity financing that you can use for your eCommerce business.
Angel investors are individuals with personal wealth that invest in startups and small businesses. These investors evaluate your request for capital based on your business plan, industry, the product or service you sell, costs of manufacturing or obtaining inventory, business expenses, and assets. The angel investor will also evaluate the market trend and your forecasts to determine your potential for profit.
In order to obtain capital from an angel investor, you’ll need to pitch them your business idea. Your pitch should be well thought-out and complete with a detailed plan, forecasts, and timelines. You’ll offer them a percentage of ownership in your company in exchange for capital. If the angel investor accepts your offer, they will fund your request for capital and draw a percentage of profits based on their ownership. They may also bring their own expertise and experience into your business, which can be a benefit in the long run.
Venture capitalists, like angel investors, provide capital in exchange for a percentage of ownership in your company. Unlike angel investors, who are individuals with money to spend, venture capitalists are firms, or companies, that make a business out of investing in startups or smaller businesses.
Typically with venture capital firms or angel investors, the investor is taking on a lot of the risk. In the event you do not make profits, they don’t get their cut either.
As part owners of your business, angel investors and venture capitalists often play a role in management and decision-making. They are also able to provide resources, such as business management experience or connections through their network that can help both you and them elevate your business.
Initial public offering (IPO)
If your business is well established, you can choose to raise capital through IPOs, or initial public offerings. This is a method of raising funds by making your company public on the stock exchange and selling shares to the general public.
IPOs provide you with the capital you need through the sale of these shares. Investors are incentivized to purchase shares because if you produce profits, they’ll get a percentage based on how many shares they own. They also take on the risk of your business not succeeding.
Limiting the amount of shares you release to investors ensures you maintain majority ownership in your company.
Crowdfunding is the process of obtaining smaller amounts of capital from a variety of sources, usually through online contributions. Equity crowdfunding is a type of crowdfunding in which your investors receive a minority share in your business in exchange for their investment.
A number of investors provide you with capital until you reach your capital goal. These investors are granted minority ownership in your company and will reap the reward of their share of your profits. However, the investors will also share in your losses in the event you are unable to produce revenue.
As with the above equity financing opportunities, it’s important to limit the amount of shares available in your company so that you maintain majority control.
Hybrid equity and debt financing
Not all equity financing options are created equal. In some cases, the lender can convert debt into equity. Usually this means you will make flexible repayments, but should you fail to pay, your company becomes equity and the lender takes control of the business. Whether this means the lender sells off your business or continues drawing profits is based on the terms of your agreement.
Many eCommerce businesses will consider mezzanine financing as an in-between type of financing. It falls somewhere between debt financing and equity financing.
Mezzanine financing is when a lender provides capital and then proceeds to take their payment based on a percentage of your revenue and cash flow. This type of financing is actually calculated as equity, so you don’t have to claim it as debt. Since this type of loan does not reflect debt, it does not inhibit your ability to take out additional loans. However, it’s classified as modified-equity, so if you default on the financing, the lender can take ownership of your company.
Like any form of funding, equity financing has benefits and drawbacks. Before choosing a funding solution for your business, it’s important to compare and contrast equity financing with other funding options.
Benefits of equity financing
- Fast capital. Many investors will provide capital relatively fast. The investor will review your industry and business model while doing their own due diligence to analyze the risk of their investment in your business. Once you meet the specific equity financing criteria, and the investor has made their decision to finance your business, you can be funded within 24 hours.
- No credit check required. One of the benefits for startups and newer small businesses is that equity financing does not necessarily require good credit or a credit score to qualify at all. Your ability to perform in the market and bring in revenue (for small businesses) and market demand (for startups) mean more to the investor than your credit score.
- No collateral required. Unlike secured loans, such as traditional bank loans, equity financing does not require that you have valuable personal assets to cover the cost of the loan should you end up in default.
- No fixed monthly repayment. Instead of fixed monthly payments, you pay out dividends based on the investor’s ownership in the company. Therefore, you don’t have a specific remittance you have to meet every month. This is helpful since revenue and profits can fluctuate. The dividends will never be more than you make in profits. This eases the strain on your cash flow and makes it easier to budget expenses.
- Your investor is your partner. With your investor’s money often comes experience, know-how, and connections. Their interest is in receiving shares of your profit, which is dependent upon your business succeeding in the market. They may have the ability to put you in touch with advisors, or help you strike a deal with a new distributor. Additionally, once they have started receiving their shares, the investors may be interested in providing more capital in the future.
Drawbacks of equity financing
- It can be expensive. When paying off a loan, you typically know how much you’ll have to pay back and how long you’ll be required to make payments. With equity financing, the investor may choose to continue collecting dividends for long after the initial investment has been repaid. This could result in your business paying out 10-20 times the original amount invested, resulting in less profit in your pocket.
- Dilution of ownership. As your minority partner, the shareholders are not your boss, but they do wield some control. The more investors you take on, the less of the company you control, which could be a slippery slope to losing control of your business. They may not agree with you on how to run your business, which can lead to conflict, too.
- You shift focus to profits. If your investor constantly pushes you to pursue profits over other needs, you could lose out on other areas for improvement. For example, finding a cheaper manufacturer overseas might lower your costs, but harm your dream of selling locally made goods.
- You may need to grow faster than you want. You may feel the pressure to grow and expand faster than you are ready or able. Scaling and growing your business should take time, research, and attention and should not be solely based on shareholders profits – though you should still take your shareholders into consideration with any business move.
Equity financing is a great funding solution for some eCommerce businesses, but it’s not for everyone. Some business owners prefer to keep full ownership of their business, so they prefer to pursue a different financing route.
If this sounds like you, 8fig might be able to help. 8fig is a unique funding and growth solution designed exclusively for eCommerce sellers. We offer fast, flexible financing to eCommerce sellers and don’t require any equity in exchange. 8fig funding is continuous, which means that instead of one lump-sum payment, you’ll get incremental cash injections aligned to your supply chain needs. This keeps the cost of capital to minimum while maximizing your cash flow. You can also change your plan as you go, so you don’t need to worry about that delayed shipment or slow sales month.
Sign up for an 8fig Growth Plan today, and see how fast you can grow your business with the right partner.
Rebecca is an eCommerce writer at 8fig. She strives to provide sellers with the information and support they need to succeed in the ever changing eCommerce space.