Have you ever wondered about the best way to fund your growth? Should you use debt or seek equity financing? For e-commerce entrepreneurs, funding decisions are a special kind of challenge.
Even when you’ve moved beyond startup status, the capital required to fuel further growth is often tied up in slow cash conversion cycles. High demand for inventory combined with sluggish payment schedules from e-commerces marketplaces can prevent you from investing in projects that move your business forward.
To hit the next level, you need to select a financing option that will help you act quickly on profitable opportunities. Debt and equity financing are two of the most common ways to do that, but each has its benefits and drawbacks. Today we’ll clarify both types of funding as well as the unfiltered pros and cons of each.
Debt vs. Equity Financing in E-commerce
- What Is Debt Financing?
- What Is Equity Financing?
- Debt vs. Equity Financing: More Ways to Grow
- Choose the Financing Option That Works for You
What Is Debt Financing?
Debt financing is borrowing money to finance your business. Also known as debt funding or debt lending, it typically works like a loan. You agree to pay back the funds you borrow, plus interest, to your creditor. Debt financing contrasts with equity financing, the other common way to finance a business, in that it doesn’t require a business owner to relinquish any ownership of the company.
Traditional examples of debt financing include bank loans and business loans. With the right amount of debt financing, you can maintain your existing operations while you invest in future growth. With the additional funding, you can launch products, expand into new territories, broaden your supplier base, and take any number of actions that can help you scale your business.
Debt financing has many advantages and some drawbacks to be aware of. Many debt financing providers require collateral, usually company assets, to secure funding. Some may even require personal collateral, as well as insight into your credit history and current credit score.
Before you consider debt financing as an option, make sure your business has the following fundamentals in place:
- Healthy revenue
- Stable sales and cash flow
- Sufficient assets (equipment, real estate, etc.)
If you already have existing shareholders in the business, you may also want to calculate your current debt-to-equity ratio (D/E ratio).
The D/E ratio measures how much debt a business has relative to its assets. You can find your D/E ratio by dividing your total debt by total shareholder equity. The higher a D/E ratio is, the harder it may be to cover your liabilities.
Common Types of Debt Financing
Here are some of the most common types of debt financing.
Installment loans, also called term loans, are the most common form of debt financing. Your lender provides you with a lump sum upfront, which you repay with interest over a fixed period. This type of loan may require collateral (“secured”) or not (“unsecured”).
Common examples of installment loans are business term loans and Small Business Administration (SBA) loans.
Lines of credit allow you to borrow money up to an agreed limit as needed and repay only what you use. A revolving line of credit can be used many times up to the limit.
Business lines of credit and business credit cards are some common examples of credit line financing.
Revenue advance loans give you an advance of funds based on your projected business revenue. The terms of these loans can vary as different lenders consider different factors when determining your lending limit, interest rate, and repayment terms.
It’s important to note that these are not the only types of debt financing available to e-commerce businesses. While local banks have traditionally been the first option for financing a growing business, today there are a number of funding providers specializing in e-commerce.
The Pros and Cons of Debt Financing
Debt financing can be a great way to fund your store — but that doesn’t mean it’s always easy or right for your business.
To help you decide whether debt financing is right for you, let’s get into some of the practical pros and cons.
The advantages of debt financing:
- It can be an inexpensive way to raise capital. The costs of interest can often be more affordable than the costs of raising funding.
- Tax-deductible interest payments. Debt financing can reduce your tax obligations because in most cases you can deduct the interest from your business income taxes.
- You can grow your company faster by quickly getting all the capital you need to invest in new products, services, or equipment.
- You retain business ownership. With debt financing, you don’t have to give up any ownership of the business you’ve worked so hard to build. This means you still receive all proceeds if you decide to sell in the future.
The disadvantages of debt financing:
- It’s a burden on your company’s cash flow. You’re responsible for paying every month, no matter what. Your interest payments will have to be a priority.
- It can lead to financial instability if you’re unable to make your payments. You could end up needing to take out more debt or even defaulting on your loan. This can result in collateral forfeiture, steep penalties, or credit rating damage.
What Is an Example of Debt Financing in E-commerce?
When used responsibly, e-commerce entrepreneurs can take advantage of a variety of debt financing instruments to fuel their growth, from cash advances to invoice factoring.
Our friends at CROSSNET developed what ESPN has called “America’s fastest-growing backyard game.” But five years into the business, the leadership team at CROSSNET was facing serious growing pains.
“As the business was starting to scale, we started working with large retailers that were putting in large purchase orders,” recalls Co-founder Chris Meade. “On our end, that was fantastic. But the question was, how can we go and build the inventory when we didn’t have an adequate capital structure?”
CROSSNET didn’t want to let profitable opportunities slip away. When they received a call from Sam’s Club for their biggest order yet, they partnered with SellersFi to secure funding for inventory using a flexible invoice factoring solution.
“We were able to set up an easy process with SellersFi to reduce our leverage and lower interest payments. And at the same time, we got a huge influx of cash from the factor to improve our own working capital status,” Chris explains.
There are many forms of debt financing. Different scenarios require different solutions. What matters most, is that you’re working with a partner who understands the unique challenges of growing an e-commerce business.
What Is Equity Financing?
Equity financing is when you sell ownership shares in your company to raise capital. Those shareholders become your equity investors.
Common Types of Equity Financing
Here are some of the most common types of equity financing:
- Venture capital is typically provided to early-stage, high-growth companies. These firms invest their clients’ money in companies they believe have the potential to generate high returns.
- Angel investors are wealthy individuals who tend to invest in high-risk, high-reward endeavors.
- Crowdfunding is earned by early-stage companies from a large number of individuals through an online platform like Kickstarter or GoFundMe.
- An initial public offering (IPO) allows your company to raise money by selling shares of your stock to the public. It’s often considered to be the most prestigious form of equity financing.
The Pros and Cons of Equity Financing
Equity financing can be a good fit for a variety of e-commerce businesses, but that doesn’t mean it’s right for everyone. Here are a few of the pros and cons.
The advantages of equity financing:
- You don’t have to repay a loan. Instead, investors are seeking a return on their investment in the form of equity and dividends.
- You can raise a large amount of capital. Debt financing is more tightly bound to your balance sheet than equity financing.
- It often comes with access to the expertise and resources of your investors. Your investors have skin in the game, so they want to see your company succeed.
The disadvantages of equity financing:
- It dilutes the ownership of the company. Everyone with equity now owns a piece of the pie and is entitled to its profits.
- It can be difficult to make major decisions without investor approval.
- It can be risky for investors and additional legwork may be required to get buy-in.
What Is an Example of Equity Financing in E-commerce?
Skincare brand Topicals is one of many e-commerce brands achieving great growth through equity financing using a combination of VC and angel investing.
The brand made headlines in late 2022 by raising $10 million in financing led by CAVU Consumer Partners.
On a mission to partner treatment for skin conditions with mental health advocacy, Topicals has an impressive portfolio of investors including Gabrielle Union, Kelly Rowland, and Jay-Z’s firm Marcy Venture Partners.
Debt vs. Equity Financing: More Ways to Grow
Debt financing can be an excellent, cost-effective way to fund your business’s growth. The downside is you have to pay that funding back with interest.
With equity financing, you don’t have to pay anything back, but you do give up some company ownership and a portion of the future fruits of your labor. From a lender’s point of view, debt financing is more secure, while equity financing carries more risk. But ultimately, the choice is yours.
At SellersFi, we believe that having control of your growth is key. While the common debate often centers around these two approaches, the truth is there are many options for securing the financing you need to grow your business.
Many emerging brands are digitally native and self-funded. Their founders are focused on sustainable growth, not necessarily securing hundreds of millions in financing. But when it comes right down to it, it’s important to know that ultimately you don’t have to pick a side.
You can customize your own funding strategy that includes some debt and some equity. For example, the leadership team at Icelandic Glacial Water was going through a major capital raise in 2022. Things were going well, but the process was lengthy, taking several months to complete.
The team needed additional financial support to keep operations running smoothly while they completed the funding round. They partnered with our team at SellersFi to secure a short-term financing bridge while they raised the capital required to fuel their long-term growth.
“We had to balance our needs between those efforts versus driving the business,” explains Raymond Thu, Chief Financial Officer at Icelandic Glacial Water. “After negotiating, we were able to find a solution that worked for both of us — from the competitive interest rates to the payment schedule to the exceptional customer service level.”
Choose the Financing Option that Works for You
No matter which route you take, it’s important to explore financial solutions specifically tailored to the needs of e-commerce. Finding a partner who “gets” e-commerce will help you keep your sales and cash flow strong while keeping you in the driver’s seat.
With the right strategy and partner, additional financing can take your business to new heights. At SellersFi, our full suite of e-commerce funding solutions has been purpose-built to meet the unique needs of growing marketplace sellers, DTC brands, and B2B businesses.
With flexible Working Capital, you can receive financing of up to $10 million in less than 48 hours, with no restrictions on how the funds are used. Learn more about how we can help you hit the next level.
Create a no-commitment account today to get started.