20 Apr What is Equity Financing for eCommerce Businesses?
Finding funding for eCommerce businesses can be challenging. Many traditional lending services won’t finance eCommerce businesses due to the perceived risk. Banks are hesitant to get involved in the eCommerce space.
The alternatives include personal finance through the founder. However, this carries risks of its own. The founder has to put their personal assets at risk to secure funding, meaning the business is directly impacting their personal life. Even so, this doesn’t guarantee capital, and might not offer enough for real business growth.
eCommerce businesses that are looking to scale need a considerable cash injection. If you can’t secure business loans, and other finance doesn’t provide the capital you need, what are your options?
Equity financing could be the right choice for your eCommerce business. This is the process of raising capital or funding for your business by selling shares in your business. The capital could come from one investor, or a pool of investors, depending on your approach.
Before considering this funding approach, it’s important to understand what equity financing is and whether it’s right for your business.
What is Equity Financing?
Overall, equity financing involves selling shares of the company for investment capital. Depending on the choice of financing, there can be one major investor or a pool of investors. There are six common types of equity financing.
1. Venture Capital
Venture capital firms or investors typically invest in small businesses or startups. These are businesses with the biggest potential for exponential growth. Typically, they will invest in businesses that are showing growth already and have the potential to continue their expansion.
As a result, many venture capital investments are considered more high risk than other kinds of funding for the investors. Since they are accepting a higher risk, they expect a larger amount of control over the business. For instance, they may expect a seat on the board of directors in exchange for their funding.
Venture capital investors often take a mentoring position within the board. They can offer their business expertise to the founder, to help drive the growth and return on investment.
If you’re considering venture capital investment, consider finding a firm that specializes in eCommerce. This will help you to make the most out of your sale of shares. The primary goal of venture capital funding is growth, from a small business idea into the next stage.
2. Initial Public Offerings
You might have heard of this funding approach referred to as “going public.” This means that the company is offering shares on a public trading market. For instance, investors can purchase shares through the New York Stock Exchange.
To go public, you do need to meet specific requirements for public share sales. Therefore, this can be a more challenging funding option for many businesses. Once approved, the company goes live for purchases on a set date.
For IPO’s, you need to increase awareness of your shares and why your company is worth investing in. Your shares are liquidated so that many individual investors can purchase a part of your company. When your company grows, so does their share value, which investors can then sell to make purchases elsewhere.
3. Small Business Investment Companies
This equity financing model is similar to venture capital, but investors (firms or individuals) pool together to form a small business investment company. The process is regulated by the Small Business Administration.
The investors finance small businesses with high growth potential. Again, this is often deemed quite risky for the investors. However, the requirements are less strict than those for the IPO process.
This approach can be challenging, as your business is competing with many others to secure funding. The capital is offered in exchange for a percentage of the company, or as a loan.
If you need money quickly, this may not be the right option. However, investors are wealthy individuals, so there may be a considerable amount of capital on offer if you can compete in the market.
4. Mezzanine Financing
Mezzanine financing combines equity financing and debt financing. This financing method begins as a loan from investors.
The lender sets the repayment terms with the company. For example, they might set performance requirements or targets. If the company grows as expected, the loan is repaid. However, if the company doesn’t grow or goes bankrupt, the lender is prioritized for repayment.
For business owners, mezzanine financing is attractive as it can offer higher amounts of capital than other financing methods. As the lender is going to be repaid, they are more willing to provide funds.
5. Angel Investors
Angel investors might also be known as private investors. They are typically extremely wealthy individuals that invest in the early stages of a startup. These investments are high risk, but offer the investors the highest return. Ultimately, they are looking to vastly increase their return on investment.
The founder and the investor typically have a relatively personal relationship. The investor joins the company in the early stages and, often, is instrumental in the company’s growth. They offer business expertise and advice to ensure maximum growth for their investment.
Angel investors need to have a real belief in the companies they are funding. If they believe the company will expand, then they increase their own funds. Therefore, to secure this type of finance, you need to make a great case for your business.
6. Royalty Financing
Royalty financing is a type of investor financing. With this type of financing, investors receive a percentage of the future revenues instead of receiving a percentage of shares in return for funds
The amount returned is usually set up to a certain amount of money, or for a set period of time. As with many kinds of equity financing, the better the company performs, the better return on investment for the investor.
Royalty financing can benefit the company, compared to other types of equity financing, as the founder doesn’t need to lose shares in the business. The investor takes future revenue, so the founder retains full ownership of the company.
Benefits of Equity Financing
Your credit history doesn’t matter
For more traditional forms of funding, like bank loans and credit cards, you need to have a good history with credit. Regardless of your business potential, if you have high amounts of debt, or have struggled to make repayments in the past, you’re unlikely to secure funds.
Equity financing doesn’t require any kind of credit history. Investors fund your business based on your business and its potential growth. If you have a good business idea, you can make applications for funding. You don’t need to prove your creditworthiness; you only need to prove the business’ future return on investment.
Cash as well as expertise
Equity financing investors can provide more than just capital. Many investors will have a considerable amount of business experience. They might be previous business owners, or have spent a long time investing in various companies. As a result, they often have a varied portfolio.
With equity financing, the investor wants to see the business grow. If the business expands as expected, they receive a greater return on their investment. Therefore, it’s in their best interest to guide you as you expand your business. Business investors work closely with founders to understand the business, and where best to invest the capital for growth. Ultimately, the business is more likely to meet its growth goals with this expertise on board.
Less risk for the company
Traditional financing methods can be risky, as they involve putting the business or the founder into debt. Securing business loans can be particularly challenging for eCommerce companies. Often, eCommerce business owners have to secure personal finance to invest in their company. This puts their personal assets at risk.
Equity financing uses investments. The investor provides capital in exchange for shares. If the business grows, both parties make money. However, if the business doesn’t perform, there’s no risk for the founder. Unlike loans, you don’t have to repay the funds.
Disadvantages of Equity Financing
Loss of profit
For the majority of types of equity financing, the investor takes a percentage of the business shares. Alternatively, they may take a percentage of the future revenues.
This means that the owner has to dilute their ownership shares, to provide the investor with a return. Without an investor, anything the company makes belongs to the owner. Once shares are diluted, the founder stands to make less as a result of the growth. As a result, there are fewer profits to reinvest into the business for continued expansion.
Loss of control
As mentioned, most investors take a portion of shares or future revenues in exchange for their investment. Not only that, but many investors like to take a seat on the board, or maintain some kind of control over the company. As a large shareholder, they do have some say over the direction of the business.
For a business that has only ever had one owner, this shift in power can be challenging. Business decisions have to be run past the shareholders and cannot be implemented straight away. It can be difficult to accept that the business is no longer completely yours.
Too many cooks
If you’ve never worked with another business person before, equity financing can create conflict. Ultimately, not every decision you make will be backed by the investors. Disagreements with investors can create a difficult back and forth and cause friction between the parties.
Ultimately, this power struggle could slow the company’s growth, as conflict takes time to resolve. The more investors, the more chance of disagreements and lengthy discussions prior to taking action.
Equity Financing in eCommerce
Equity financing can seem like a much more viable option for eCommerce businesses. Where banks and other lenders deem eCommerce to be too high risk, the right investor should see the value in your company.
For a growing eCommerce company, outside expertise is extremely valuable. You know you need to grow, but you might not be sure exactly where to invest your funds to ensure that growth. Search for an investor with experience in your market and who has worked with similar companies.
Bear in mind that equity financing isn’t a guaranteed form of funding. It’s not easy to secure a major investment, and you need to sell your company well. They might be more amenable to investing in an eCommerce business than a bank, but you still need to make a solid case for your business.
At Yardline, we understand how challenging it can be to secure finance for your eCommerce business. That’s why our growth capital solution is tailored to eCommerce businesses. Our Seller Success Team offers expertise and advice, as well as capital, to help you meet your growth goals.
Get in touch with us today
to discuss a cash injection for your eCommerce business.