It’s almost impossible for an e-commerce business to get started without some type of capital. Capital pays for research and development, production, marketing, your online storefront, a workforce, and more. When money runs low, you might seek out different types of business funding. No matter what stage your company is at, additional capital might be needed in order to accomplish specific goals, such as expanding operations or increasing inventory.
The biggest challenge when deciding to take on external capital is determining which type of funding will work best for your business. Below, we’ll take a look at the different types of business funding available and the pros and cons of each.
Why e-commerce businesses need to seriously consider their funding options
Even the smallest, most basic business needs some type of investment to get started. In most cases, the adage that you need to ‘have money to make money’ really rings true when it comes to starting your own e-commerce business. While many people invest their own funds into their businesses, in many cases, it’s not enough to get it off the ground beyond a short period of time.
For businesses operating on a larger scale or at a more advanced stage, they might look for funding to expand or increase inventory before a busy holiday season. Excess funding might also be required for digital marketing and social media campaigns as a way to increase customer acquisition. Ideally, funding can help fuel the company’s short- and long-term initiatives, ultimately helping to drive revenue and maintain sustainability.
At the end of the day, every business has the goal of obtaining as many customers as possible and maximizing revenue no matter what their target audience is or what they’re selling. Without funding, you might reach a point where you struggle to meet these business demands.
For example, if you sell a physical product but can’t afford to increase inventory before a busy holiday season, you run the risk of delayed orders or customers deciding to opt for purchasing from a competitor. If you have the available funding, you can use front-loading practices to better prepare your business for the anticipated increase in customer demand.
Another potential problem is revenue stagnation. If you’re barely breaking even or growing steadily but slowly, there won’t be any extra money to invest back into the company and encourage growth.
Here’s a look at some of the different types of business funding that e-commerce companies most commonly turn to when trying to source startup capital, increase inventory production, and more.
The 5 different types of business funding you need to know
1. Equity Financing
Equity financing describes offering up a portion of company ownership in return for financing. This might involve finding an investor interested in owning a portion of your company or opening it up to the public through shares or stocks.
Pros vs. cons
The major advantage with this type of business funding is that investors only see profits if the business does well. Your success is their success, so they are highly incentivized to work in the best interest of the company. Additionally, you don’t need to make any interest payments with this type of funding.
On the other hand, the major disadvantage is giving up ownership of your business. Stakeholders and investors don’t always see eye-to-eye with business owners on the direction the company should take and tactics used along the way. In some cases, you may have to give up more than 50% ownership of your company thereby essentially giving up decision-making power. This can cause problems in the management and operations of the company.
Businesses that benefit the most from equity financing
Equity investment is a good choice for startups that may not be sure of their company’s future, or who need guidance and expert advice on how to structure their business. One thing to note is that it’s very important to have a solid business plan in place and complete your market research before you start pitching to investors.
2. Debt Financing
Debt financing involves taking on debt as a way to generate revenue for your business. This might occur by borrowing money from friends or family members, or taking out a loan from a financial institution. In most cases, you’ll probably need to pay interest on the loan over time.
Pros vs. cons
An advantage of debt financing is that expenses like principal and interest payments are often classified as tax-deductible business expenses.
The biggest drawback is that these loans must be paid back, even if the business fails. Additionally, there’s usually a high rate of interest, and some loans may require collateral in exchange for the funding. The risk is that if your business doesn’t generate revenue fast enough to start making payments, it might result in defaulting on the loan.
Businesses that benefit the most from debt financing
Debt financing is ideal for business owners who want to retain ownership of their company. These types of loans are best for established companies that have more assurance in being able to return greater revenue with the injection of capital. They may use debt financing to expand the business or fund campaigns to increase sales.
3. Bootstrap Financing
Bootstrap financing is essentially using your own funds to get your business off the ground. This approach is usually the first form of funding that entrepreneurs resort to before moving onto other sources. It forces you to comb through, optimize and manage your finances better so you can uncover any unused capital.
Pros vs. cons
Bootstrap financing is a solid way to acquire additional financing without the risks of traditional debt. You still end up owning your entire company so no equity positions need to be given up. With less debt on hand, when it comes time to source from external lenders and investors, your company will be more appealing versus if you had large amounts of debt on your accounting ledger.
The biggest disadvantage when it comes to bootstrap financing is the availability of your own money. You can only invest as much funds as you have available, and this may not be enough to spur growth as quickly as needed.
Businesses that benefit the most from bootstrapping
Bootstrapping is ideal for businesses at an earlier stage, especially small startups that are just starting out and unsure of performance and sustainability.
Crowdfunding is the method of raising capital through the collective efforts of large pools of individuals, including friends, family, customers, individual investors, and the public. It’s primarily executed online through social media and crowdfunding platforms such as Kickstarter, GoFundMe and Indiegogo, whose purpose is to help entrepreneurs generate buzz and funds for their projects.
Pros vs. cons
Similar to bootstrapping, a huge advantage to crowdfunding is you still own 100% of your company. Instead of offering equity in exchange for funds, participants are being rewarded with perks.
Crowdfunding is also a great way to test the market without needing to build out a full website or company. In the end, if your product is well received, you are able to create a community of early adopters and ambassadors.
One major downside to crowdfunding is that, while platforms like Kickstarter may have thousands of potential backers registered, it still requires a lot of hard work and planning to get their attention and bring traffic to your landing page. In order to be really successful, you need to do a launch campaign that will attract the attention of potential funders, which can cost you a lot of money, effort and time.
Businesses that benefit the most from crowdfunding
Crowdfunding requires products that catch the public’s eye so companies that have unique and innovative offerings to the market are more likely to find success through this method.
5. Revenue Share Financing
Revenue share financing is when a company agrees to share a percentage of future revenues with investors in exchange for up front capital. Loan payments are correlated to ongoing gross revenues, typically with fixed fees and repayment rates. This means that when the company does well, investors get back faster. But when revenue is down, payments are correspondingly slower.
Pros vs. cons
With revenue share financing, you still maintain full ownership and control over your company. Equity, personal guarantees, and board seats aren’t part of the deal.
However, there is a chance that the emphasis on business priorities will tend to revolve around methods that generate immediate revenue. This can potentially hinder the achievement of longer term goals of the business if not managed carefully and strategically.
Businesses that benefit the most from revenue-share funding
Revenue sharing is a great model for most companies, especially those who have a comprehensive grasp of their month to month sales. This will allow them to predict how much they will owe on payments and be able to manage their budgets responsibly.
Equity financing, debt financing, bootstrapping, crowdfunding, and revenue sharing all have the potential to be effective business funding methods. By understanding the different types of financing options available to your business, you set yourself up for success in being able to access the capital you need.
With knowledge of the pros and cons of each type of financing, you’ll be able to make an informed decision about which approach will work best for your company. Considering your company’s overall goals, the current state of your market and how the different types of funding you obtain may affect your business will ensure the future success of your company.
Have you experienced success (or failure) with any of these types of funding? Share your nuggets of wisdom below!