The most efficient uses of working capital, equity, and profits

Date
March 10, 2022
Category
Finance
Written by
Mark Corballis

Many eCommerce startups find it hard to secure funding through traditional channels or are hesitant to raise equity funding because they don’t want to dilute ownership of their business. But a lack of efficient financing can have massive effects. CB Insights has analyzed over 110 startup post-mortems since 2018 and found that the inability to secure capital is the number one reason why startups fail.

There’s a way to deploy multiple financing options that’s sustainable for revenue growth and allows you to retain your majority ownership shares. In fact, eCommerce startups should be using all the funding options at their disposal to gain more stability, become profitable quickly, and reach their potential.

To keep your eCommerce business growing, you need to understand when to deploy each type of financing and how best to make each one work.

Here’s what you need to know about working capital, equity, and profits…

Working capital is ideal for marketing and inventory

Working capital financing is great for immediate investments like marketing and inventory. You’ll get financing when you need it and remittances are based on a percentage of your daily sales. And you don't have to give up equity to secure this type of financing, so you can retain future profits and decision-making power.

Suppliers often require eCommerce companies to pay for purchase orders on inventory upfront before they’ve sold the stock and turned a profit. Working capital financing is deposited directly into your bank account. You’ll be able to place orders with suppliers and replenish your inventory so growth is sustained into the future.

You typically need to spend money to acquire new customers, and working capital financing can come in handy there, too. You can use the funds to pay for marketing and advertising costs upfront. As you increase brand awareness, convert more customers, and sell more stock, you’ll see a quicker return on your investment.

Say your company uses a subscription-based model and sends a monthly box to customers. You’ll need to spend on advertising to acquire new customers. You then need to sell each customer four months’ worth of boxes before you recoup what you spent on ads and inventory. A working capital solution provides you with immediate funding to cover the cost before you make a profit on that customer.

How to manage working capital: Seek out revenue-based financing options

Traditional debt financing lenders just want to be repaid, regardless of what happens to your business. They’re not looking out for your best interests, and they don’t understand the unique challenges that impact eCommerce companies, such as seasonal sales cycles. Instead of going the traditional route, seek out a flexible revenue-based financing option like Wayflyer that puts your business first.

In revenue-based financing, remittances are based on a percentage of your daily sales instead of paying one lump sum every month. This way, there’s never too much strain on your cash flow if sales are down.

For example, say you receive $250,000 in funding to buy inventory. You agree on a remittance rate of 12% of your daily sales. Your remittances automatically scale based on how much you sell. If you sell zero products one day, you won’t transfer a cent. If you sell $1,500 the next day, your remittance will be $180.

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Equity is best for research and product development

Use equity financing to invest in what’s going to make your products — and your company — more valuable and more profitable years down the line so that you can see the greatest long-term revenue returns.

Equity equates to ownership in your company. When you raise equity, you’re selling off ownership shares. Investments from equity financing need to be worth that trade-off. Is six months of Facebook ad spend worth a stake in your company? Probably not. What about developing a new product that’s going to dominate the market in three years? That’s a worthwhile investment.

Some examples of places to invest your equity for future growth and value:

  • Research and development: Companies need to invest resources now to develop products that will be competitive years down the line. These products might not be ready to launch for a year or two, but when they do, you’ll have a new product, an additional revenue stream, and a differentiator from your competitors.
  • Hiring: To build outstanding products, you need a team of great people to help you get there. But hiring successful, well-qualified people for your eCommerce company isn’t a low-cost investment. When you’re looking to expand and add a new department, your equity can help you finance it because you’ll see the returns long-term.
  • Expansion into a new market: You’ve identified a potential opportunity for growth in a new market, but it’ll take your company some time to become competitive in that market. This is a great opportunity for investing equity. You don’t expect to see returns right away, but you know the potential to generate future revenue is considerable.
How to manage equity: Find a balance between bootstrapping and equity raises

Whenever you raise capital through equity financing, it dilutes your ownership in your company. There’s still value to raising this capital, but equity raises should be done sparingly.

Some startup owners are wary of taking equity financing because they don’t want to dilute ownership at all. But this philosophy — called bootstrapping — has its drawbacks. Startups that bootstrap have very little capital to make healthy decisions about their future. They often make short-term decisions to try and turn a profit without considering the long-term impact on growth. For instance, they might try to satisfy one large wholesale customer in the short-term by tweaking their product — instead of focusing on innovative product development.

As long as you’re investing equity into growth opportunities, you’ll see a valuable return. But you still need to avoid continually raising equity and diluting your ownership. To do so, draw a clear boundary between your equity financing and your working capital cycle. Use working capital to fund overhead costs and only deploy your equity for stable, sustainable growth.

Reinvest profits in expansion and paying down debt

If you’re turning a profit, you’re doing exactly what you set out to do! But don’t just sit on that cash. Be as strategic about where to invest your profits as any other financing available to your company.

The most efficient place to invest your profits is back into your business. Whenever you have a surplus of cash, you want to keep it working for you. This way, it’s creating value for your company — which is key if you’re just starting out.

You have options for reinvesting your profits:

  1. Expansion and growth: Invest in areas where you can keep growing as a company and bring in more revenue. With a surplus of cash from profits, you can make healthy decisions without relying on outside financing, so you can see a greater share of the return. For example, use your profits to buy a new warehouse so you can increase production capacity.
  2. Pay down debts: You can also use your profits to pay down debts, helping you stay profitable in the long run so you can keep more of your future revenues.
How to manage profits: Base it on your business lifecycle

Your exact choices for where you invest your profits will depend on where your eCommerce business is in its lifecycle. Early-stage companies will have different priorities compared to those that are more mature, and understanding your own business stage can help you make better decisions about your company’s future.

If you’re a new business just starting to turn a profit, keep reinvesting your profits into expansion and revenue growth. This is a time to be ambitious. Your business is your lifeblood, and to keep it running, you need to keep it growing.

If your company is reaching maturity, you might want to start thinking more conservatively about how to handle profits. You can use your profits to pay dividends to your shareholders and get cash out of your business. Treat profits as a fair reward for the time and energy stakeholders have given to help the company blossom.

Balancing all your funding options gives you the flexibility to grow

Clear lines between equity for the long term and working capital for the short term are great. And you should also think about how your financing options work cohesively together to drive profits. Avoid bootstrapping and instead combine your equity and working capital financing so you can gain the capital you need to grow without diluting your company. Proactively seek out the best supplier terms and remittance rates that are tailored to your business so you can keep more of your profits and then shrewdly reinvest them to keep expanding.

Take a hand-in-hand approach to your equity and working capital financing, and you’ll give yourself the runway you need to keep stock on hand and keep up with demand throughout all stages of the product lifecycle. Explore funding options for your working capital now from Wayflyer.

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Written by
Mark Corballis
Mark Corballis is Head of Funding at Wayflyer

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