eCommerce Funding is broken

TLDR:

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Early-stage eCom funding is broken.
Tool: Finaloop (Real time P&L)

Wonder what I look/sound like?

It’s so easy to spend months seeing someone on social or a newsletter and thinking you get to know them only to realize you have no idea what the person sounds/looks like.

I recently got back on the podcast circuit and joined Brett Curry on Ecommerce Evolution and Dylan Kelley on the Wavebreak podcast to give a Q1 rundown of what’s going on in eCom. We jumped into what’s going on with the big players, where the opportunities are in the market and a little bit of macro. If you want to hear me dive deeper into the topics I’ve been covering on the pod check them out.

I appreciate the 942 peeps jumping in on a Sunday to talk about eCom. Thank you for joining me on this adventure. Let’s dive into a problem we’ve all faced before. Funding for an early stage eCom startup.

eCom Fundraising is broken

Coming from someone who invests in early stage eCommerce startups this might sound a little hypocritical. But after spending the last decade either trying to raise money or investing into early stage eCom there’s a fundamental flaw that’s broken in the market.

Let’s quickly cover the 3 types of funding that are typically available to eCommerce startups and how to navigate them.

1) Debt

The classic vehicle where a bank/financial institution loans money with interest collateralized against assets. eCommerce businesses without wholesale rev don’t really have ‘assets’, one of the main reasons the debt d'jour for the last 5 years has been Revenue based financing.

Think of this as your Shopify Capital or Clearco style loans where you get a variable rate loan based on current daily sales volume. Since these players are loaning against future sales (high risk asset) the interest rates are going to be significantly higher (Closer credit card and Pay day loans).

While these seem attractive because they only remit (you pay them back) a percentage of your daily sales, these can also be crushing if you don’t have immediate growth. Those daily remittances can tie up cashflows if you have to payback 17%+ interest out sales each day.

Most people don’t realize you’re signing a Personal Guarantee (PG) when you sign those loans. So if the business doesn’t pay the loan back you as an individual are liable.

The more traditional debt vehicle of early stage Retail business that are selling to major retailers/department stores is called Factoring. To oversimplify the concept: You get a Purchase Order (PO) from a major retailer like Target for $100k. You take that PO to a bank of get 80-90 cents on the dollar in a loan for the PO with an X% interest rate on that money.

Everything goes well you pay the bank back with interest and you’ve funded your order. If everything doesn’t go well the bank takes the rights to your income from the Retailer or other collateralized assets to make them whole on the loan.

Factoring is a great growth vehicle when you confidently have a wholesale channel that has strong consistent performance with growth. Unfortunately it’s rare to get factoring if you don’t have Retail POs.

There’s obviously always Credit card debt, but that comes with its own trials and tribulations.

2) Venture Capital (VC)

Take everything from here with a grain of salt as this is a major focus for me, but I’ll try to explain some inside baseball from the investor side as to why this does and doesn’t work for early stage eCom brands.

On the opposite side of the conversation from debt is VC investments which are fine with little to no assets, but want to see astronomical growth. It’s for the founder appealing because it’s a long payback horizon where you can inject cash into the business today and only pay it back once you’ve had an exit.

This is primarily one of the reasons it exploded in the space over the last decade. The problem…? this inherently centered around outliers. Every VC is looking for a $500m-$1B+ outcome which is wildly unlikely for 95% of eCommerce stores. Most eCommerce stores need help growing. Not rocket fuel. They just need a little extra runway of good ole gasoline to get to a healthy sustainable business.

Really where VC makes sense for a brand is if they need to make some major investment outside of usual business operations: Tooling/facilities investment, tech investment, more aggressively invest in an acquisition model that’s working well.

In every other scenario you are strapping a rocket onto a company that probably doesn’t need to grow that fast otherwise.

Tool that Needs to be on your radar

Finaloop I mentioned them a couple of weeks ago, but this one felt right to mention them again.

The best way to raise a round of funding for your company is to optimize your numbers into more growth. Margin expansion, Dialing in your CAC, optimizing your cash flows. Some smart financial engineering can create the cash in your business instead of fundraising.

You can’t get there if you don’t know your real time P&L numbers. Don’t hire a bookkeeper. There’s an app for that.

3) Private Equity (PE)

This is probably the trickiest decision for most brands because of how these deals and structured and how much ownership the original owner needs to give up for these deals to work.

I’m grossly oversimplifying it but: typically a PE firm will acquire a business for a blend equity and debt (similar to buying a home) where the business will be responsible for paying back the debt while the firm grows the equity value of the company.

If you are at the appropriate scale and find the right partner this is a massive unlock for brands. The capital, operating experience, and connections help fast growing brand usually navigate multi-channel expansion (Wholesale, retail, Marketplace).

That being said you need to be north of $10-20m in GMV before this outlet is really a viable option where you are probably selling 30-80% of the company for the PE firm to grow it to the next level. (This is broad strokes here are many flavors on this).

Where the space has gone in the wrong direction over the past 5 years is the aggregator model diving too early in the market and getting to the same business size through more volume. That’s a whole other newsletter by itself. This is also more of an exit strategy than a funding strategy.

Just like the other models: there are some benefits and tradeoffs here, but it’s also reserved for only the few that make it to that level.

4) So What can you do?

Until the new players on the block come up with a new solution it goes back to the fundamentals.

Typically the best business find something inherently about their business that they can exploit and scale to the size where they grow into the phase that Debt and PE becomes viable.

While these don’t capture the headlines as often there are plenty of brands who have accomplished this. Typically they have mastered their business to the point where they can do 1 of 2 things. Or usually both.

1. Exploit a Customer acquisition strategy to grow quickly without requiring much money upfront.

2. Optimize their Supply chain to a tee with great vendor terms.

Point #1 gets much more into how you’ve built your company. This typically requires a lot of hustle, ingenuity and big bets. But if there’s an arbitrage opportunity you can exploit take it as far as you can.

Every couple of years a channel comes along that is so powerful that when you jump on it changes your business. These channels are great to build your business on, but hard to jump into them once you’ve scaled.

To Point #2 this is easily the least utilized tactic that so many company would benefit from. There’s a laundry list of items to tackle here but the most important one is RENEGOTIATE your terms with your supplier + 3PL.

Most businesses growth stalls or they run our of money is because of cashflow. Moving when you pay your suppliers is a massive cash flow unlock that will change your business.

Moving payment from when you receive the invoice to: Net 15, Net 15 from when inventory hits the docks, Net 15 from when you warehouse those all have considerable impacts on your cashflow.

If ocean fright from China takes 5 weeks to get to your warehouse and you went from paying on invoice, to paying Net 15 from warehousing the item you just bought yourself ~2 mos of cash in the bank that you can use to grow your business faster.

This is all a negotiation so you need to know your numbers well to understand what you may have to concede for better payment terms, but the right deal will be worth it. Same thing for your 3PL. Push for better terms.

Now, the bigger you get the better your terms will be but if you are doing a meaningful amount of business with any of your vendors and you’ve established a track record as a good client they’ll negotiate with you. Don’t try to put them out of business or have onerous terms, but slightly less margin or later payments on your account is better than them losing your business.

4) A better future?

I’ve spent close to 5 years thinking about a new financial vehicle to provide the short term cash injections that asset light but high sales growth businesses need.

We’re definitely getting closer to the right model here on 2 fronts:

• Applying the YC Safe model at early stages. It’s convertible debt with an interest component.

  • Option A: The loan converts to equity under a certain set of circumstances and investors own the business.

  • Option B: The company pays the loan back at an agreed upon rate before it converts to equity.

  • It’s not perfect and most times is treated like a typical venture investment. If investors with lower expectations applied this

• Revenue based financing.

  • There are a couple of the inherently beneficial value props to founders like easy access and payback as you go terms.

  • Where this got tripped up was predatory interest rates in 15-25% range.

Considering eCommerce businesses are essentially the storefront business from 30-80 years ago is it surprising that there isn’t more of a community bank model where people who have done well in the space provide loans or equity investments to other businesses that they know and understand the potential value of.

eCommerce has always been so Tech adjacent that the funding environment gets too distorted by the software/tech side of the investment landscape. But there are now thousands to millions of people building small business that have terrible banking options.

A financial institution run by experienced professionals in the space that’s willing to underwrite loans at reasonable rates and make non-VC equity investments would have 10-100s of thousands of small business that would be potential customers.

My hope: Shopify takes this angle and becomes the Commercial bank for eCommerce companies. They already process and move payments, have all the data and are loaning out $500m+ in loans to brands already.

If they internalized more of these banking features and got a charter, they’d be able to run this entire process themselves further enabling more people to start and run businesses. Plus it would unlock further service offerings that Shopify could monetize to it’s existing customer base.

🧠 The Takeaway

 The main funding models are broken for the majority of eCommerce companies and that doesn’t look to be changing anytime soon.

1. Debt is too hard/expensive to access for most growing brands.

2. VC only works for the 1% that are after a $1bn valuation.

3. PE is only funding for the top growth that have passed a considerable sales threshold.

👷 What can you do about this?

1. Don’t wait for a miracle. Optimize your cashflows now.

2. Fastest way to grow is to find an acquisition channel without high upfront costs.

3. Renegotiate your supplier terms.

As always. Stay confident, connect with your customers, and keep crushing it.

Jeremy Horowitz

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