6 Types of equity financing for e-commerce businesses
October 18, 2021
When considering options for business financing, the two most common types that e-commerce brands turn to are equity financing and debt financing. In most cases, businesses that go down the path of equity financing position themselves as having that special something that makes them stand out from the crowd. In particular, startups that offer a unique product or service to the market might benefit.
This type of financing is also ideal for companies that are already achieving a good amount of growth and want to get to the next level or expand their business into new territory. Equity financing is a good option for e-commerce businesses of all sorts, including direct-to-consumer retailers, B2B SaaS, mobile apps, and subscription box companies, but can be difficult and time consuming to acquire.
In this article, you’ll learn about the various equity financing options for e-commerce businesses, including the different types, pros and cons, and types of business structures that are best suited for each option.
What is equity funding and why should e-commerce businesses care?
Equity financing is when companies offer up a portion of business ownership in the form of shares. In return, the company receives funds that can be invested back into the company or used to pay off expenses.
Securing business funding is a major first step for e-commerce businesses just starting out. For example, Bokksu is a subscription box business that partners with family-owned snack businesses in Japan to deliver curated, authentic food experiences to customers around the world.
The startup has received equity funds from a variety of VCs ever since they began in 2015. The additional capital has been necessary for practically every aspect of the business, including market research, product development, paying invoices, and much more.
Now, Bokksu has been able to position themselves as one of the fastest growing leaders in their niche.
An injection of capital is important for additional growth, even for e-commerce businesses already established in the market and reaping great profits. In this situation, companies will have greater potential of acquiring investor funds because of the strong business case and proof in market demand. Investors will have greater confidence in receiving the necessary returns as the company continues to grow.
6 common types of equity financing
There are several ways for e-commerce businesses to obtain equity financing. Below are the six most important types to consider.
Venture capital is a type of private equity financing that investors provide to startups and small businesses with the potential for exponential growth, or that have grown quickly and look like they will continue expanding. VCs usually invest in higher risk investment, so in exchange for funding they require stake in decision-making. This means they can have a very significant say in company decisions, depending on how much they own. It’s not uncommon for VCs to expect a seat on a company’s Board of Directors to oversee management of the company.
VC funds have become very attractive and highly sought out with the rapid emergence of tech startups, with many trying to figure out how to position themselves as a high potential VC investment opportunity.
Initial public offerings (IPOs)
An IPO is when a private corporation raises funds by offering shares to public investors through markets like the New York Stock Exchange. Companies need to hire investment banks to market, gauge demand, and set the IPO price and date, as well as continue to drive interest and share updates to shareholders and the market. Additionally, IPOs must comply with the guidelines of a governing body like the SEC (Securities and Exchange Commission) to remain publicly traded.
Small business investment companies (SBICs)
SBICs are a type of privately-owned investment company that is licensed by the Small Business Administration (SBA) to provide small businesses with equity financing. They are a great alternative to venture capital firms for startups looking to access capital.
Funding is offered in exchange for a percentage of the company, a loan, or a combination of the both. This type of financing tends to be more competitive and businesses might not receive funding as quickly. However, SBICs have the benefit of having a less stringent and extensive process than IPOs.
Mezzanine financing is a combination of debt and equity financing. In this situation, lenders have the right to convert their loan into an equity interest. It enables lenders to be prioritized ahead of existing owners in case the company defaults or goes into bankruptcy after venture capital firms and other senior lenders are paid.
Mezzanine financing is frequently associated with acquisitions and buyouts and is considered to be one of the highest-risk forms of debt. However, this means that it also offers some of the highest returns when compared to other debt types, ranging between 12% to 20% per year. Often, these loans will be provided by the long-term investors and existing funders of the company.
Angel investors (also known as a private investor, seed investor, or angel funder) are individuals who invest in the very early stages of startups, typically in exchange for ownership equity in the company. They tend to look for opportunities that offer a higher rate of return than those provided by traditional investment opportunities.
Angels are usually people that have a more personal relationship with a founder since they are involved at such an early stage. Due to the higher risk, the relationship is typically more hands-on, and the angel often has a deep belief in the company they are supporting.
Angel investors typically use their own money, as opposed to venture capitalists who make use of money pooled across a variety of investors in the form of a fund. Given that, the rate of return for a successful angel investor portfolio is approximately 30%. This might seem quite expensive for early-stage startups, but when considering that cheaper sources of financing are not usually available to these types of businesses, it’s a feasible option.
Royalty financing involves a business receiving investor funds, a.k.a. an advance that can be put toward activities such as launching a new product or expanding the business. In exchange, the investor receives a percentage of the company’s future revenues, a.k.a. royalties, over a certain period of time, up to a specific amount.
Royalty financing can be a great option for small businesses that offer products with a considerable range of price elasticity. This enables them to raise prices to cover the percentage of royalties, if needed. This option wouldn’t be a good choice for companies operating on restricted profit margins. Additionally, royalty financing enables entrepreneurs to obtain capital without giving up a significant amount of ownership in their company to external investors.
The pros and cons of equity financing for e-commerce businesses
When it comes to equity financing for e-commerce startups and small businesses, there are plenty of options to consider. Each has its own advantages and disadvantages.
Reasons to acquire equity funding
- Less risk – The company isn’t liable to investors if it fails. That’s the risk stakeholders take when they decide to invest in your company.
- Credit problems won’t hold you back – Equity financing can still be obtained even if you have bad credit, whereas other forms of financing through traditional financial institutions would be unfeasible.
- Cash flow is easier to maintain – There are no fixed monthly loan payments to make, which is helpful for startups that may not yet have positive cash flows.
- Gain expert advice and support – Investors have an interest in ensuring the company succeeds so they will provide resources and knowledge that will aid in the management, operations, and growth of the business.
Reasons to explore alternative forms of funding
- Profit sharing – You’ll need to give a good chunk of your profits to equity partners. How much will depend on the terms you agreed upon, but investors generally expect a higher level of return the riskier the investment.
- Loss of control – In order to receive funding, you’ll need to give up a portion of company ownership to your investors. This means your equity partners will have a significant say in how the company is managed and operated.
- Potential for conflict – Your equity partners won’t always agree with you when it comes to decision making. And if you have multiple investors, it’ll make the experience that much more challenging.
Equity financing can be a feasible form of funding for e-commerce businesses that have an innovative offering to the market and want to get themselves off the ground. It’s also a great option for companies with demonstrated growth and expect to continue to grow exponentially.
There are a variety of different forms of equity financing. Make sure to carefully consider the pros and cons of each type and conduct as much research as you can before deciding which one to pursue for your company.
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