Why growth strategies dictate funding requirements
Businesses should think carefully about what the right type of investor looks like for them and what types of investments they should make themselves. The type of investor you work with is best dictated by the amount of funding required and what it’s needed for. Broadly speaking there are two routes open – debt or equity.
Businesses use debt, typically in the form of a loan, for smaller raises while more substantial funding is usually contingent on some form of equity. E-commerce firms generally need a larger influx of cash for one of two reasons: to drive economies of scale and to enter new geographies.
The bigger the business, the greater its bargaining power to set favourable agreements on stock procurement, shipping, warehousing etc. This is often the strategy behind buy and build M&A strategies, which may also be guided by the need to target new audiences in aligned sectors. We see this thinking at play through the recent spate of acquisitions by Boohoo Group and Asos.
Once a business has thoroughly pushed the limits of all growth channels – from affiliates to influencers and everything in between – in its home market, it will need to look to new territories to find new audiences. This requires significant capital expenditure to develop local infrastructures and increased OPEX on the likes of marketing and staffing.
Examining the options
Earlier stage businesses may find themselves in a Catch-22 situation because banks are highly risk-averse and aren’t an option for short-term loans: this is problematic for start-ups and scale-ups as this is most typically what they need to pay for inventory and marketing (customer acquisition). However, they can’t repay the debt until they’ve sold the stock – with no cast-iron guarantee they will be able to do so! As such, these firms’ revenues will often fluctuate between being in the red to the black and back again until they have built up cash reserves.
A new breed of specialist revenue-based finance firms working within e-commerce, such as Wayflyer and Outfund, have sprung up to fill this gap in the market. These players give growing businesses access to smaller merchant cash advances, typically between £50,000 to £5 million, without the recipient having to relinquish any equity or personal guarantees. Rather, the investor bases its lending decisions on their e-commerce data as an indicator of longer-term viability and future sales growth.
As we’ve seen, maintaining growth for later stage businesses will require more substantial investments and they will need to look at some form of equity, either through IPO or through private investors.
Moonpig and The Hut Group’s hugely successful exits on the public market have been very effective statements of intent. Looking beyond the headlines, IPO can be restrictive for entrepreneurial businesses. Agility may be sacrificed at the twin altars of governance and public scrutiny, as such it is best suited to the most established brands.
Those that want to remain privately owned would be better advised to look to private equity – with the caveat they do their due diligence first. The PE community is very tuned in to e-commerce at the moment, consequently securing funding shouldn’t be too challenging. Specialists in this space are few and far between though and the PE firms instead tend to specialise by the amount of cash they are providing.
Private equity investors are looking for a 2X/3X return within a set period, often five years. Some are set up to offer consultancy on operations, others aren’t. Private equity firms will require board seats and input towards strategy management teams will need to work within these conditions to consider this option and be willing to sacrifice some control of strategy.
A third way?
A fresh approach to growth has emerged over the past 12 months that offers an alternative to the traditional funding-led strategies. It comes in the shape of a new segment of third-party specialists to whom businesses can outsource their e-commerce function wholesale – from front-end to supply chain management to distribution in exchange for sharing some upside in the form of sweat equity or bonus fees.
Often these agreements will place a brand under an umbrella group, which also allows it to scale quicker thanks to the associated efficiencies of scale and combined bargaining power. It provides the benefits of M&A, but without the associated costs and onboarding headaches. It’s a tempting proposition. This effectively de-risks any operational considerations within the business allowing the senior management team to focus on strategy and new product development.
If this sounds too good to be true, it can be – depending on your long-term exit strategy. If this involves a sale, then vendor lock is a significant risk. An e-commerce business is the sum of its parts – the unit economics, which take in the cost of acquiring customers, their lifetime value by channel, by geography, re-order rates, churn and more.
Part of the operating and marketing infrastructure may be dependent on other platforms, which can be hard to disentangle – as is the value held in all the other technologies within the third-party stack. In which case, the seller has little to effectively offer other than the equity held in the brand name.
The short, mid and long-term growth strategy of any ambitious e-commerce business should be guided by the principle that growth is, ironically, finite. At least until new audience segments are unlocked. This means funding needs will change over time, but close analysis of data means there’s never any excuse for being taken by surprise – and equally a founder should always walk into investor relationships with eyes open.
Fran Quilty, CEO and founder, Conjura