Working capital is crucial for ecommerce businesses—it helps pay rent, staff, bills, and a whole host of other overheads. In fact, 82% of small businesses fail due to mismanagement of cash. But for many ecommerce enterprises, knowing when and how to raise capital is one of the biggest challenges they face. Fluctuating energy prices, global pandemics, interest rates, and general market volatility make the 2020s a difficult decade to make financial decisions. What businesses need is an overview of the options available to them. In this blog, we’ll explore the pros and cons of how ecommerce businesses can raise working capital and how viable they are in an unpredictable economic climate.
Private equity is a model of financing where a firm or fund uses money raised from investors to buy an equity stake in a private company. Once the company has grown in value, the firm sells its stake at a profit and repays investors.
Private equity funding is susceptible to market volatility in various ways. First, private equity firms tend only to invest in profitable or near-profitable companies, usually for a majority stake. Businesses need to be able to present a detailed plan describing past performance, projected growth, and a viable exit strategy to secure funding. Planning for the future can be challenging in periods of economic turmoil.
Economic downturns can make PE investment more available to ecommerce companies. PE firms tend to play a long game and won’t be put off by a temporary dip in the market. In fact, PE firms expect businesses to wait longer before going public during a slump, creating an opportunity for more stable investments. Firms also tend to see downturns as an opportunity to buy stakes in companies for less, meaning there’s a greater chance for ecommerce companies to secure investment for working capital, but with less negotiating power to ask for large amounts.
Interest rates are another factor when it comes to private equity. When rates are low, many investors looking for significant returns will look away from fixed income and credit securities. If PE firms can then secure investment capital at low rates, they have plenty of choice of where to spend it and can enjoy a healthy internal rate of return (IRR) and eventual return on their investment. That’s all good news for an ecommerce business looking for working capital funding. But when interest rates rise—as they currently are—this has the opposite effect. Investors run back to fixed income and credit securities, fundraising becomes more difficult for PE firms, and asset valuations drop as initial public offerings become less appealing. That puts a spanner in the works for PE firms looking for a clean exit and makes it harder for businesses looking for funding.
Venture Capital is technically a form of private equity, only focussed on promising startups and young businesses rather than more established companies.
Economic downturns have a significant effect on VC firms. Since they’re generally hunting for the next unicorn, market-susceptible companies trading in consumables rather than tech products or CPGs are unlikely to seem like a good bet in times of uncertainty. To secure funding, businesses will have to provide a detailed assessment of how macro factors like energy costs, interest rates, and inflation could affect them. Firms will also be concerned with efficiency. Any business looking for funding should be prepared to demonstrate strong sales efficiency, solid unit economics, and plans to grow capital efficiently.
Interest rates also impact strongly on venture capital fundraising. In 2017, a 1% increase in rates reduced the ability of VC funds to attract investor capital by 3.2%. For context, that means a 1% hike in 2021 would have wiped out $10.5 billion from the total raised by VC firms in that year. That’s $10.5 billion that wouldn’t be available to ecommerce businesses seeking funding.
Crowdfunding is the raising of capital from a large number of micro-investors. It generates $17.2 billion in North America each year, so crowdfunding can be a great option for companies with an established social community. Ecommerce enterprises can build communities through social media, live events, newsletters, and outreach. For more tips on how to use community, take a look at our community building whitepaper.
Economic downturns are especially detrimental to the crowdfunding space. Investors have less disposable income, so they’re more likely to tighten their belts. When VC finance is more scarce during a downturn, there’s also likely to be more competition for crowdsourced funding, making it harder for ecommerce companies to secure the working capital they need.
For businesses that decide to take the crowdfunding route, the best approach is to reach out for advice from people who have done it before, build a strong, diverse network of potential investors, and employ a good marketing strategy to bring maximum visibility to your campaign. With a loyal base of consumers, businesses may even be able to secure funding during a downturn, emphasising the need to build communities around your brand.
Loans, credit cards, and overdrafts are longstanding methods of securing business funding. They have the benefit of being backed by established financial institutions but are, therefore, highly susceptible to changing interest rates.
Recessions have a substantial impact on approval rates.During the 2008 recession, rejections for overdrafts and business loans rose by over 50% and 160%, respectively. As banks predict an increased risk of borrowers defaulting, they’re less inclined to lend—especially to young businesses without a strong credit history or proof of revenue. Companies can always expect a bank to perform a thorough review before giving them money, but checks will only become more stringent in difficult economic times.
Interest rates are a central concern when looking for funding from banks. Taking a fixed-rate loan when rates are high could lock a business into paying more than it can afford once rates come back down. While opting for a variable rate can leave borrowers exposed to crushingly high rates as central banks increase interest to fight recessions. What might seem a good deal at the time can turn out to be massively damaging to a company’s working capital. Before taking a loan, ecommerce businesses should always take advice on current interest rate trends and forecasts.
Venture debt is a short-term financing solution where early stage companies take loans from bank and non-bank lenders—typically between equity funding rounds—and repay them with the proceeds of the next round.
Market volatility can make venture debt a risky prospect. Because this form of funding is used primarily by early stage businesses, it presents a higher risk to lenders. That means it’s more expensive and can come with covenants and obligations that increase the risk of default—if a borrower isn’t able to keep their promises due to unforeseen circumstances, they’re liable to lose a slice of control in their company. If business is booming and a company’s growing fast, venture debt can be a great option. It leverages equity and provides flexible working capital against operational glitches and unforeseen overheads.
Economic downturns don’t totally preclude venture debt as an option for ecommerce businesses, but as with other forms of finance, it’s always worth having a solid short-term plan to see companies through to the next funding round.
Revenue-based financing is subject to a different regulatory regime than traditional debt financing. It allows borrowers to repay a loan as an agreed percentage of gross monthly profits instead of at a fixed rate.
Economic downturns have a much smaller impact on revenue-based borrowers because their repayments adjust in line with their profits. Unless a business loses money, they aren’t at risk of missing payments.
Severe economic downturns can significantly impact the revenue-based financing ecosystem as a whole. While borrowers are protected in the short term, as lenders take the hit from smaller repayments and can’t recover collateral if clients default, they’ll be much less likely to lend again once terms end.
Ecommerce SMEs will always need funding to help meet their working capital needs, and during periods of market volatility, their requirements are only likely to increase. While taking a loan of any kind always presents a risk, the best strategy is always to have a solid plan in place—both to present to lenders and to keep up with repayments.
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