7 Ways To Fund An E-Commerce Business
Guest post written by Aaron Burton founder of 20XMedia.com, an e-commerce marketing agency.
Looking to buy a business? An E-commerce store is probably your best bet as we approach 2020. They are easier to run and are typically less costly than the traditional brick & mortar businesses.
Plus, you get to overcome geographical limitations and expand your market to national and international levels with minimum capit1al investment.
With that in mind, it’s abundantly clear that you need a financing plan, not just to buy the business but also to keep it operational and profitable.
This article covers seven next-level ways to buy an e-commerce business with little to no money down:
- Seller financing
- Leveraged buyouts
- Government-backed SBA loans
- Venture capital
- Private Equity
- Working capital
If you haven’t been living under a rock over the last five years then you would know e-commerce is booming, enough to propel Amazon’s Jeff Bezos to the top spot on the word’s richest list.
Why Buying a Business Makes More Sense Than Starting From Scratch
The fancy name for this business strategy is "entrepreneurship through acquisition."
True, there are benefits and drawbacks to both buying an e-commerce business and starting one from scratch, but many people agree that the positives come down firmly in the “buying a business” camp.
For one, the product has already been validated in the marketplace with instant customer access to earn income from day one.
This already makes it easier for you to secure financing since most lenders are more inclined to fund the purchase of a business with a proven ability to generate income rather than support an unknown start-up.
Read our article on how to buy an e-commerce business on the exchange marketplace
Now that you know what business you potentially want to buy, it’s time to explore some of the funding options available to you.
#1. Seller Financing
Seller financing or owner financing is when the original owner of the business you want to buy offers you a loan to cover a portion of the purchase price of the business.
You’ll make a down payment as soon as the deal closes while the financing from the seller covers an agreed amount of the sale price, plus interest, and any other terms set by the lender.
Since seller financing rarely covers the entire cost of a business, buyers usually use other forms of financing, like Small Business Administration (SBA) loans, in tandem with their seller’s loan.
Seller Financing Requirements
Seller financing is more common in real estate arrangements, but the requirements are pretty much the same for buying an e-commerce store.
There are two important forms of paperwork required -- one is called a promissory note which spells out the terms of the loan and expectations for repayment. The other will be a deed of trust which provides security for the loan.
Your down payment is usually the seller’s first line of defense, but they might also ask for some form of collateral.
You or the seller can hire an attorney to draft the promissory note and other necessary legal documents.
That being said, Shopify sellers are less likely to be open to seller financing. However, if the acquisition is big they may let the buyer place a large enough down payment.
#2. Leveraged Buyout
A leveraged buyout is basically leveraging the company’s assets to get a loan. Simply put, it is a financing model to purchase a company using debt.
The defining characteristic here is that it's the company that you buy that takes on the debt, while you put some money (equity) down and take a significant ownership stake.
In order for this to work for an e-commerce store, the business must have inventory to leverage against
That’s why if you are buying a dropshipping store on Shopify, then it will be hard to use this model to finance your purchase.
How to Structure a Leveraged Buyout
The amount of debt that lenders are willing to provide to support a leveraged buyout varies greatly and typically depends, among other things, on:
- The quality of the assets of the e-commerce business to be acquired (cash flow stability, growth prospects in the market, physical assets, etc.)
- The amount of equity you supply
- Your business history and experience
- The overall economic environment
Businesses with high-quality assets may be considered for debt volumes of up to 100% of the purchase price. But this is a very rare scenario since risks must also be measured and online businesses have their fair share of risks.
The usual debt ratio provided for “normal” businesses ranges from 40–60% of the purchase price with the remainder financed with equity.
Leveraged buyouts can also use other financing options like seller financing, SBA loans, and inventory financing to complete the purchase.
#3. SBA Loan, Government Backed
An SBA loan is the gold standard of business financing among small business owners. They are long term and flexible, with lower rates from lenders partially guaranteed by the US government.
However, they are highly competitive so getting the loan isn’t always a given. SBA loans are becoming more popular on sites like empire flippers.
Amazon stores are more likely to be SBA loan eligible. Similar to leveraged buyouts, an SBA loan would like to see inventory as well as some history of good management behind the store.
SBA Loan Requirements
While there are several criteria, you can better your chances of getting an SBA loan if you can fulfill the following minimum requirements:
- At least two years of business history under your belt
- A 640+ personal credit score
- $100,000+ in annual revenue for the business you’re buying
How to Find SBA loans
The SBA Lender Match system can connect you with participating SBA-approved lenders to apply for an SBA loan.
The process is pretty straightforward and involves answering a few questions about your business and outlining exactly why you need the SBA loan. You will then be matched with interested lenders and you’ll get to talk to them about your loan.
#4. Venture Capital
Venture capital is a type of financing provided by well-off investors, investment banks and any other financial institutions for small businesses and startups with long-term growth potential.
Although there is a degree of risk on the part of the investors and institutions that put up the funds, the possibility of recouping above-average returns makes for an attractive payoff.
Over the years, venture capital funding has risen in popularity for new businesses or ventures with limited operating history, especially if the business owners lack access to bank loans, capital markets, or other debt instruments.
Keep in mind that with venture capital, the investors usually get equity in your business so they usually have a say in company decisions.
Venture Capital Requirements
Venture capital doesn’t have as strict requirements since these types of investors are primarily interested in investing in a company with vision and a high expected return.
They are also open to making e-commerce investments if the business has a nice track record and you can propose a plan on how to grow it further.
Venture Capitalists love e-commerce startups that can clearly outline
- A winning business plan
- The amount of startup capital required
- The level of control desired
- A realistic budget
- A current valuation that allows for a good return on investment, and
- Have an experienced management team
How to Find VC Companies
Well, you’ll want to focus on meeting the requirements first. Take the time to craft a compelling proposal with a detailed blueprint of how you plan to keep the business profitable Hire a professional to prepare these documents for you if need be.
With that out of the way, you’ll want to start by streamlining your search to venture capital companies that invest in e-commerce ventures.
You can begin your search by checking with venture capital associations like the SBA’s Small Business Investment Company (SBIC) program and the National Venture Capital Association (NVCA). They provide tools and resources that can help you find the right VC companies.
#5. Private Equity
In simplest terms, private equity (PE) financing is when institutional or high net worth individual investors buy a controlling stake in a business and streamline operations to increase revenues.
This means that even if you manage to secure PE capital to finance your e-commerce business purchase, the business won’t actually be yours. Private equity firms buy businesses to give their investors a yearly return so they will be strict with what they invest in since its not their money.
In a way, private equity is similar to venture capital, but there are some key differences worth noting.
For one, private equity firms mostly go for established companies with proven profitability ratios. These could be companies that are declining or not making the profits they should be due to inefficiency.
Private equity firms buy these businesses. On the other hand, Venture capital firms mostly fund startups with high growth potential.
Private Equity Requirements
The investment criteria for private equity financing are as stringent as they come. Different PE firms have their own unique set of requirements, but the general ones include:
- Strong market position and long-term competitive advantages
- Multiple growth avenues
- Stable, recurring cash flows
- Low capital expenditure requirements
- Favorable industry trends
- Strong management team
- Multiple value creation sections
How to Find PE Firms
Finding a PE firm is easy. A simple Google search will reveal a list of those in your regional areas.
What you really want to know is how can I get PE funding for this business I want to buy? Securing private equity to finance the purchase of a business is all about working the connections you have.
In 2014, yogurt giants, Chobani needed funding to the tune of $750 million and was able to get it from PE firm, TPG. It turned out the cofounder of Chobani knew a prominent Turkish businessman who knew the CEO of TPG.
Do you see what happened there? A $750 million deal was concluded because one guy knew a guy who knew another guy… If the business you want to buy can qualify for PE financing, then you must have a lot of connections. Work those connections!
#6. Working Capital
Working capital measures a company's liquidity - the ability to run everyday operations.
While working capital is not an actual funding source for buying a business, it affords a clever way to get funding without putting down any money.
This is by seeing how much working capital the business qualifies for and leverage against that.
Getting a working capital loan can be useful if, for instance, you just put down a large downpayment to buy your e-commerce business and now find yourself strapped for cash to continue running the business.
These operational costs can include payroll, marketing, and debt payments.
Working Capital Requirements
Working capital loans are in abundance for Shopify stores and usually, come with very slim requirements.
Of course, you’ll need to be able to fulfill the minimum requirements like clear repayment terms and guarantee/collateral in the case of large funding applications.
How To Find Working Capital
Since we’re talking about buying and running a Shopify store, we might as well get our working capital funding from Shopify itself.
This program is known as Shopify Capital and is designed to provide business owners with the funding they need to scale and execute strategic plans in their business.
If approved, the amount will be deposited into your business bank account with a percentage of your daily sales repaid until the total owed is repaid.
Crowdfunding is a way to raise money from anyone with money to invest. This can be donations from your family, friends, friends of friends, strangers, other businesses, and more.
It basically utilizes the easy accessibility of vast networks of people through crowdfunding websites and social media for the opportunity to solicit support from the crowd.
The requirements for securing crowdfunding financing tend to vary with every crowdfunding platform featuring its own regulations.
In any case, under current U.S. federal law, the Securities and Exchange Commission (SEC) regulates the sale of securities to the public as an investment, which is essentially what crowdfunding is about.
What are the Top Crowdfunding Websites?
Thankfully, crowdfunding has become so popular that several websites have popped up and have helped Shopify business owners.
Our top picks include:
Some of the most popular Shopify stores that have been crowdfunded are MVMT Watches and Snow Teeth Whitening.
The Bottom Line
Thanks to the continuous rise in the popularity of e-commerce, it’s become easier to secure funding for your Shopify business purchase.
The next step is for you to perform due diligence and make sure the business you want to buy can successfully meet the requirements of these funding options.
The best part is that you don't have to rely on only one option, so you could diversify your funding sources and have enough left to fully position your new business for higher profitability and competitive advantage.
Frequently Asked Questions
Question 1: What happens if you don’t pay back a loan?
Answer: The penalties for defaulting on a business loan will have been clearly outlined as of the time you applied for the loan. Either way, it can have a serious impact on your business financing going forward, from the loss of your assets to having a negative impact on your credit rating and hampering your future financial options.
Question 2: Do I need a good credit score to get funding?
Answer: For the most part, yes. It’s one of the first things a lender will look at before deciding to accept or reject your loan application. Still, it is possible to get business funding with bad credit. However, this might mean that you won’t have much wiggle room for negotiations since these lenders are already taking a huge risk.
Question 3: What's the difference between a personal loan & a small business loan?
Answer: The main difference between these loan options are their respective purposes. A personal loan is intended primarily for personal use and is issued to an individual to do with it as they please, provided they can prove that they can repay it. Small business loans, on the other hand, are loans intended for business-related expenditures.
It’s not uncommon for owners of small businesses to divert some funds from a personal loan towards their business and vice versa, but it’s not really ideal. Some lenders even make sure to specify in their terms that personal loans must only be used personal use and business loans for business news.