This chapter is an extract from LegalVision’s Online Business Manual. Download the full guide here.
Financing Your Online Business
Launching an online business has a low cost-barrier to entry. Even if you don’t have engineering expertise in your founding team, the cost of hiring a team of developers and launching a Minimum Viable Product is low. Online businesses can use platforms like Shopify and BigCommerce to launch almost overnight. But an online business still needs financing.
Online businesses need access to capital to grow and scale. There are three ways in which you can finance the growth of your online business:
- Profits from sales to your customers
- Raising equity finance
- Raising debt finance
Financing Growth through Sales and Profits
The best way to grow an online business is by making sales. There is a great deal of talk in the startup community about raising capital. But some of Australia’s most successful startups have not raised external funds, for example, online fashion retailer Showpo. They simply built a product that customers wanted, made lots of sales, and reinvested the profits into growth.
If you are looking to build an online business that will generate enough revenue to support your lifestyle, raising external capital does not make much sense. Focus on selling your product and keeping complete control of your business.
If you are looking to scale quickly and are spending significant amounts of capital on growth and development, then you are likely to be running your business with a burn rate (i.e. losing money on a monthly basis) for a substantial period until you become profitable. To do this you’ll generally need to raise external capital. One way to raise capital, in a way that does not affect your cash flows, is equity finance which is issuing new shares in your company to investors. The investors will become shareholders in your company.
Most entrepreneurs will raise the first round of equity capital from their friends and family before looking to angel investors and then venture capital funds. If you are considering raising equity capital, please download the LegalVision Startup Manual. It covers all the tips and tricks you need to know about capital raising.
Many small businesses approach banks or non-bank lenders such as Prospa or Sail for debt funding. Debt finance can be a good option if you are:
- looking to raise a small amount of capital;
- purchasing an existing profitable online business; or
- willing to provide a personal guarantee (i.e. secure the loan against some of your assets).
The obvious benefit of debt finance compared to raising equity is that you can retain 100% ownership of your company. The downside, of course, is that you must repay the loan as well as make interest payments. Only take on debt that you can afford to repay, even if trade slows down.
NAB Case Study: How to Finance a Growing Business
There are two common ways to finance a growing business: debt finance and equity finance. Whether you choose debt or equity depends on your business’ cash flow and the amount of capital you need to grow your business.
Debt Finance vs Equity Finance
Debt financing is where you borrow an amount from a lender, such as a bank or credit union, and repay the amount plus interest over a period of time. The ‘price’ to access the capital is the interest payments.
Equity financing is where you trade shares in your company for cash. The ‘price’ to access the capital is some number of shares in your company. Providers of equity finance include angel investors, venture capital funds and private equity funds.
Which Should I Choose For My Business?
Equity finance is advantageous because you share the risk of your business with your investors — if your business is unsuccessful, you don’t need to pay your investors back. In exchange for accepting this risk, investors share in the company’s profits. Also, equity finance does not put a strain on your cash flow, because there’s no need to make interest payments. But equity capital can be hard to come by because there are far fewer equity investors than debt financiers.
Debt financing is easier to access for most businesses, and you retain ownership of your business. Some lenders require you to provide security for their loan — you give the lender the right to seize certain assets if you default on the loan. Take care when providing a security — although it will reduce your interest payments, it also puts your assets at risk.
There are different debt finance options, depending on your growth goals. If a small business aims to conduct business in overseas markets, trade products (such as letters of credit and open account terms) work well as they help to manage fluctuating exchange rates and credit risk. If a business needs to buy inventory and equipment or wants to expand its team, a simple term loan is the most flexible and the best option for small businesses. Typically, you can choose a fixed or variable
interest rate. The choice depends on your risk appetite.
Most businesses will finance their business through a combination of debt and equity to balance the pros and cons of each option.
Practical Tips When Assessing Debt Financing Options
Understand your business’ accounts
Cash flow issues can arise when businesses take on excessive amounts of debt. Limiting your business’ debt will also help with your credit rating, and your ability to apply for further funding.
Plan for the future
Work with your lender to achieve the cash flow requirements of your business. For example, if your business experiences fluctuations in sales during the holiday season, ensure your debt financing solution will help you manage any seasonal cash constraints.
Keep the lines of communication open with your lender
If you expect that adverse business conditions will affect your ability to make loan repayments, communicate with your lender early to avoid defaulting on your loan. Lenders can often relax repayment conditions for short periods, but only with prior warning.
If you have any questions about financing your business, you can contact LegalVision’s online business lawyers by calling 1300 544 755 or filling out the form on this page.
This chapter is an extract from LegalVision’s Online Business Manual. Download the free 53-page manual which includes all chapters and features case studies from NAB, Deliveroo, Airtasker and HubSpot.
This manual covers all the essential topics you need to know about starting your online business, including setting up your online business, protecting your brand, growing your team and scaling your business.
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