Giving away equity to fund inventory and marketing is inefficient. Here’s why

Date
March 1, 2022
Category
Finance
Written by
Mark Corballis

Raising a round of investment is an incredible feat for any entrepreneur. With more capital behind you and seasoned investors backing you, there are undoubtedly huge opportunities ahead.

However, part of the challenge of raising equity investment is making sure you spend the money in the right areas of your business. In short: you don’t want to end up deploying equity funding to solve working capital problems. Here’s why.

Using equity to fund inventory dilutes your ownership for short-term gains

Equity financing involves raising capital by selling off ownership stakes in your company. It’s a long-term play on your company’s future, and you want to invest those funds where they’re going to bring valuable, sustainable growth.  

But when eCommerce companies use their equity to fund their working capital cycles, the cash isn’t available to invest in long-term growth and sustainability. Ownership is quickly diluted, and the fast but limited gains from selling products aren’t enough to recoup that long-term investment.  

There’s a clear misalignment between equity financing and working capital (like inventory and marketing):

  • Equity investments should be used to help you make sound decisions for the long-term health of your company. To make sound decisions, you can’t only be focused on turning a quick profit or pleasing your largest customer today. You want to make secure long-term investments with your equity instead. You’ll have money in the bank, and you can focus on innovative growth to help you beat out your competition years down the road.
  • Inventory and marketing spend, on the other hand, is the opposite of a long-term investment. When you invest in inventory or customer acquisition, you’re spending money today in order to see gains tomorrow, not next year or five years from now. A purchase order may get you enough stock to keep up with six months of demand, but eventually that cash will run out, and probably quickly these days — Asia-U.S. shipping contract rates are up 122% since 2020. You’ll just need to raise more capital again after that.

If you keep selling ownership shares and spending that cash on working capital, you’re limiting your future growth — and if you repeat this cycle too many times, you're eventually going to run out of shares to sell.

If you keep selling ownership shares and spending that cash on working capital, you’re limiting your future growth — and if you repeat this cycle too many times, you're eventually going to run out of shares to sell. You’ll lose controlling interest, and ultimately, you won’t be the key decision-maker. Your company’s future will be in someone else’s hands completely.  

So, how can you ensure that your equity remains invested in sustainable revenue growth and still find a way to buy stock for the short term?

Pairing short-term working capital solutions with equity funding breaks the cycle

A working capital financing solution helps you efficiently fund things like marketing and inventory — the aspects of your business where gains are realized very quickly.

Unlike equity financing, working capital financing is non-dilutive. You don’t have to give up any ownership shares to secure it. You’ll get immediate access to capital to buy up stock or spend on marketing to acquire new customers. Once you’re generating some revenue, you can pay off that financing while retaining the controlling interest of your company.

When it’s time to place a PO on raw materials and products, explore flexible working capital solutions like revenue-based financing that are tailored to suit your company's particular working capital cycle. This helps efficiently manage long lead times, precariously high costs of shipping, strict supplier payment terms, and other inventory challenges.

Say you need to put in a $100,000 PO for inventory with a four-month lead time, and your supplier requires payment upfront. Use a working capital solution to finance the purchase order upfront and get your inventory shipped, then pay it back as you sell your product.

When you deploy equity and working capital financing in tandem, you have a longer runway for making secure, long-term decisions.

When you deploy equity and working capital financing in tandem, you have a longer runway for making secure, long-term decisions. The working capital covers your overheads, and you’ll have a longer period of time before you need to go out to market and raise a round of equity again.

Combining equity funding with working capital finance
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Invest equity into long-term revenue growth

To see the most value from your company’s equity round, invest that funding into sustainability for the future. “Future growth” doesn’t mean the container of T-shirts you need to sell over the next six months — that’s what you need to turn a profit now. Instead, put your equity toward the new product line you want to unveil in two years or the expansion you want to lead to a new market. That’s long-term revenue growth.

Some areas where equity spend can have a particularly high ROI include:

  • Hiring: Use equity financing to hire a recruiter or a manager, add a new dep