7 Financing Options for DTC Brands

Providing insight into alternative forms of financing for DTC founders.
By Brent Murri, Jack Gorab, Gaelen Hendrickson

Last Updated: September 19, 2022

Published: September 15, 2022

This is the second article in a multi-part series on M13’s Future of Commerce thesis. View part one here.

Read on to learn:
  • The state of venture capital funding for direct-to-consumer brands
  • Things to consider when figuring out what funding is best for your business
  • Some alternative sources of funding that may be right for you



The state of VC funding for DTC brands

Before we talk about funding, we’d be remiss not to mention the impact Shopify has had on the world of commerce and venture capital funding.

Founded in 2006, Shopify helped to modernize the e-commerce enablement sector—SaaS providers that allow direct-to-consumer (DTC) merchants to run their business online.

Shopify offered sellers simple tools that made it easy for them to set up an online storefront in days or weeks, and to accept payments online. This provided DTC founders with a much-needed alternative to physical store build-outs.

Over the next decade, Shopify established itself as the leader in commerce infrastructure and went public in 2015 at a $1.3B valuation, powering 160K online stores at the time. By lowering the barrier to entry for online merchants, the DTC industry exploded. By the end of 2021, Shopify commanded a $200B+ valuation, powering over 2 million merchants (author’s note: as of this publish date, Shopify has an approximate $50B market capitalization).

Unlike traditional brick-and-mortar retailers that rely primarily on foot traffic to enter their stores and buy products, Shopify merchants need to primarily acquire shoppers online. Their customer acquisition strategies are largely driven by online advertising—purchasing expensive ads on Facebook, Instagram, and Google—which has become increasingly cost prohibitive, inefficient, and subject to ever-changing complex rules and regulations over the years

In the early days of DTC, venture capital dollars funded online growth strategies for category leaders like Bonobos (raised $128M), Casper (raised $340M) and Warby Parker (raised $536M). But with rising customer acquisition costs and increased competition, exit outcomes have become more limited and venture dollars have started to retreat.

In 2018, DTC brands received over $1B in venture funding, which was up significantly over the $423M in funding these brands raised only two years prior. But since 2018, the flow of venture dollars into DTC brands has steadily declined by an average of 7% per year.

The below charts paint a good visualization of how funding into the DTC space has dropped off over the last four years, while sales in the category continue to show strong growth. As this trend continues, a growing gap will arise in the dollars needed to sustain the DTC market.

VC dollars trending down while VC revenue trends up


Sources: (1) Pitchbook. Includes U.S.-based early stage investments (Angel to Series B) in consumer verticals including apparel, consumer non-durables, consumer electronics, home furnishings, appliances, and recreational goods; investors that primarily classify as “Venture Capital”.
(2) eMarketer. Digitally Native Brand D2C Sales within Direct-to-Consumer Ecommerce Sales, US report.


With more merchants expected to come online over the coming years and fewer venture dollars available to fund them, where will founders find the capital to grow?

Over the last few years, we’ve seen innovative new financing companies emerge to help fill the funding gap. With so many options available in the market for DTC founders, we have created a guide on how to assess your various funding options and figure out the best alternative financing solutions to grow your business.

What to consider when choosing funding for your DTC business

There are a number of considerations DTC founders must think about when deciding to take on financing to help them grow their businesses. Here are some essential things to evaluate as you assess your financing options.

How will you directly use the funds?

While it seems simple, this is one of the most important things to consider. There are different funding options for different use cases, and each has nuances that founders need to understand.

Inventory financing, for example, can only be used to specifically purchase raw materials or finished goods whereas revenue-based financing is best used for predictable and repeatable spend like direct marketing costs.

Think about the ultimate use of funds and how that aligns with your immediate and long-term goals and use that framework to prioritize your funding options accordingly.

What is the cost of capital?

Each source of financing and each provider has a unique cost, which can include interest rates (fixed or variable), revenue share, origination fees, advance fees, and/or in select cases, warrants that turn into equity down the line.

Before you choose a source of funding, determine the annual percentage rate (APR) you’ll owe on the capital—not just the interest rate. The APR is the all-in annualized cost of borrowing and includes the interest rate (or equivalent), origination fees, and closing costs.

Is there collateralization or securitization involved?

Collateralization is the use of an asset as collateral to secure capital, and this provides downside protection to the capital provider. Collateral can take the form of personal assets (e.g., equity, house) or business assets (e.g., equipment, inventory). If the borrower defaults on the loan, the capital provider could have the right to these assets so it’s important to understand what assets might be at risk in the case of a default.

Are there personal guarantees?

Certain financing solutions come with personal guarantees, so the borrower may have to pledge their personal assets or ensure full repayment in the event of a default. Essentially, a personal guarantee means that in the case of a business default, the borrower is held personally responsible to pay back the capital (even after any business collateral is recouped). Again, it’s crucial to understand how you may be personally liable to cover any capital in a downside scenario.

What are the funding and payment timelines?

You’ll need to understand how fast you have access to capital and when you’ll need to repay it, plus any stipulations (like prepayment penalties or additional funding capacity) that may affect your payment timelines.

Founders are faced with numerous funding options, ranging from cheap debt to expensive equity. We break down these options below to describe what they are and review pros and cons related to each.

7 founder financing options


7 alternative financing solutions for DTC founders

There are many different funding options available for DTC founders in the capital markets today. Here are seven options to consider, ranked from least to most expensive, plus a detailed breakdown of the different options.

SBA or bank loan icon

SBA loans or bank loans

What are they?

Loans provided by a banking institution.


Small Business Administration (SBA) loans are backed and guaranteed by the U.S. government. They’re given out by traditional lenders including banks and private lenders.


Bank loans (also called term loans) are non-revolving, one-time lump sum payments with a defined interest rate and payment schedule. They’re issued by traditional lenders including banks and private lenders.


SBA loans are likely the least expensive forms of financing for startups, followed closely by term loans from banks.


Typical borrowing amounts

$5,000 - $1,000,000


Average interest rate*

5-8% APR


Sample providers

JP MorganSBA LendersWells Fargo

Pros
  • Often the cheapest form of capital
  • Negotiable repayment terms (5-25 years)
  • Flexible with how you use the funds
Cons
  • Takes significant time and energy to underwrite and receive funds
  • Need high personal and business credit scores (690 or higher for personal; 155 or higher for business)
  • Typically require your business to be profitable
Other considerations
  • Most require you to be in business for at least 2 years, but there are exceptions. This makes it harder for startups to obtain these loans
  • Loan can be collateralized, meaning if you don’t repay, the bank has claim on assets you own



Revolving credit facility or Line of credit icon

Revolving credit facility or line of credit

What is it?

A revolving credit facility, or line of credit, is also a loan typically offered by a bank, but the borrower has the flexibility to withdraw, repay, and withdraw capital again. Interest only accrues on the outstanding withdrawal amount.


This is generally used to fund operational expenses in order to free up working capital for other uses. If you pay off the interest each month, this can be a very affordable financing option.


Typical borrowing amounts

$10,000 - $10,000,000


Average interest rate*

4-15% APR


Sample providers

AmplaJP MorganFundboxKabbageSVB
Upper90Wells Fargo

Pros
  • Typically lower interest rates
  • Only pay interest on funds drawn
  • Flexible with how you use the funds
Cons
  • Need high personal and business credit (690 or higher for personal; 155 or higher for business)
  • Lenders will typically require borrowers to maintain certain covenants (e.g., debt-to-equity ratios)
Other considerations
  • Most require you to be in business for at least 2 years, but there are exceptions. This makes it harder for startups to obtain these loans
  • Look out for the total cost of capital including hidden fees like origination and prepayment fees



Business credit card icon

Business credit card

What is it?

These are similar to traditional credit cards, but business credit cards have much higher credit limits.


Business credit cards are generally better to use for smaller day-to-day expenses, and they don’t require personal guarantees.


With today’s offerings, business credit cards are largely untied to personal credit, so founders don’t have to worry about corporate cards affecting their credit scores.


Typical borrowing amounts

$10,000 - $5,000,000


Average interest rate*

12-25% APR


Sample providers

American ExpressBrexRampRho

Pros
  • Quick decision process (approvals within weeks)
  • Flexibility with how you use the funds
  • Attractive cash-back programs (1-5%)
  • No personal guarantees
Cons
  • Monthly spend limits can be lower than other forms of debt, which means they’re not a good option for large purchases like inventory or equipment
  • Interest is high if you don’t pay off your balance
Other considerations
  • Many providers offer all-in-one banking and card solutions to streamline financing services (e.g., Rho**)



Accounts Receivable factoring or financing icon

Accounts Receivable factoring or financing

What is it?

Accounts receivable (AR) factoring allows companies to sell their AR to a factoring provider at a discount. The company gets immediate cash. AR financing allows companies to get a loan based on outstanding invoices and the invoices themselves act as collateral.


Say you operate a consumer brand and you receive a large purchase order from Target for $500,000. You could decide to use a factoring provider to free up cash from a capital-intensive purchase order (PO). If Target will eventually owe you $500,000 for your PO, a factoring provider might offer you $475,000 now and take over your AR with Target. In time, when payment is due from Target, the factoring provider will receive the full $500,000 from Target. With the $25,000 difference, they will collect their predetermined fee and pay you back what’s left over.


Typical borrowing amounts

$5,000 - $1,000,000


Average interest rate*

10-20% APR (70-90% advance rate)


Sample providers

FundboxKabbageLendio

Pros
  • Quick and easy process to get approved
  • Frees up capital to use on other business needs
Cons
  • Can be expensive depending on repayment periods
  • You give up part of your promised AR
  • Factoring companies will interact with your customers directly
Other considerations
  • Easier to get with large, established retailers (i.e., a PO from Target will be easier to lend against than a PO from a small boutique)



Inventory or purchase order financing icon

Inventory or purchase order financing

What is it?

Inventory financing is asset-based funding that’s used to purchase inventory where the inventory itself serves as collateral.


Businesses usually use this option to fund purchase orders or limit working capital exposure and cash flow gaps due to large inventory quantities.


With this type of financing, businesses can effectively use the value of their unsold inventory to support their business in a number of ways. For example some lenders pay your suppliers directly and provide you with extended payment terms, improving your cash conversion cycle.


Continuing with the earlier example about the order from Target, instead of using cash from your balance sheet, an inventory financing lender might approve you for 50% of the inventory value and give you a loan for $250,000 to use for the purchase order. Once your goods are sold at Target, you use the proceeds from sales to pay the lender back.


Typical borrowing amounts

$5,000 - $1,000,000


Average interest rate*

10-100% APR


Sample providers

FundboxKabbageOnDeckUpside8fig

Pros
  • Quick decision process (usually funding within 48 hours)
  • No long diligence process or credit checks
  • Frees up capital to use on other business needs
Cons
  • Can be expensive depending on repayment periods
  • Lenders won’t want to offer terms for low-turnover inventory
  • Depending on type of inventory there can be a lengthy audit process to determine the value of goods
Other considerations
  • Good option for businesses with large amounts of physical assets
  • Lenders may want to value your inventory at “salvage” value, lower than what it’s worth today. High turnover businesses are more attractive



Revenue-based financing icon

Revenue-based financing

What is it?

Revenue-based financing is an agreement where merchants repay capital from investors only when revenue is generated. Investors share a portion of the revenue until the initial capital is paid back.


One thing to note: revenue-based financing is not a loan, and any representative from one of these providers will avoid calling it that. Rather, it’s an agreement to buy a portion of your future revenue. This is sometimes called a merchant cash advance (MCA), and it’s generally better for repeatable and more predictable spend like marketing costs.


While reasonably easy to obtain, revenue-based financing can be the most expensive form of capital if you look at an annualized interest rate. When you factor in repayment periods, annual rates can get into the high double digits and even triple digits.


The provider might charge a flat 6% fee, for example. This fee is assessed on a daily basis and is based on sales hitting your account. If you borrow $100,000, you’ll need to pay back the provider a total of $106,000, and they’ll take a portion of your daily sales until the $100,000 + $6,000 fee is fully paid.


If it takes you a year to pay that back (hopefully that’s not the case!), then you’re paying an effective 6% APR. But most DTC merchants are making daily sales to customers and pay it back much faster than that. If you pay it back in one month, then you’re effectively paying a 72% APR (6% x 12 months = 72%)!


Typical borrowing amounts

$5,000 - $5,000,000


Average interest rate*

10-300% APR


Sample providers

CapchaseClearcoSettleShopifyStripe CapitalWayflyer

Pros
  • Quick decision process (usually funding within 48 hours) and likely the fastest way to receive alternative financing
  • No long diligence process or credit checks
Cons
  • Expensive and not a long-term solution
  • Limited in how you can use the funds
Other considerations
  • This can be a good use of capital if you have a proven, high ROI-generating marketing channel that you want to accelerate your growth through quickly
  • It can be harder to get if you have existing debt. Other debt providers, like banks, want to be paid first so they won’t want an MCA taking money before them



Equity icon

Equity

What is it?

Equity is often considered the most expensive form of financing because you give up ownership of your company. While we don’t categorize equity as an alternative form of financing, we wanted to present the pros and cons of considering equity in lieu of non-dilutive solutions.


VC dollars have retreated from DTC as a category, but there are still funds that continue to deploy capital into the sector. In addition to capital, they can offer founders experience, counsel, and true long-term partnerships.


Typical borrowing amounts

Variable


Average interest rate*

N/A


Sample providers

Angel InvestorsBlackjaysCavuCoefficient CapitalHalogenLerer HippeauVerityWillow Growth

Pros
  • Positive signaling. If you receive VC funding, then there is validation that the business is strong
  • Founders get mentorship and partners with experience
Cons
  • Dilutive to founder ownership
  • Most expensive form of funding
  • Long process (2-4 months of diligence)
  • High legal fees for financing docs (a SAFE document is the exception)
Other considerations
  • Having a true partner around the table can open many doors including introductions to retail partners, service agencies, influencers and ambassadors, and more
  • In a Pre-seed or Seed round of funding, you should expect to give up 10-25% ownership of the company



Case study: Upside Financing

Brands experience long and inefficient working capital cycles, owing payment on their purchase orders (POs) 1-3 months before receiving cash on the sold goods.


Here’s the typical cash conversion cycle for brands.




Upside Financing, an M13 portfolio company, gives brands a negative cash conversion cycle. Brands receive extra time to convert goods into cash before owing payment on the purchase order. This frees up capital to spend on marketing or other growth initiatives.



This is especially advantageous for DTC brands that are pursuing an omnichannel approach and leveraging both online and offline sales to grow. Other alternative financing solutions will typically underwrite only a brand’s online sales, while Upside takes in a holistic understanding of all sales through Shopify and retail locations. This can unlock significantly more capital for brands that are selling in omnichannel retail environments.


Typical DTC brand requirements to qualify for Upside Financing:

  • Minimum of 6 months sales history
  • Production runs completed with a co-packer
  • Existing retail relationships
  • No AR past 60 days overdue



More funding options available to founders today than ever before

Commerce is entering a stage where venture capital will be harder to come by. Less equity is supporting brands, while more brands are being created each day. But the good news is founders now have many options available to them. This means they’ll have the opportunity to explore less expensive forms of financing, ultimately hitting their growth goals while maintaining more ownership of their companies.

Read part 1 of M13’s Future of Commerce investment thesis:



*Rates vary significantly from lender to lender.
**An M13 portfolio company

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