Boost Your Scale with the Right Kind of Debt Financing
Let’s be honest – scaling a DTC brand takes lots of capital…ALWAYS.
Incorporating the right kind of debt financing into your growing brand’s capital structure can
Make or break your ability to scale in such a capital-intensive business
Reduce or eliminate the need to raise equity funding, which protects your ownership stake
Unfortunately, the wide range of debt financing options available can be overwhelming for founders to sort through, and choosing the wrong type of debt facility can quickly bring your brand’s scaling momentum to a screeching halt.
So, this week I will walk you through the good and the bad of the most common types of debt financing products that are utilized by DTC brands. By understanding the advantages and disadvantages of each option, you’ll be better positioned to make informed decisions that align with your brand's scaling goals.
Revenue-Based Financing
Revenue-based financing was made popular by lenders like Wayflyer, Shopify Capital, and Clearco.
It offers several benefits. First, the underwriting process is quick and easy, often taking just a few minutes to receive loan approval after connecting your Quickbooks and bank accounts. Additionally, this financing option does not require personal guarantees or covenants, and it is unsecured, meaning you don't need to pledge any of your business's assets as collateral.
However, revenue-based financing comes with some major drawbacks. The cost of capital is extremely high, typically ranging from 20% to 40% APR. Furthermore, making daily principal repayments results in a limited amount of capital being put to work over the loan's life.
I don’t typically recommend revenue-based financing unless it’s the only debt product a brand can get approved for.
SBA Loans
SBA loans have several benefits. First, they tend to be the lowest cost of capital debt option for earlier-stage, growing brands. They offer flexible terms lengths, allowing repayment periods of up to 10 years, while conventional loans usually only allow up to 5 years. The major benefit of a longer term length is that more capital stays in the business for a longer period of time. Additionally, they provide the ability for earlier stage brands to qualify for debt financing when traditional lenders would otherwise decline the application because of limited tax return or business history.
However, there are some downsides to consider. SBA loans require personal guarantees, and they come with stringent protections, including covenants and heavy repercussions in the event of default. Additionally, SBA loans require a senior-secured lien on all business assets. This means that if you’re unable to make loan payments, the lender has the right to seize and sell the business’s assets for cash. Moreover, your negotiation leverage is limited since the SBA mandates certain contract provisions that cannot be altered.
In summary, SBA loans can be a great source of low-cost debt capital for earlier-stage brands that can’t qualify for conventional financing. But - they come with onerous lender protections that are nearly impossible to negotiate.
Asset-Based Lines of Credit (ABLs)
Asset-Based Lines of Credit (ABLs) have several advantages. They offer flexible drawdown and repayment timing, making them suitable for short-term capital needs like seasonal inventory buildup. ABLs have very onerous lender protections, like SBA loans. But – oftentimes you can negotiate many or all personal guarantees and covenants out of the contract, which represents a major advantage over SBA loans.
There are several drawbacks associated with ABLs. Loan documentation can be complex and burdensome due to extensive lender protections. Typically, ABLs require a senior-secured lien on all business assets, although exceptions can be made for specific assets such as intellectual property and intangibles – if you know how to negotiate with ABL lenders. While ABLs tend to have a higher cost of capital compared to SBA loans, they are considerably more affordable than revenue-based financing.
Buy Now, Pay Later Facilities
Buy Now, Pay Later debt facilities have been made popular by lenders like Ampla, Settle, and Flexport Capital. Here’s how it works. This lending structure mimic vendor payment terms. The lender pays your suppliers directly, then you pay the lender back in 30, 60 or 90 days. The lender charges a financing fee for the service.
This financing option is particularly beneficial for emerging brands that lack the negotiating leverage needed to secure favorable payment terms with suppliers. Oftentimes with Buy Now, Pay Later there is potential for negotiating limited asset liens, collateral requirements, and operating covenants.
Nevertheless, there are limitations to consider. Most notable - Buy Now, Pay Later facilities are less flexible in terms of cash advance timing. Advances must align with vendor payment schedules, restricting the brand's ability to request advances as needed during cash shortages.
In Summary
Selecting the appropriate debt financing option for your growing consumer brand requires careful consideration of the pros and cons associated with each option.
Revenue-based financing provides easy approval but comes at a high cost, while SBA loans offer lower rates but involve personal guarantees and stringent lender protections. ABLs offer cash advance and repayment flexibility but require collateral and detailed loan documentation. Buy Now, Pay Later facilities mimic vendor payment terms but have limitations regarding cash advance timing.
By thoroughly assessing these factors, you can make informed decisions that align with your brand's financial needs and growth trajectory, ensuring sustainable and successful scaling.
One last thing I want to mention – this article is not an exhaustive debt fundraising manual. It is only the tip of the iceberg when it comes to running a debt fundraising process. It takes an expert CFO to walk a brand through the entire process of evaluating, negotiating, and on-boarding a new debt facility.
At Free to Grow CFO we are debt financing experts. From 3-statement financial projections to assess debt financing needs to advising on loan document negotiation - we can help you run the debt fundraising process from beginning to end.
If you’re ready to learn more about how Free to Grow CFO can help you procure and structure the right debt stack for your growing brand, click here to book a free intro call.
Until next time, scale on!
