How D2C Brands Use Debt to Finance Growth | F50 Insights Post III

By Sonal Gandhi
Chief Content Officer at The Lead

Capital valuation and equity raises slowed down in 2022, especially among direct-to-consumer businesses. Venture investors are also now insisting on profitable growth as opposed to the “growth-at-all-cost” models of the pre-pandemic years. Many of the brands we interviewed for the Foremost 50 list believe fundraising will continue to be challenging in 2023. And those who have recently or are planning to raise capital are being very deliberate and thoughtful in its deployment.

But the fact is, young brands need capital for growth and just like brands before them, many are turning to debt-based financing. Debt-based financing isn’t new — it was a channel that traditionally wholesale brands used to primarily borrow against POs, inventory, or receivables. But, the offering has been updated with the evolution of brands and there are now growing options available for direct-to-consumer brands based on their unique business models and cash-flow requirements.

According to Andrew Barone, SVP and Director of the Pipeline Division at Rosenthal & Rosenthal, which offers growth capital solutions exclusively for consumer product companies including high-growth D2C brands, “leveraging debt allows companies to focus on profitable metrics and supporting the business with cash flow, which can ultimately lead to a better future valuation if equity capital comes into the business”.

Alternative options for financing growth are becoming easier to access.

Andrew helped lay out the options that are growing in popularity amongst D2C challenger brands:

1. Asset-Based Lending

Asset-based lending is the most traditional type of financing, as well as the most cost-effective. Borrowing against the brand’s balance sheet, the lender provides funding based on inventory cost value, typically between 50-60%. If the business has a wholesale channel, receivables can also be leveraged for cash flow typically up to 85%. However, D2C brands taking advantage of Section 321 to avoid paying duty on imports should be sure to ask their lenders if inventory located in Canada or Mexico is eligible for borrowing.

2. Revenue-Based Financing

For brands that are primarily D2C, this borrowing option is based on a company’s historic sales where a lender looks back at 1-3 months’ worth of sales to determine a credit line to draw against. Borrowing rates are dependent on the prior period’s sales average and can be a more expensive debt option compared to asset-based lending. Typically, the company pays the lender back daily, around 10-20% of credit card receipts from website sales. Seasonal brands, like outerwear companies, that need to bring in inventory during the summer months with minimal near-term sales to leverage, should be wary of this option.

3. Accounts Payable Financing

Accounts payable financing is a great option for companies that receive extended payment terms on inventory purchases from a lender rather than the supplier directly. The lender will typically extend payment terms on purchases to their borrower in 30-day increments, up to as much as 120 days with payback auto-debited from their borrower’s operating account. Companies can pay suppliers immediately without having to use their own working capital. Think of accounts payable financing as PO financing for direct-to-consumer brands that lack capital or supplier terms but know they can sell through items quickly and efficiently with a high enough margin to cover the cost of this type of capital.

As many D2C brands branch out into wholesale they can also access options such as:

1. Factoring

As many D2C brands branch out into wholesale they can use factoring, a form of secured lending, to get working capital to run their companies. A factor lends up to 85% against the brand’s receivable for cash flow and will assume the credit risk. Factors also handle all aspects of managing the receivable (i.e., ledgering, reporting, and following up with customers on your behalf when payment is due) and essentially become an outsourced receivables department. While slightly more expensive than asset-based lending, the added services and benefits beyond increasing cash flow make it worth it for many businesses.

2. Purchase Order Financing

When companies receive a large purchase order from a retailer, but they lack the capital or supplier terms to produce the order, a purchase order (PO) financing firm can help. PO financing solutions range from a letter of credit if suppliers require cash in advance to produce goods or a wire transfer to the supplier for final payment when the goods are ready to be put onto a vessel and shipped. Typically, if margins on the order are 25% or greater, a PO financing firm can provide 100% of the cost of the goods to produce the order, including freight and duty payments.