Understanding Financing in the Online Business World
Financing in the online business world is difficult.
It’s not impossible, but it can seem pretty close at times. Buyers who are not heavily liquid with their capital are at a disadvantage. Since there are a limited number of tools for leverage out there to use, most buyers have to consider creative financing to find the money in more nontraditional ways.
This is also bad news for sellers. Because of the lack of financing open to these kinds of assets, the overall multiple you might get from selling your business is lower because there is no financing that can help prop up that multiple by giving more buyers access to purchase the business.
The Most “Traditional” Financing Path for Online Businesses: HELOC
Home equity lines of credit, or HELOCs, are a line of revolving credit similar to a credit card but with an extremely low-interest rate since a line of credit uses real estate you own as collateral. Some people call these a 2nd mortgage, and they can be used for anything you want.
Most people use a HELOC to fix up their property, such as a damaged roof, or redo their interior decoration with new floors. Big one-off costs like these are one of the reasons HELOCs were made in the first place.
But… you can also use a HELOC to pay for an online business.
If you have real estate equity, this can be a viable path for you to be “liquid” enough to make better offers to sellers. Since the interest rates are quite low, you can often pay these loans off quickly through the profits of the business you’ve acquired.
The Less Traditional Path
For most buyers, this is where the majority of financing ideas will come from. While this is a good starting point, this is by no means an exhaustive list. There are plenty of new creative financing routes opening up every day.
The Family and Friends Method
We honestly wouldn’t recommend this, but we’d be leaving a common method out if we didn’t discuss it.
Reaching out to your current network, or family and friends, can be a powerful way to raise capital quickly, depending on your relationships with them. However, when you put money between friends and family, the relationships can get weird. The topic of money can lead to all sorts of arguments, miscommunications, and, frankly, an overall unpleasant experience for you.
We only recommend this method if you’re 100% sure that this won’t be the case for you. If you do go this route, and if you promise anything other than just paying them back, make sure you still get it in writing and keep it professional. You can tell them you just want to protect them by making clear what they expect to get out of investing with you before they give you the capital.
Raising Capital
Honestly, this could be a whole another article or even a book. Raising capital is a huge subject, and we are seeing more and more funds get created in our space that specialize in doing just that.
Raising capital involves convincing others to give you their money in exchange for some kind of return, typically a dividend that gets paid out to them based on the success of the investment. We only recommend this for more advanced buyers, as there can be many pitfalls associated with doing this in terms of legal work, communication, and the process required to raise the money.
Some good groups where you can raise this capital are likely in your hometown right now. You don’t need a crazy venture-backed company to give you money to get your feet wet in this space.
There are likely local investors and real estate clubs in your town. These are prime capital-raising targets, as these people are already interested in investing their money somewhere, so are likely more open than the typical person to listen to the opportunity you’re presenting.
Also, consider other local entrepreneurs that are so busy they don’t have time to think about leveraging their money. An example of this would be dentists that own their practice. No matter how successful they want to become, there are only so many hours in the day to see patients. Thus, it is a balancing game of raising their hourly rates to the maximum that the market will allow before clients begin to look elsewhere. These professionals are often looking for ways to use their money as a form of leverage to grow their bank accounts that doesn’t require a great time commitment from them.
Seller Financing
This is the big one. Seller financing is by far the most common method for buyers to finance their deals and is commonly referred to as an “earn out”. The great thing about seller financing is that typically you won’t get charged an interest rate, as most sellers either don’t think about it or find setting it up to be too cumbersome.
That effectively gives you the opportunity to have a 0% interest loan.
Seller financing is done in all kinds of ways, and before you decide to go down this path, we would recommend you read our definitive guide to deal structuring first.
Not all businesses are good choices for seller financing. If you try to structure a deal at the wrong time, it could end up costing you the deal altogether as you lose out to another buyer that made a full cash offer.
The Importance of Working Capital
We want you to leave this article inspired by all the different financing strategies you can use to acquire an online business. However, we don’t want you to leave here and leverage yourself out of business.
First of all, you should never buy an online business with what we call “emergency money”. If you are thinking that buying an online business is the ticket out of your financial woes, think again. A lot can happen in this industry; anything from a Google algorithm update to an Amazon policy change has the potential to cripple or kill off a business in its entirety.
You should never spend money unless you are completely okay with losing 100% of it. That really goes for any kind of investment you make.
The second point we want to make is the importance of working capital. While investing in an online business can deliver you intense levels of ROI, they often only do that if you have some money to grow the business AFTER you’ve acquired it.
You should have a few thousand to tens of thousands of dollars (depending on the business) to keep it operating through a slump or to use to aggressively grow the business through investing in it.
Working capital is not something often talked about, but it is incredibly important. This is especially true if you’re looking to buy and grow the business rather than just acquiring the business as a more hands-off cash flow stream.
Financing is a great tool to leverage. When you use it wisely, it can be used as a stepping stone to change your life, level up your career, and give you access to some of the highest ROI-producing investments you can get your hands on.
