Here’s why D2C brands are choosing to take the revenue-based financing route
Startups in the D2C segment raised a whopping $1.4 billion across 100 deals in 2021. But despite the investor interest, many D2C brands are opting for revenue-based financing. Here’s why.
One of the world’s fastest-growing ecommerce markets, India has seen a D2C boom in recent times. Accelerated by the pandemic, direct-to-customer brands are focusing on consumer feedback, R&D, and varied business models to launch international quality products.
Startups in the D2C segment raised a whopping $1.4 billion across 100 deals this year.
The spurt has seen the emergence of two unicorns - Licious in the food category and The Good Glamm Group in the personal and beauty care segment – and the sector seems poised for further growth.
Despite the good tidings, a 31-year old founder of a personal beauty care brand recently expressed reluctance to approach an investor and decided to go the revenue-based financing (RBF) way.
Revenue-based financing helps startups and entrepreneurs raise capital without any equity dilution; it is based purely on the revenues they project and make.
“There isn’t a better time for a homegrown brand. Consumers are open to experimenting and trying newer products. There is an ecosystem that enables and makes it relatively simpler to launch a brand, and of course there is funding. But it is always better to look at options in the early days, and find ways to not dilute equity,” says a founder, seeking anonymity.
Taking the RBF route
D2C brands are witnessing explosive growth in India, thanks to the nearly 200 million Indians who shop online. Fuelling this growth is capital-intensive, and many D2C brands have, in the past year, gone knocking on the doors of institutional investors. But this means parting with valuable equity to access growth capital.
Revenue-based financing changes all this.
Abhiroop Medhekar, Co-founder and CEO, Velocity, says, “What this means for the larger ecosystem is that founders will no longer have to worry about funding if they are generating healthy revenues. They can use revenue-based financing to keep growing on their own terms, without losing control.”
VC interest in the D2C sector has been rising, but remains inaccessible to a vast majority of brands. A report by Velocity adds that out of 75,000+ independent ecommerce stores hosted on platforms like WooCommerce and Shopify, less than 0.5 percent are equity funded.
The concept of revenue-based financing has seen wide uptake in more developed ecommerce markets such as North America and Europe.
It’s interesting to note that world’s largest e commerce investor is not a venture capital firm, but North American revenue-based financier ClearCO, which has invested over $2 billion in over 5,500 business.
How does RBF help?
RBF platforms like Velocity, Getvantage, and Klub have seen significant growth in India. Getvantage has made 150 investments across 75 D2C brands, and cumulatively, with Velocity, revenue-based financing has been leveraged by around 250 D2C brands in India.
“The reason I chose revenue-based financing is really, equity, which I didn't have to give up. There is no collateral like in a bank loan. The process is smooth and the interest rate is much lesser than any traditional financing option,” says Armaan Mann, Founder, Dame Essentials.
Armaan founded her D2C beauty brand in 2016 and the Chandigarh-based startup raised funding from Getvantage.
“There is a long cycle of product creation and testing for personal care and beauty care brands, and traditional VC capital generally needs a high growth engine and push. You need to be nimble and on a high growth trajectory. It takes time for D2C brands to reach that level. Product creation itself needs a significant amount of capital,” she adds.
Another founder, seeking anonymity, says most D2C businesses are capital-intensive, with a significant need for capital to deploy inventory, sample and test products, and get consumer feedback.
“Raising funding through the traditional VC model would mean us significantly diluting equity. And, many times we aren’t sure if every product will work,” the founder says.
Growth engine for product or scale?
Moreover, VC’s prefer to invest in companies that have the potential to be large and achieve aggressive growth targets, thereby excluding thousands of D2C brands that are profitable and cater to niche segments.
“The D2C movement in India and worldwide largely comprises companies that have bootstrapped their way to success. These businesses have a fairly stabilised working capital cycle that includes major expenditure on inventory and marketing. The hurdle to growth for most of these businesses is deploying more capital towards the same,” Abhiroop says.
In the last year alone, the startup ecosystem saw close to 900 to 1,000 new brands across 10 categories - almost 100 to 200 new brands in each of the 10 categories.
These D2C brands aim to bridge a large consumer demand gap. Larger companies aren’t able to fulfil these demands due to their long gestation cycles, in terms of product development and launches.
“If you look at the model, most of these D2C brands make significant revenues, and have strong models from day one. They are catering to a niche that didn’t exist earlier as the consumer is looking for better options. The consumer of today is looking for newer brands, especially those that are natural and clean,” says Bhavik Vasa, Founder, Getvantage.
He explains most startups - despite having the growth - aren’t able to access investors as it isn’t easy to touch base with them without connections.
“Fundraising is about momentum. And D2C brands also need to have the same momentum and speed for product building.”
The Indian direct-to-consumer segment is in a stage of hyper growth. Reports suggest the market is expected to grow at a CAGR of 25 percent from $44.6 billion in FY21 to $100 billion by FY25. Increased internet penetration, widespread use of digital payments, and COVID-19 induced adoption of online buying resulted in 88 percent of oder volume growth for D2C brands in 2020.
“The need for growth capital is the differentiating factor for D2C brands, and, in our own small way, with alternative funding models like revenue-based financing, we’re able to back, fuel, and fund the growth of such companies,” Bhavik explains.
Why not venture debt?
Venture debt is an option as well, but Abhiroop explains it is more of a top-up to companies that have already raised venture capital. The problem? Only 0.5 percent of companies get VC funded.
“What about the other 99.5 percent who could still be building a good online business? RBF does not depend upon VC funding and funds the companies purely on the basis of their revenues.
"Also, unlike venture debt, RBF does not require any equity warrants and is therefore a truly non-dilutive form of capital,” Abhiroop says.
He explains that apart from capital, D2C businesses struggle with negotiating better commercials from logistics providers, marketing agencies, payment gateway providers etc. They also spend a substantial amount of time on consolidating metrics across multiple marketing and revenue channels.
Preparing a consolidated view is often critical to the success of a brand, but creates substantial overheads.
The revenue-based financing model works extremely well for businesses that earn their revenues online, including D2C, SaaS, and mobile applications amid others. These businesses value the flexibility RBF provides during the initial phase of their growth journey.
As the sector gears up for further growth, it will be interesting to see how RBF as a route grows for D2C brands in India.
Edited by Teja Lele