How to Fund Inventory

Welcome back to INTRO to Finance. I'm Jason, and we’re one month closer to the end of 2020. Today, we're breaking down a financial topic that we've had a lot of questions about since our first issue of ItoF:

“How do I fund inventory?”

Unlike a software business, founders who sell physical products need capital to build that initial physical thing. They either solve for this by providing their own money, or bring on early investors. The founder might think equity is the only option for funding a significant inventory build.

However, you should never solely fund inventory with equity capital. If you have a product that continues to sell well, it’s probably not worth giving up ownership for such a short-term funding need. A little secret from the pros – even the fastest-growing product companies use a blend of debt and equity to meet demand.

Inventory Begets Inventory

When you already have inventory that’s selling well, there’s value it can help you unlock. Lenders can and will provide you with capital based on a % of the inventory cost. 

The value assigned to the inventory is the product cost – not the listed sales price. In a worst-case scenario, the lender will try to sell the products themselves to recoup what you haven’t paid back. However, these lenders are likely not as good at marketing your product as you would be, and may not be able to sell them at full value.

As inventory fluctuates up and down, so does available funding. This funding is a line of credit. You can choose the amount you would like to borrow, pay it back at any time, and only pay interest on the borrowed amount.

For example:
The line of credit is 40% of a company's inventory. The company has access to $400k in funding based on $1M in the current inventory balance. The company only borrows and pays interest on $100k.

Note in the example that the company doesn’t have 100% of the inventory cost available to them in funding. The same is true in real life. It’s rare to see a lender offer you over 50% of the inventory balance in the form of financing. 

The Amazon Dilemma

One critical detail in making all of this work is the lender's ability to take hold of the products to sell if something goes wrong. Well, if you’re warehousing your goods at Amazon, that can get a little complicated. Amazon doesn't typically allow a third-party lender the right to the products they warehouse.

Suppose you only have a small percentage of your products held by Amazon. In that case, you may be able to make the financier comfortable. However, in most cases, the lender will remove the Amazon-held inventory from the calculation of available capital to your business.  

If you’re selling primarily through Amazon, your best options might be Amazon lending or other marketplace financings, such as Payability. These structures provide you with capital today in exchange for a fixed percentage of your future sales up to a certain amount. 

For example: 
You receive $8,000 based on your $10,000 in sales. For the next 20 weeks, you pay back a percentage of your sales volume until you pay back the full $10,000. 

Because this type of financing is based on your sales and not entirely on your inventory, it may not have as much impact to ramp up inventory – especially for meeting seasonal sales.

No Better Funding than Profit

One significant aspect of Inventory Finance is that even with limited business history, you can tap into funding based on a stockpile of a product with good resale value. However, Inventory Financing can be more challenging to tap into until you reach over half a million in annual sales.

How do you get from your initial product run to a scale that allows you to access this kind of funding? You can still finance other parts of your business, like sales, using options like e-commerce financing to free up cash to fund product builds. Or focus on profitability from a customer’s first purchase. As one of our scouts pointed out, having a profitable customer relationship from the start is essential to DTC brands.

Not every product company has to sell tens – or hundreds – of millions in equity to scale like Casper, Warby, or Juicero. Some have decided to use a blend of debt and modest amounts of equity investment, such as Rothy's and Mizzen + Main. But others have found a way to avoid equity investment altogether, like Tuft & Needle, Native, Rogue Fitness, and Spanx. 

For the record, the fastest growing company I worked in my past life as a lender was a bootstrapped consumer product company. Whether you take the bootstrap approach or not, there are ways to build and finance inventory that isn't at the cost of your ownership.

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