- 12 July, 2000 12:49
Funding an e-commerce project is much like funding any other project, according to David Duryea, a consultant at Conley, Canitano & Associates, a US-based company specialising in enterprise resource management and Web strategy.
A company's options include paying the cost out of cash flow, taking out a bank loan or selling bonds or stocks.
It often makes sense to spin off an e-commerce venture as a separate company to make it more attractive to investors. The converse can also take place - the e-commerce project can transform the entire company, changing its business models, revenue streams, customer base and supply chain.
Duryea has just finished a project for the third-largest egg producer in the country, helping to turn it into an e-commerce company by spinning off the division that sells egg yolks in bulk to restaurants.
But before the company could decide how to pay for the project, it had to figure out how it would structure the new business.
If the online business is spun off, then it can go after the same sources of funding as all Internet startups - banks, investment bankers and/or venture capitalists.
Before the stock market turned bearish, there was "plenty of money out there", says Duryea. "But I also think that we've had enough correction. We'll see it perk up again. The amount of growth that can be made by going to the Internet is substantial, and that attracts a lot of investors."Once a company decides to spin off an e-commerce project into a separate company, the next step is to produce a business plan and calculate the expected return on investment.
"It's back to the fundamentals," Duryea says. "The technology enables you to do things you haven't done before, but the basics don't change."Duryea has seen e-commerce companies spin off and become operational in as little as three months. "It's easier to start a company from scratch than to reinvent a company," he says. "There's so much baggage out there."If a company decides to keep the e-commerce project in-house, then a different set of issues comes up. Here, funding may be slightly easier than for other major initiatives. However, some managers need to be educated about how e-commerce efforts differ from traditional business projects.
"There's a different reality," says Richard Wise, vice president and director of e-commerce at Mercer Management Consulting in Massachusetts. "Manufacturing plants, for example, can take 30 years or so to pay back. So a lot of managers are in traditional businesses where the investment picture looks like this: I dig a deep hole and slowly climb back out of it."Because the initial investment in an e-commerce project can be high and the payout period long - and because it's extremely expensive, if not impossible, to change strategies midcourse - managers tend to be very conservative and conduct a great deal of planning and analysis before they give the go-ahead, Wise says.
"But with e-commerce, you can build the service incrementally and you can dynamically reconfigure the business as you go," he says. "Senior management doesn't often realise that they have this flexibility."Financing the projectThere are three major means of internal financing, according to Duryea: internal cash flow, debt and selling shares.
"The best way to finance something is internal cash flow," he says. "It's the cheapest way around. If you issue more shares, it dilutes the shares and the earnings per share. If you go after debt, that's interest charged right off the bottom line. But if a company focuses on growth and becomes its own bank, that's the cheapest way to go."Duryea suggests that a company with a maturing product dedicate some of its profit to research and development, with some of the capital targeted toward investing in new market growth.
"To me, an investment in e-commerce systems is not different to an investment in any other corporate asset," says Jeffrey Lockenvitz, information technology controller at United Parcel Service of America in Georgia.
Almost all companies fund their e-commerce projects through cash flow, at least initially, says Tim Newington, vice president of equity research at Credit Suisse First Boston. Later, they may go to capital markets for additional financing.
In addition, e-commerce projects don't necessarily have to hurt the company's stock price, says Newington. "You have to look at their potential," he says.
"If there's a high expected return on investments, then the investors will support it."But because e-commerce expenses are structured differently to traditional capital expenses - there are no manufacturing plants to depreciate over 30 years, for example - it may make sense to set up a tracking stock or spin off the business, says Newington. That way, it's clear that the money is being spent for a non-traditional project.
Taking on additional debt is the least appealing way to go for most companies - e-commerce projects rarely generate immediate returns, but the debt service payments must be made.
"It all depends on how much you want to spend on interest versus how much you want to put into investments," Duryea says.
He adds that after cash flow, his preferred source of funding is the stock market. "You can raise the capital but not have the debt expense that you have to pay every month."If speed is an issue and there's not enough ready cash to pay for a project, then short-term debt could be a good idea, he says.
"You'd have to go to the banks to borrow the short-term debt on the premise that you're going to raise the capital and replace that short-term debt with either venture capital, a second issuing, bonds or something like that," says Duryea.
But a better alternative, he says, is to stagger project rollouts to reduce the amount of up-front money needed.
"What I would do is take things that are sold easily, like products that are shrink-wrapped - CDs, books, things that can be packaged quickly - and get a Web site up in 60 days to sell a prepackaged, limited set of products," says Duryea. "Then I'd be able to generate some cash flow from that and show investors that it is working and then ask for the rest of the capital."According to Wise, the key to a successful e-commerce initiative or other major project is commitment from senior management. Sometimes, support from top brass can even overcome an apparent lack of financial resources. "A lot of the funding for these projects is coming from senior executives' slush funds," Wise says. "When you get the CEO on board, no matter how tight the budget, you can find the seed money."And the egg producer? The company is already selling some frozen egg products online and it decided to spin off its e-commerce venture as a separate company sometime next year, says Duryea. The $500,000 launch was paid for partly out of cash flow and partly with bank loans.
"Now, they can sell to all the restaurant chains all over the country and get access to them over the Internet," Duryea said.