Securing the correct kind of finance can have a big impact on your growth trajectory and overall success when developing and growing a Shopify app.
Though there are a few well-funded, venture capital-backed solutions on Shopify, the majority of Shopify apps are bootstrapped. Bootstrapping can be beneficial in a lot of ways; it encourages a culture of discipline and helps founders make the most of their limited resources while maintaining full control over their business. However, the limited resources might slow down the growth potential.
If bootstrapping isn’t your thing, there are a few external funding options: investors, loans, and revenue sharing. These choices all have advantages and disadvantages. Venture capital (VC) funds or angel investors can help you grow rapidly, but they also come with a trade-off in ownership and control. On the other hand, loans allow founders to retain full ownership but come with the burden of regular repayments and interest costs.
In this issue of Scaling Apps, I’ll be exploring revenue-sharing funding with Alex Romm, the co-founder of Epsifund, which offers finance for Shopify app developers.
1. Can you explain revenue share funding and how it works?
Revenue-share investment is a simple but powerful tool as it aligns with the founders’ goals.
It does not dilute their ownership and doesn’t push them towards crazy growth at the expense of their well-being. We typically invest 4-8 times MRR and get our investment back through an agreed percentage of MRR on a regular basis. The best part is that the cost of such investment for founders is known upfront as it’s a flat one-off commission with no hidden terms.
2. What are some of the key factors that app founders should consider when looking for funding?
It’s always good to start from the first principles approach and answer a simple question of what goals you’re trying to achieve with this funding and your business. Everything you do, fundraising included, should ideally be aligned with your long-term goals. When starting, do your research to understand what funding options might be available and cross-check with the stage of your business development to ensure your fundraising isn’t a one-off story but a continuous program.
Everything you do, fundraising included, should ideally be aligned with your long-term goals.
3. How does revenue share funding compare to other types of funding, such as venture capital or traditional loans?
One doesn’t preclude the other, but generally, revenue-based funding doesn’t require businesses to have any form of external investors. Being a bootstrapped business is perfectly fine. Venture capital is looking for outsized results, so you’re likely to be pushed to the brink of your performance potential and may find yourself burnt out soon as you’re effectively hiring yourself a ruthless boss in the face of a VC.
Loans are typically for later-stage businesses with tangible assets. If you manage to secure a bank loan, you’re likely to be subject to security/collateral requirements, personal guarantees, and financial covenants that would constrain what you can do with your business.
The beauty of revenue-based funding is that you don’t need to be a late-stage business. There’s also no burden of a fixed payment that a loan typically has. No dilution, personal guarantee, or hard collateral is required for revenue-based funding.
4. What advice would you give to Shopify app founders who are seeking funding for the first time?
Go wide, don’t just look down one path. There are so many new funding products available for businesses generating revenue, you won’t believe it. People like Epsifund would not just give you funding but help you connect to other fellow developers, agencies, and a wide range of future investors. Your success is in their interest, and they don’t need any of your equity.
5. How should app founders determine the valuation of their business when seeking funding?
There are multiple approaches to funding. We like DCF (discounted cash-flow model) albeit it’s a bare-bone valuation as we call it. This is purely based on the ability of your business to generate cash within the next few years (typically 5). It’s a good starting point as it’ll give you a solid base. You can then look at comparable peers within the Shopify ecosystem to see what valuation multiples could be applied.
Try and see if there are similar businesses and have a feel for what sort of multiple may apply to your business. Compare it to the DCF-driven valuation and go for something in the middle. I’m a big fan of a valuation range. Nothing is fixed in stone, so talk in ranges to give yourself some useful leeway when dealing with potential investors.
Retention ensures that your business is capable of generating a stable stream of cash in the long run. Cash is king.
6. What are the most common mistakes founders make when valuing their business, and how can they avoid them?
I think we are still seeing a fair amount of divergence between what people think their business should be valued at and what the market is likely to pay for them. Many people get obsessed with growth rates and gross margin levels. The reality is that any solid SaaS B2B business is likely to have a high margin and fairly strong growth at the early stages.
Rather than boasting your growth rate and gross margin, try and differentiate by exhibiting strong retention metrics. Retention ensures that your business is capable of generating a stable stream of cash in the long run. Cash is king.
7. What key metrics and financial details should founders track and present when seeking funding?
MRR retention, customer (merchant) retention, or logo retention as some people call it. Churn is the opposite side of the retention. Growth is important and not just the last 30 days of growth but what level you’ve been achieving over the last twelve months. Gross and Net Margin are also important indicators. Customer LTV and CAC are equally important as they allow for defining your unit economics.
8. How does revenue sharing work?
It’s a simple solution that is effectively an interplay between three key parameters: funding amount, percentage of MRR repayment, and one-off fee. We are typically happy to be flexible and work around the needs of our clients, making funding proposals truly bespoke.
To give you a quick example, let’s say your MRR is $25k and you’re looking for $100k funding to make key hires into your team. You get revenue-based funding of $100k and agree to share 20% of your MRR every month. Your investor is charging you an 8% one-off fee which means you’ll only need to share your percentage of MRR until $108k is returned to the investor. If your MRR is growing modestly, you’re likely to return that in 12-13 months or over a slightly longer period if MRR stagnates.
Revenue-based funding for Shopify apps
9. What are the benefits of revenue share funding for Shopify app founders?
The key benefit is the flexibility I described above and the ease of getting it versus the enormous amount of effort required to raise equity funding or get a loan from a traditional financial provider.
Plus, as it doesn’t consume a penny of their equity share in the business. Save this dilution for later when you’re big enough to dictate your terms to VCs. Look at how Mailchimp did it.
10. How do you evaluate Shopify apps for funding at Epsifund?
We are obsessed with data, so we always want to see how apps are performing. We like assessing the dynamics of the metrics. One may hear us talking about cohort analysis, which is when we split your customers (merchants) into monthly cohorts to see their performance at a more granular level.
Getting an idea of how much funding you can get is simple - you only need to connect your Shopify Partner’s account to get an indicative offer. If you decide to proceed, you need to connect your bank account and sometimes other data sources (e.g., Google Analytics and/or Google Ads if you’re using it).
