The Ultimate Guide to e-Commerce Financing
There is one inevitability that every business owner must face, that is financing. Whether it’s creating a new product or managing the seasonality of your business, someday, you will need access to additional capital and it’s better to weigh your options now than later. The right financing is key to future success.
This article will tackle the common options for eCommerce funding and the pros and cons of each.
The two most common financing for any business is debt and equity financing.
In debt financing, you borrow a sum of money from a financial institution, either at a fixed or variable interest rate. This type of financing provides you with funds but won’t impact how you manage your business. It is a transaction that does not create a relationship other than creditor-debtor between the parties. The lender won’t be able to exercise management over your business, but the lender can seize your assets in case of failure to pay.
On the other hand, equity financing exchanges funds for a share in your company. It is the process of raising capital through the sale of shares. Examples of as shares, venture capital, taking on a partner, and convertible debt. Unlike debt financing, this option will expose your company to a change in management. While you don’t need to pay back, you are effectively allowing other people to become part-owner and affect the way you manage your business.
Now that we know the difference, let’s tackle some of these financing options
1 Venture Capital Funding for eCommerce
It is a type of private equity financing. These venture capital investors look for companies, usually, start-ups and small businesses, that have the potential for financial success, are believed to have the potential for long-term growth, and are preparing for further expansion. This funding need not only come in monetary form but could also be in technical or managerial expertise.
This kind of financing has become increasingly popular for tech start-ups or companies that have just started with no access to financial institutions, banks, or capital markets.
The advantage of venture funding is the way it can provide quick access to capital without requiring repayment even if your company fails. Also, because the companies of venture capitalists can now partake in the management of your business, you have access to their experience in mentoring and networking.
The drawback is the dilution of ownership because you now have outsiders coming into your business to partake in management. Moreover, venture capitalists only provide capital to businesses with high and rapid growth potential, plus, one that is popular with the general public. If you cater to a niche market, it might not apply to you.
If you are comfortable giving up some control over your business, this financing option will suit you well.
2 Inventory Loan Financing
It is a type of short-term business loan offered to retailers so they can buy stock. The loan is secured against the inventory, which is used as collateral in the event it remains unsold.
An example is a surfing store that makes a high volume of sales during summertime and lowers during wintertime. The low sales during the off-season could mean that they don’t have enough capital to buy the inventory to meet the increased demand during the peak seasons. The company could take the loan during the winter when sales are low. The high sales during the summer could then pay for the loan.
The advantage of an inventory loan for eCommerce Financing is that it solves cash flow problems for seasonal businesses. And being a debt financing, it does not dilute your ownership of the company.
However, if you don’t sell your inventory, you could find yourself in a far worse situation where you lose more money. Not only will you be operating on a loss, but you also lose your inventory. Inventory loans also seem to turn off traditional lenders if they find them in your books.
Because this financing fits the needs of a seasonal business, make sure you have had consistent and reliable sales during your peak season to avoid any problems with payment. If you have trouble predicting what your sales will look like, an inventory loan will be risky for you.
3 Accounts Receivable Financing
Accounts receivable financing, also called factoring, is a type of financing in which a company receives financing capital related to a portion of its accounts receivable. This is done by selling its receivables to a factoring company that takes on the responsibility of collecting them. It could also be done by taking a loan and the receivables are made the collateral.
Even if you sell 100% of your inventory but they are all on credit, you don’t exactly have cash on hand. How are you going to replenish inventory? You can leverage those receivables and take a loan.
The advantage of getting this for your eCommerce business is that it does not have physical collateral and thus is more accessible to small businesses. This loan will not dilute your ownership while providing you with quick capital. The downside is that the rates for these loans tend to be higher.
4 Traditional Bank Loans for eCommerce
This is your standard loan from a financial institution. The bank lends you money and you have to pay with interest which is based on risk estimations by the institution. These loans need physical collateral to secure them.
On one hand, this loan does not dilute ownership, and interest rates are usually lower. On the other, it is typically difficult to qualify for these loans since requirements are more stringent.
If you need a longer-term line of credit and your business has high-value assets for collateral, the traditional loan would fit your needs.
5 Merchant Cash Advance
This one is a short-term debt financing specialized for the eCommerce business, offered by some online platforms like Shopify and Paypal. Basically, the lender evaluates your online sales and lends you money based on that evaluation. The loan is repaid by a certain percentage of your daily sales.
Compared to other financings this is less risky as the funding is based on your overall sales volume rather than an unrealized future cash flow. It is specially designed for eCommerce businesses and is more accessible than other types of financing. The loan proceeds are also unrestricted, meaning they are not earmarked for a specific predetermined purpose. You are free to use it however you see fit.
However, the terms are not so great, capital amounts are usually smaller and interest rates are high. If you suddenly have lower sales, you might need to find another way to make up for the difference.
If your sales are erratic and not stable, you should reconsider this method.
Financial success could be the difference between which financial institution or entity you choose for raising capital. The possibilities are endless, but choosing a financing option that can yield the most capital while being safe for your business should be the first of your concern.
If you are unsure about these options and where your business stands, asking for an expert opinion can help you avoid financial hiccups and save you from the potential loss of business.