The Complete Guide to Ecommerce Funding

Ecommerce is a uniquely competitive market. Sellers are constantly testing new products and juggling seasonal inventory. They’re reacting to fluid economic conditions. And they’re always competing for listing placement.

Most ecommerce businesses (even successful ones) are also dealing with a complicating factor: they often manage cash flow on a razor’s edge. This makes it complicated to add inventory for a busy season, launch PPC campaigns, or test new products to grow their business. But in order to grow, they need to do all of those things.

Online sellers need external funding to bolster their cash flow. Even if they have cash on hand, investments won’t pay off for months, which can leave them in a short term crunch. However, traditional lenders don’t always provide capital to ecommerce sellers. This leads sellers down a path of diverse, and sometimes unusual ecommerce funding options. These options can be confusing, and not all of them are appropriate for your growth targets. That won’t stop lenders from offering agreements with aggressive repayment plans or profit-gouging terms.

This guide covers the cash flow and funding challenges that ecommerce businesses encounter. It then provides an overview of several ecommerce funding options, touching on the requirements, advantages, potential pitfalls, and use cases for each option. By the end of the guide, you should have a good idea of which options are best suited for your ecommerce goals.

Table of Contents:

Ecommerce Funding Challenges

The financial challenges for online sellers stem from cash flow pressure points baked into their business, and the lack of tailored solutions to address it. Let’s take a closer look at the causes of cash flow issues and also the shortcomings of traditional funding options.
 

Ecommerce cash flow requirements

With the growth of ecommerce, small businesses have moved some or all of their businesses online. There’s a huge opportunity for growth in ecommerce, but there’s also tremendous competition. Small businesses are competing for attention for their online store, but also for marketplace listings in crowded spaces. While there’s plenty of potential sales to make, it requires strategy and investment to win.

The growing demand for ecommerce means that sellers need more cash to succeed. For ecommerce businesses and Amazon sellers, cash needs fall in three main buckets: Inventory management, marketing costs, and long-term growth.

Inventory management

Inventory management is a balancing act for ecommerce sellers. In order to meet sometimes unpredictable demand, sellers need to have enough inventory, but not too much. Businesses with high seasonality or fast growth that have not yet determined demand can find inventory management challenging.  

When inventory is too high, cash is locked up and cannot be used for growth marketing. (If you sell on Amazon, too much inventory can also lead to storage fees or other penalties for your shop). Having too little inventory means cash goes uncollected from sales that never materialize, further aggravating the cash flow problem. (Too little inventory in marketplaces can also lead to stockouts, which will devastate your listings). 

Depending on whether you are selling on Amazon, Walmart.com, your own Shopify website, or another marketplace, your inventory requirements will vary. Therefore, ecommerce sellers sometimes need to access external sources of cash in order to balance inventory and cash flow.

Marketing costs

Ecommerce is highly competitive and customers are geographically dispersed. Therefore, marketing is the lifeblood of an ecommerce business. Investment in digital marketing and PPC is critical to attracting and maintaining customers. The cash crunch occurs because marketing spend is upfront, and even successful campaigns will take weeks or months to return with sales revenue.

In the world of ecommerce and retail, launching products with marketing support often requires trial and error. How much should you spend on PPC at launch? If sales are slow, do you have a product problem or a listing problem? How much (if any) should you throttle your spending as your listing rises up the ranks? How much (if any) should you throttle your marketing spend during slower seasons?

Learning what works in ecommerce marketing takes time and investment, and sometimes you’ll need to learn what doesn’t work before you find the right formula. When cash is tight, that’s not easy to do. An ecommerce business will struggle without free cash flow to invest in marketing and promotional campaigns.

Long-term growth

Cash reserves are essential for ecommerce sellers to invest in larger business growth strategies. Building a direct to consumer private label brand and a loyal customer following takes time and money. Inventory and fulfillment might require you to lease or buy a warehouse. Every few years, website technology and user interfaces evolve, requiring further investment. Finally, successful ecommerce businesses owners quickly find that there’s too much work for one person. Building a team requires capital, but you won’t want to stunt your operations in order to build a team.

Related: The Definitive Guide to Small Business Cash Flow

Shortcomings with Traditional Lending Practices

Ecommerce businesses often need short term cash to capitalize on competitive opportunities. The problem is that online sellers have difficulty working with traditional lenders.

Traditional lending providers have not caught up with the ecommerce business model. The brick and mortar businesses they lend to are fundamentally different from ecommerce businesses. Consquently, traditional lenders impose limitations such as higher rates and lower loan amounts on ecommerce businesses–that’s if they decide to lend at all. 

Traditional lenders struggle to underwrite ecommerce businesses for three key reasons:

  • Traditional underwriting is mismatched

To assess lending risk, banks and credit unions use old school criteria like business credit scores, credit histories, collateral, industry information and historical financials. They don’t use metrics that are meaningful indicators of ecommerce business potential. These metrics include online sales volumes, website traffic, conversion rates, and online ad performance.

  • Lack of collateral

Physical assets, such as inventory or a building, are generally required by banks as collateral. There are few material assets in ecommerce.

  • Perceived higher risks

Banks are averse to risks associated with credit card sales, which is the main source of ecommerce sales. Ecommerce businesses are also subject to cyber risk, which could negatively impact performance. Ecommerce businesses often have a diverse array of customers with less predictable behavior. It is easier for banks to lend in an industry or market where they understand customer behavior, such as the restaurant industry. When underwriters cannot accurately predict where the business’s customers will come from, they perceive the business as more risky.

Basic small business financing 

Just like any small business, ecommerce companies can turn to basic small business funding options for cash flow. These options can help manage cash flow, but they also present challenges.

Bootstrapping

Savings, credit cards, loans, and gifts from friends and family fund many small businesses. This method of financing is called bootstrapping. Bootstrapping can work for a while by keeping expenses, such as marketing, to a minimum. Many ecommerce businesses start with bootstrapped funds. 

For Amazon sellers in particular, sellers might budget enough to test initial orders of a few products, but must have at least 2-3 times their initial investment in reserve. If the product sells successfully, they’ll need to order again (and more) before they realize their sales from their initial orders. Selling in marketplaces at any scale requires significant investment before your first revenues, creating cash flow issues from the start.

As you can imagine, the funds you receive from bootstrapping don’t cover big investments like inventory or growth marketing. As a result, bootstrapping limits your growth potential.

Investors

The next logical step after bootstrapping is to seek investors. Outside investment is an option once your business generates sales and sustains operations. You can find investors by joining an accelerator, incubator, or mentoring program, participating in pitch competitions, and crowdfunding. More often than not, when you get investor funding, you’ll give up some control and ownership of your business and you’ll have to answer to investors for strategic and operational decisions.

For most ecommerce business owners, outside investment is not a desirable route for funding. The profit margins are tight to begin with, and many ecommerce business owners entered the field to run their business independently.

Business credit cards

In addition to providing short-term financing, business credit cards help ecommerce companies build credit. Once the business is established, business credit helps a seller get more funding from lenders or better credit terms from vendors. However, just like bootstrapping, credit cards can only take your business so far if you’re looking to grow. Using credit cards is also expensive over the long-term, and you can’t pay employees or buy large amounts of inventory with them.

The influx of cash flow from credit cards only lasts until the end of the month when the bill is due. Carrying anything other than a zero balance will cost the business significant interest, which is not worth the small headstart on expenses.

Ecommerce Funding Options

Where can you get funding if you don’t want to give up ownership of your ecommerce business or you need serious cash flow to compete and grow?  In order to compete in a crowded market, ecommerce sellers need to find a funding solution that fits their unique short-term capital needs. To address the cash flow needs of ecommerce businesses, new financial companies have emerged with innovative products. Among them are subsidiaries of traditional lenders, online marketplaces, and even shipping companies. 

Ecommerce funding options include mainstream lenders and specialized lenders who understand ecommerce’s unpredictable sales, seasonal sales cycles, inventory requirements, and trends. These lenders assess customers based on their potential, demonstrated by online sales, digital footprint, and ad performance metrics. 

Merchant cash advances

Merchant cash advances (MCAs) are a popular method of ecommerce funding. An MCA is a loan in return for a fixed percentage of a borrower’s daily credit card sales receipts. The money is an advance on future sales, through which the advance is repaid. MCAs are typically short term, with a term of two years or less.

MCAs are popular because they don’t require a ton of paperwork, credit history, or business collateral. Applications are usually approved quickly because they are not loans. MCAs are also easy to pay back, with the percent deduction from sales made automatically by your credit card or payment processor. The provider of the MCA then collects directly from the account where your sales are deposited. It’s an easy, low risk funding option for both parties.

But there are disadvantages. MCAs are one of the most expensive ways to boost cash flow. Factor rates are used instead of interest rates for repayment. If a provider advances you $20,000 with a factor rate of 1.2, you must repay the provider $24,000. Essentially, that’s a 20% interest rate. MCA APRs can reach 300% depending on the size of the advance, fees, and repayment period. Want to avoid the higher rates by repaying early? You may not be able to reduce your high APR by repaying the advance early without a penalty. In addition, paying back a cash advance will not build business credit. 

When would you use an MCA? They’re a lifeline if cash is tight but you have a short term cash crunch or opportunity. Another example is seasonal businesses with high-demand or trendy products that need to invest enough to maximize sales and promotions during peak seasons. Additionally, MCAs can be a quick solution for grabbing market share by funding rapid expansion.

Ecommerce loans

Lenders who specialize in ecommerce loans understand how online selling works. These loans aim to accelerate growth, cover marketing expenses, and increase inventory/sales. Unlike traditional lenders, ecommerce lenders use sales history rather than business credit to determine a loan amount. Loans are then structured and approved to help sellers access the fast cash they often need. Terms vary among these specialized lenders. Two common types of ecommerce loans are fixed-term loans and lines of credit. 

Fixed term loans

A fixed-term loan is probably the most common type of ecommerce financing. Over a set period of time, usually less than two years, you pay back your loan in fixed amounts.

The advantages and disadvantages of fixed term loans are the same as with traditional loans. You can spend a lump sum however you like. However, you are locked into the repayment schedule regardless of cash flow. There may also be higher interest rates or collateral requirements. Many lenders tack on origination or closing fees, too. 

Why seek a fixed rate ecommerce loan? These loans tend to have lower interest rates because of the stability of repayment. Ecommerce businesses with a good track record and a stable business model can benefit from these loans. Those with younger or less robust ecommerce businesses, however, might have to go to online lenders who charge higher interest rates (over 30% APRs). 

Line of Credit

A line of credit (LOC) allows you to borrow money up to a pre-approved credit limit at any time. You can draw cash and make repayments as needed, only paying interest on the capital you draw down. ‍APRs on line of credit can range from 3% to 80%. Borrowing limits vary widely too. To get the best deal, you’ll have to shop around.

A line of credit is a flexible and affordable way to boost cash flow when you need it without the strict repayment commitments of a fixed loan. You don’t have to apply for a new credit line whenever you need cash, As compared to other short-term borrowing options like credit cards, LOCs let businesses borrow a lot more capital at lower rates. You generally pay less interest than a fixed loan because you only pay interest on the money you use.

That said, LOCs have a few minor disadvantages. Some lenders may require minimum amounts to be withdrawn, and sometimes a personal guarantee or a minimum personal credit score is required for approval. 

Generally speaking, if you have an ecommerce business that is highly seasonal or has unpredictable inventory requirements but a solid track record of doing business, a line of credit can be a helpful and affordable source of inventory and seasonal-related financing. 

Alternative ecommerce financing

New lenders and fintech companies are addressing the cash flow challenges of ecommerce businesses. These funding companies specialize in ecommerce.

‍Ecommerce platform financing

Walmart.com, Amazon.com, Shopify, and other ecommerce marketplaces have become underwriters. Based on seller performance, these platforms allocate a credit facility to ecommerce businesses who use their platform. 

Amazon, for example, offers top-performing sellers traditional Amazon Seller loans. Interest rates range from 10% to 18%, with terms ranging from 3 to 24 months. The length of your Amazon Seller loan will have a significant impact on your monthly payments and your business cash flow. They are therefore a better option for a mature Amazon business.

Amazon has started offering flexible daily cash advances for a percentage of the capital fee. For sellers receiving Amazon payouts only twice a month, this can help cover an emergency or fund a large inventory purchase. 

Shopify makes lump-sum loans to qualifying ecommerce vendors for a fixed borrowing cost. Sellers pay back the loan and the borrowing cost via a daily sales percentage automatically deducted for loan repayment.

Walmart.com now offers line of credit financing to qualified sellers in its marketplace. Through a partnership with Goldman Sachs, sellers on the platform can apply for a line of credit up to $75,000.

Platform financing has many advantages. Most importantly, the lender understands your business’s sales and cashflow, so it can underwrite and structure financing terms more easily and confidently. However, many sellers won’t qualify for platform-based financing. Getting approved may be difficult if your business isn’t well established.

Revenue-based lending

Revenue-based lending is increasingly popular with ecommerce lenders because it is well-suited to ecommerce cash flows and sales cycles. Instead of incurring interest on capital borrowed, the business pays a flat monthly fee of 1% or 2% of the capital advance plus a revenue share percentage. This revenue share is collected until the loan amount and fees are repaid. The payback period and frequency of payments are usually determined based on historical sales.

The advantage of revenue-based financing is that no credit score is required for approval. Businesses can manage cash flow more flexibly in terms of repayment. The borrower only pays when it suits their cash flow. With this flexibility, sellers can borrow significantly for growth without sacrificing equity and control. However, most of these loans require you to have been in business for a minimum period of time and have a substantial sales record.

Revenue financing is an especially suitable option for companies with proven sales records looking to ramp up sales through extensive marketing. By advancing the funds for promotion and growth, as business sales grow, so does revenue shared, so there is an incentive to not only grow but to pay back the loan as soon as possible.

Profit-based lending

Ecommerce funding that is profit-based is relatively new. Instead of an interest rate, capital is lent for a percentage of profit. Lenders receive a percentage of profits until full repayment is made. Profit-based lending has the advantage that businesses get to pay all expenses before paying back the loan. This feature allows a good deal of flexibility in managing cash flow. If you have a very slow month, or generate.

Comparing the cost of ecommerce funding solutions

There are more options for ecommerce funding than ever before. The question is, how do you decide between them? One way is to take the amount of cash you need to borrow and compare the annualized cost of borrowing, or APR. Let’s say you need $100,000 for marketing. Here’s a comparison of different ecommerce funding options for that amount.

The True Cost of Ecommerce Cash Advances

Suppose you take a cash advance on daily sales every day for 60 days at a fixed fee of 2%. Let’s say your average daily sales are $1,000. After 60 days you will have paid $1,200 in fees (2% X 60 X $1,000). This is equivalent to an APR of 7.3%.

Now let’s say your daily sales are $3,000 and you apply the same plan. After 60 days, you would have paid $3,600 in fees, or an APR of 12.1%.

Depending on the nature of your cash flow needs, there are multiple factors to consider besides the converted APR and the total fees paid. First, you really only improved cash flow by a few days. You were going to collect that money anyway; but instead you got a little bit of it in advance, just a little bit at a time. In most cases this will not fund a large business growth plan. In addition, you have become dependent on the advance, as you’ve entered a continuous cycle of degraded payouts until you go a full cycle without taking an advance. It is very difficult to take advances for *only* a certain period of time.

Ecommerce loan from Amazon

Amazon fixed loan rates for sellers average between 6% and 15%. Let’s say you borrow $100,000 at a 12% APR. Here is how your cash flow would be impacted for a 3, 6 and 12 month fixed loan.

 

 

Monthly payment

Total payment

Total interest paid

3 month loan

$ 34,002

$102,006

$2,006

6 month loan

$17,255

$103,529

$3,529

12 month loan

$8,885

$106,619

$6,619

Based on the large variation in monthly payments between these three repayment periods, it’s important to consider the impact of the monthly payment on your cash flow versus the amount of interest ultimately paid on the same $100,000. In other words, sometimes it can make sense to pay a bit more interest over a long period of time, especially when the loan allows you to capitalize on an opportunity that might take 6-12 months to pay off.

Ecommerce loan from an online lender

Online lenders offer a variety of fixed rate loan terms and if you have solid sales and good credit it’s worth considering an online loan over a higher rate eCommerce platform loan. If you were to borrow $100,000 and had a great credit score or a solid sales track record, you could perhaps garner an APR of 8% for a 4 month loan with fixed monthly installments. Your monthly payment would be $25,671 and your total payment would be $101,659, for a total interest payment of $1,659. 

Profit-based loan

If you borrow $100,000 via a profit-based loan at 10% of your profit, there is a wide range of potential payback scenarios based on your monthly or annual profits and the time it takes you to pay the money back. For simplicity of comparison, let’s say you do $1 million in revenue your first year with $300,000 in net profit. Your payment to the lender in year 1 will be $30,000, an APR of 30%.

Profit-based loans can seem attractive since risk is low, and there is no timetable for which to repay. But it is in fact the most expensive proposition we have covered if your business is successful (which is the entire goal). If you have an open account in a profit-based agreement, pay it back as quickly as possible so as not to cripple your ability to grow your business. 

The Bottom Line on eCommerce Funding

The explosion in ecommerce businesses in recent years has created a gap in the lending market that online marketplaces and fintech companies have begun to fill. Ecommerce businesses have numerous options for short-term cash flow funding.

Business owners can access growth capital and cash flow using ecommerce financing solutions without giving up ownership or control over how and when funds are used and repaid.  However, high interest rates, a lack of business credit building, and minimum sales requirements are some disadvantages of ecommerce funding options.

With the many ecommerce financing options available now, it’s challenging to compare them all. Be sure you understand the goals you’re trying to achieve, the additional cash a funding offer provides, and the total cost of repaying the offer. This will enable you to decide which type of funding is most suitable for growing your ecommerce business.

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