E-Commerce Financing: A Guide to Your Options

Most e-commerce businesses will need to access additional capital at one point or another. Whether launching a new product line or managing seasonality in your business, getting the right e-commerce financing can be key to success. 

What we’ll cover:
Debt vs Equity Financing for E-Commerce
Venture Capital Funding for E-Commerce
Inventory Loan Financing
Accounts Receivable Financing
Traditional Bank Loans for E-Commerce
Merchant Cash Advance

In this guide, we’ll go over some of the most common options for e-commerce funding, and the advantages and drawbacks of each. First, however, let’s take a moment to explain the two main funding types: debt financing and equity financing.

Debt vs Equity Financing for E-Commerce

When you need money for your e-commerce business, two primary options are taking on debt or selling equity. 

In debt financing, you agree to borrow money at a fixed or variable interest rate. Your business must repay the amount and interest over a set period. However, the lender cannot exercise control over your business (though they may seize assets or otherwise take action if you fail to repay the debt).

In equity financing, you raise funds by selling a stake in your company to one or more investors. The investor(s) will agree to buy a certain percentage of your business’s ownership at a certain valuation (for example, if your business is valued at $5M, an investor might pay $500,000 for a 10% stake). Money raised by equity financing does not need to be paid back; however, since the investor is now a part-owner of your company, they influence how your business operates and future growth plans.

Venture Capital Funding for E-Commerce

What it is: Venture capital is a type of equity financing. Venture capital investors (individuals or firms) look for companies they think have the potential for enormous growth (i.e., companies that might grow 100x or reach billions in revenue or market cap). While VC funding is most strongly associated with tech companies, it can also be available for e-commerce or consumer products funding if the investor thinks the growth potential exists. 

Example: A new sustainable fashion brand has had early success building an engaged customer base but needs capital to expand its marketing reach and continue developing sustainable recycling processes that will allow it to offer more products. 

The company pitches itself to several VC firms on the premise that sustainable fashion is a rapidly growing consumer space, and demand is projected to increase substantially over the next few years.

One firm believes the brand is well-positioned to emerge as a market leader and offers them a term sheet. In exchange for $2M in investment, the VC firm gets 20% ownership of the company and a seat on the board to help guide decisions.

Advantages of VC Funding for E-Commerce

• VC funding provides an avenue to raise a large amount of capital relatively quickly.
• Many firms offer mentorship and networking opportunities to their portfolio companies, giving you access to guidance and expertise to help grow your business.
• VC funds don’t need to be paid back, even if your company fails.

Drawbacks of VC Funding for E-Commerce

• Since VC funding is equity financing, accepting VC investment dilutes your business ownership. In the future, your investors will share some control over your business decisions.
• VCs are only interested in companies with very high, rapid growth potential. If your business serves more of a niche audience, VC e-commerce funding will likely be unavailable to you.

Is VC Funding Right for Your E-Commerce Business?

Suppose your business fits the high-growth profile of what VC investors look for, and you’re comfortable giving up some control. In that case, considering VC funding may be a good idea. VC investors can also be a good choice for e-commerce funding for businesses that want to grow quickly.

Suppose you prefer a slow-and-steady approach to growth or don’t want to share ownership of your business with investors. In that case, VC funding is probably not for you. 

Inventory Loan Financing

What it is: A short-term or revolving credit line that e-commerce or retail businesses take out so that they can buy inventory. The loan is then repaid after the inventory sells. The inventory is the collateral: if the company can’t repay the loan, the lender can take the unsold inventory instead.

Example: A snow-sports merchant makes a high sales volume from October to April and a much lower volume from May to September. Because the business has little cash flow over the summer, they often don’t have the cash to purchase inventory for the high season.

The company takes out an inventory loan in early fall to buy the products it will sell over the winter. Then, with the income from winter sales, the company can pay back the loan and still make a profit.

Advantages of an Inventory Loan for E-Commerce Financing

• Inventory loans help seasonal businesses overcome cash flow issues that make it challenging to operate throughout the year.
• Specialist lenders that understand e-commerce and retail business offer inventory loans and tend to be more readily available than traditional bank loans.
• Taking out an inventory loan doesn’t dilute your business ownership, and you’ll maintain complete control over the company.

Drawbacks of an Inventory Loan for E-Commerce Financing

• The intention with an inventory loan is that you’ll repay it with the money you earn from selling the inventory. If you can’t sell the inventory before the loan is due (or if you sell less than you expect), you may have trouble making the payment.
• Banks sometimes frown on inventory loans. If you’re also trying to get credit through a traditional financial institution, having an inventory loan on the books might make them less likely to work with you.

Is Inventory Loan Financing Right for Your E-Commerce Business?

If your business is highly seasonal, but you have reliable sales during your busy season, an inventory loan might be a good option for increasing your short-term liquidity. However, it’s worth noting that pre-orders can help mitigate some of the risks of coming up short on sales if you take this route.

An inventory loan might be a riskier choice if your upcoming sales are less predictable (for example, if you need capital to expand into a new product category).

Accounts Receivable (AR) Financing

What it is: On your balance sheet, outstanding accounts receivable invoices (i.e., money owed to you) are considered an asset. Sometimes called factoring, accounts receivable financing leverages those invoices to raise money. 

This can either involve selling the invoices to a factoring company (who then collects on them) or taking on a loan with the AR invoices as collateral. If the loan isn’t repaid, the factoring company can then take and collect the collateral invoices.

Example: A CPG company has sold many products to its channel partners, primarily national grocery chains, for $1M. However, most of its channel sales are on net-60 payment terms, so that the company won’t receive the money for another two months. 

To keep operations running smoothly until the payments come in, the CPG company takes an AR loan for $300,000, using one of its outstanding invoices as collateral. Suppose the company can’t repay the amount by the specified date. In that case, the lender will take the invoice and collect it themselves to get the money back (and likely penalize the company for defaulting).

Sixty days later, the CPG company receives the expected $1M in revenue and repays the $300,000 loan, plus a certain percentage for interest.

Advantages of Accounts Receivable Financing for E-Commerce Funding

• AR loans don’t dilute your ownership, so you won’t have to share decision-making.
• Because AR loans don’t require any physical collateral, they’re often more accessible to small and internet-based businesses or those that may not own many physical assets.
• Accounts receivable financing gives you access to liquidity faster than your invoice net terms, which can help prevent temporary cash crunches for otherwise-healthy businesses.

Drawbacks of Accounts Receivable Financing for E-Commerce Funding

• Your ability to repay the loan depends on your customers paying you on time. You may be in a tight spot if an expected payment doesn’t arrive and the AR loan comes due.
• Rates for AR loans tend to be higher than for other finance options.

Is Accounts Receivable Financing Right for Your E-Commerce Business?

If your business is structured with a long delay between sales and payment, and your customers reliably pay on time, an AR loan might be a good option for maintaining cash flow. At the same time, you wait for the revenue to arrive.

Suppose your customers have a spotty history with payment dates. In that case, an AR loan might be riskier than other e-commerce financing options.

Suppose you have the leverage with your customers to negotiate shorter payment terms (for example, net-30 instead of net-60). In that case, it’s worth it to try. Getting your revenue faster can negate the need to take out an AR loan and save you the money you’d spend on loan rates.

Traditional Bank Loans for E-Commerce Funding

What it is: A standard loan from a financial institution, similar to a mortgage or a car loan. The bank agrees to lend you money at a specific interest rate, generally based on their estimation of your lending risk. You will usually be required to provide collateral to guarantee you’ll repay the amount. For larger businesses, traditional banks also offer revolving lines of credit, which function similarly to a credit card.

Example: A home goods company plans to expand its offerings with a new high-end furniture line but needs significant capital to create and market the latest products. The company applies for a business loan from its banking partner to get the necessary funds. 

The bank examines its financials to determine if they fit the lending guidelines. Because of the substantial amount of money the company requests, the bank requires the company to offer collateral to recoup at least some of its costs if it fails to pay. 

The company pledges its manufacturing equipment as collateral to secure the loan, and the bank extends a line of credit to cover the new product launch costs. In addition, the company agrees to a set payment schedule with a special interest rate. 

Advantages of Traditional Bank Loans for E-Commerce Financing

• Traditional bank loans usually come with a set payment amount schedule, so there won’t be surprises on what you owe and when.
• The interest rates on conventional bank loans are typically lower than the interest offered for AR financing or inventory loans.
• As debt financing, traditional bank loans don’t dilute your ownership.

Drawbacks of Traditional Bank Loans for E-Commerce Financing

• Traditional banks are relatively cautious in their lending, and it can be difficult for small businesses to get approved for what they need.
• The conventional loan origination process often moves more slowly than other financing options, which can be problematic if you need cash quickly.
• The collateral requirement can be a hurdle for small or internet-based businesses with few physical assets. Suppose the company itself doesn’t have enough potential collateral. In that case, the bank may require the owner to secure the loan with their assets.

Is a Traditional Bank Loan Right for Your E-Commerce Business?

If you’re looking for a longer-term line of credit, and your business owns enough value in physical assets to secure the amount you need, consider applying for a bank loan. Again, the right banking partner can make a big difference here; if you go the traditional loan route, look for a bank that understands your business type (retail, CPG, e-commerce, etc.).

If you need quick, short-term liquidity, or if your business doesn’t have much to use as collateral, a traditional bank loan might not fit your needs well.

Merchant Cash Advance

What it is: Specialized short-term debt financing tailored to e-commerce businesses, offered by e-commerce platforms such as Shopify, Stripe, and PayPal, and some specialized lenders like Clearco. Based on their findings, the lender evaluates your online store sales and contributes to lending you a certain amount. The lender then takes a certain percentage of your daily sales until the loan is repaid.

Example: A boutique cookware brand has built a small, devoted following on word-of-mouth and organic social. The brand needs to get its products in front of a broader audience to grow further, but it doesn’t have the capital for a big marketing push.

The brand primarily sells through Shopify and qualifies for Shopify Capital funding. It takes a merchant cash advance from Shopify to fund its multi-channel marketing campaign. Shopify then collects a certain percentage of its sales until the amount is paid back at the end of the term. For example, suppose the marketing campaign is particularly successful, and sales sharply increase. In that case, the company may repay the advance faster than planned.

Advantages of Merchant Cash Advances for E-commerce Financing

• Since the funding is tied to your overall store sales volume rather than an expected future cash influx (e.g., receiving a large customer payment), a merchant cash advance can be less risky than an inventory or AR loan. 
• This financing product is designed for the e-commerce business model. It may be more accessible to smaller businesses than traditional loans.
• Other types of loans are sometimes earmarked for specific uses only (for example, if you apply for a loan to buy a delivery vehicle, the bank will not allow you to use the money on marketing instead). Merchant cash advances are generally not earmarked, so you have much flexibility in capital spending.
• Merchant cash advances are a form of debt financing and do not dilute your ownership.

Disadvantages of Merchant Cash Advances for E-commerce Financing

• The terms for a merchant cash advance are frequently worse than many other forms of financing – the capital amounts are smaller, with higher interest rates and associated fees. 
• Suppose you have an unexpected dip in sales during the repayment period. In that case, you may need to make up the difference through direct payments, which could cause cash flow problems.

Is a Merchant Cash Advance Right for your E-Commerce Business?

If you primarily sell through a platform that offers to finance, and your business makes a reliable amount of sales income, a merchant cash advance might be a good option for accessing short-term capital.

If your sales are unpredictable, or you don’t have the margins to absorb the fee costs, this type of financing may not be the best fit.

When you need capital to grow your ecommerce business, there’s no shortage of options. So, remember that all forms of funding have pros and cons, and carefully evaluate the impact on your business before taking on new financing.

This article is provided for informational purposes and is not intended as financial or investing advice. Always consult an appropriate professional for advice on your specific situation.