post by:
Michael Goldstein
It wasn’t too long ago that if you were running a business and needed a loan to help develop and grow, you had little choice other than applying for a loan from a bank. The bank had pretty much all the power and could simply refuse to lend to you if they decided you posed too much of a risk to them.
Banks also had the final decision about how much money to lend you and how long you would pay it back to them. Even today, big banks only approve 13.6% of loan applications (small banks are only a little better with an approval rating of 18.9%). This means that there are so many small to medium-sized e-commerce businesses out there that can’t secure the funding they need from traditional bank loans.
There are now alternate lending options that business owners can look at. These could actually provide much better choice and flexibility as well as putting some control back into the hands of the business owners. Having an understanding of some of the alternate lending options you could have available to you can go a long way in making sure you have access to the funds you need exactly when you need them.
Lines Of Credit
When business owners are considering their options for securing much-needed funds, lines of credit probably isn’t one of the first that comes to mind. A line of credit is, in principle, similar to a credit card (it should be understood that they are very different methods of lending but they have similarities in how the idea of each works).
In very basic terms, a line of credit works by a lender offering you access to an agreed amount of money. You don’t necessarily borrow the total amount in one go though. Instead, you access it in a similar way to how you would use a credit card. You can borrow chunks of the money and only pay back what you borrow (with interest added on). You can repeat this process up until you have borrowed the full amount that was agreed on when the line of credit was offered.
Lines of credit can be extremely useful for e-commerce business owners who have varying financial needs from month to month. Having access to the funds they need each month can make the difference between success and failure. For example, if an e-commerce business owner has a line of credit of $20 000 available to them, they can use this to keep things running smoothly when unexpected expenses occur. Let’s say the e-commerce business owner wants to expand their product range. To get the new inventory shipped, they will need an additional $5000 on top of their usual monthly outgoings. They can take the $5000 from their line of credit and pay it back in monthly installments. They will have to pay a bit of interest but this is usually less than you would pay on a credit card or other lending options.
After a few months, one of the computers the e-commerce business owner uses to run their business needs replacing. As they still have at least $15 000 left on their line of credit (after taking the initial $5000 for the new product range), they can take the money they need from this to replace the computer and keep their business running effectively.
One of the benefits that lines of credit have is that you don’t have to give up any equity in your business. This can be a big factor when it comes to deciding which type of funding solution is best for you and your business. If you don’t want to give up any control or ownership of your business, a line of credit could be a potential lending option.
Lines of credit are normally a bit cheaper than a business credit card too. The amount of interest paid on any money borrowed tends to be less while the overall amount you can borrow might not be too different.
There are some downsides to lines of credit too though. The first is that they aren’t always particularly easy to get in the first place. Unless you have a good credit history to back up your ability to repay any money borrowed, you might struggle to get a line of credit. If your business is still fairly new, this can be a big obstacle to overcome as you may not have been operating long enough to prove your business’s money-making potential.
Another thing to think about when considering lines of credit is that, like a credit card, the longer you take to pay back any money borrowed, the more you end up repaying as interest is continually added until everything is repaid in full. Unless you only need a cash injection for a short-term expense, a line of credit might not be your best option.
A line of credit can be a very useful financial safety net for your business, offering you the extra money you need when you need it the most. This funding option might not be the best for all business owners but it can certainly make a difference to some.
Merchant Cash Advances
Merchant cash advances aren’t normally a good first choice alternate lending option. While they can certainly be useful for many businesses, their overall cost to you can make them a potentially dangerous option for some.
A merchant cash advance works in a fairly straightforward way. A lender approves you for an amount of money that you can borrow. You get this in one lump and can use it for your business’s financial needs at the time. To repay the money borrowed, the lender usually takes a percentage of your debit and credit card sales.
This method of repayment can work very well for businesses that don’t always have consistent sales figures. For example, an e-commerce business selling walking boots will likely have higher sales in the summer months when more people enjoy spending time outdoors hiking. While the business will still make sales throughout winter, they will likely be less than at other times of the year. If the business owner had taken out a traditional loan, they would have to pay back the same amount of money every month regardless of how well their business performed. With an MCA, the slower business months require a smaller repayment to be made to the lender as the repayments are based on an agreed percentage of debit and credit card sales as opposed to a set fee.
Merchant cash advances don’t have an agreed timeframe to be paid back either. This makes sense if you think that repayments are made based on a percentage of credit card sales your business makes. If you take more credit card payments for a few months, the repayments made to the MCA lender will be more substantial meaning the borrowed amount is paid back quicker. However, if your business makes fewer credit card sales, the repayments will be lower.
This structure can work out very well for some businesses but it can lead to a cycle of debt that can be difficult to break so you need to be very careful when considering this as an option.
There is obviously a charge for any money borrowed through a merchant cash advance. This isn’t charged through interest like other funding options though. Instead, your MCA will have a factor rate that decides the total cost of any money borrowed. The factor rate you pay is usually somewhere between 1.1 and 1.5 but it can vary based on how long your business has been operational, the current financial state of your business, and your current level of credit and debit card sales (obviously, as an e-commerce business owner, pretty much all of your sales will be via credit or debit card so this can play a part in your factor rate).
To work out if you are getting a good deal on your MCA, you can work out how much you will have to pay back in total by multiplying the amount you’re borrowing by the factor rate. For example, if you’re offered a merchant cash advance of $35 000 with a factor rate of 1.3, you will have to pay back $45 500 in total. This means that you will be charged $10 500 to borrow the money you need.
It’s worth remembering that the factor rate won’t include any additional fees that your lender may charge such as admin fees, setup fees, and similar. Merchant cash advances can be an effective way of getting a cash lump sum into your business without having to agree to a set figure to be paid back each month. They can be expensive though so you need to make sure that there aren’t any other lending options better suited to you and your business.
Microfinancing
Microfinancing is borrowing small amounts of money to help your small e-commerce business continue to operate, grow, and develop. One of the big problems traditional bank loans pose for small businesses is that the relatively small amounts of money the business needs aren’t big enough for the bank to consider worthwhile lending to them.
With microfinancing though, a small business can get a microloan of up to $50 000 to cover the costs associated with getting a successful business up and running. Although this may be the top end of how much can be borrowed, on average, around $13 500 is borrowed when microloans are obtained.
Microfinancing has a history beginning in Asia in the 1970s. It has evolved since then and has now found its way into the US and international business world. There are now quite a few microloan providers in the US that have been helping small businesses get the funds they need to help their businesses continue on the road to success.
Before thinking too much about microfinancing (in particular microloans), it’s worth keeping in mind that many providers have pretty strict criteria about the types of business they lend to. A lot of microloan providers will only lend to new businesses or small businesses being run by specific, usually discriminated against, groups. For example, some lenders might specifically focus on offering financial support to small businesses being run by women as, traditionally, women have been under-represented in the business world and have faced additional challenges compared to their male counterparts. While this isn’t the case for all lenders, you do need to make sure you do the appropriate research to make sure you apply to one who could be in a position to help you.
One of the big advantages that microfinancing has is that, as the loans are usually aimed at new businesses, the application process is more straightforward than more traditional lending options. The goal of microfinancing is effectively to help a new business build enough credit history and sales performance to be able to obtain larger traditional bank loans in the future. With that in mind, it makes sense that getting a microloan would be easier to make sure as many businesses as possible can benefit from them.
That being said, microloans aren’t necessarily easy to get. While they are certainly easier to obtain than other funding options, they do still require a bit of effort to secure the funds you need. You’ll likely need to provide a detailed business plan to your loan provider. The idea of a business plan is to show your lender that you have a clear plan in place for how you will achieve success and that you take your business very seriously.
You’ll likely also need to look at your personal credit history. As microloans are designed for businesses with little to no credit history, a lender may look at your personal history to decide if they will risk lending you money. Making sure your personal debt is in hand (and as low as possible) can go a long way in increasing your chances of being approved for microfinancing.
Another thing to think about when considering microfinancing is that, usually, lenders will want some kind of collateral or a guarantor to back up your agreement. This could be in the form of property or other high-value items or it could be an individual with a good credit history and a suitable income to back you in your loan application. If you were to miss a payment, either your collateral will be used by the lender to reclaim their money or your guarantor would be expected to make the payment on your behalf.
Small e-commerce businesses could potentially benefit from microfinancing. It can be a very effective way of getting a relatively small amount of money into your business to get things moving in the right direction. Running costs of small e-commerce businesses can be quite low so large bank loans might not seem like the right way of funding your plans. If you are in a position where microfinancing is a possibility, it could be exactly what you need to give your e-commerce business a big kick start in the business world.
Asset-Based Loans
Asset-based lending can be a way for businesses to obtain a loan even if they have a bad or limited credit history. Instead of looking at the history of a business, lenders take some kind of collateral to make sure they will always be in a position to get their money back whether repayments are made or not.
Commonly used collateral for asset-based lending includes property, accounts receivable, equipment, or inventory. As all of these tend to hold their value, asset-based lenders can usually give loans to businesses that banks might not be able to do so (as they rely heavily on credit history).
A key benefit to asset-based lending is that your business can move into a position where more money can be borrowed as it continues to grow. For example, if you use your inventory as the asset placed against your loan, as your business makes more sales, you’re able to increase the size of your inventory. As your inventory grows, the amount of collateral you can offer a lender also increases meaning they may be willing to lend you more money.
Another important thing to bear in mind with this type of lending is that you, as a business owner, can spend the loan money on any business-related expense you see fit. Traditional bank loans usually require you to tell the bank what you plan on spending the money on before they decide whether to lend it to you or not. If they approve your application, you can then only spend the funds on the specified expense. With asset-based lending though, once you have the funds, you can use them for any expenses that occur in your business. You don’t need to state what you’ll be spending the money on in your application so the loan could actually end up being extremely useful for multiple business expenses.
Asset-based lending applications are usually processed quite a bit quicker than traditional funding applications too. Once the collateral you’re offering has been evaluated and approved, there isn’t much else to do before the lender will release the funds to you. Obviously, depending on what the assets being offered are will play a part in the length of time needed to assess them, but this type of lending can be processed much quicker than you might expect.
You should always consider the risk to your business when thinking about asset-based lending. While it might seem like a great way of getting much-needed funds into your business without having to go through detailed credit checks, you need to keep in mind that if you can’t afford the repayments, any collateral you offered against the loan can be lost. If the collateral was your business inventory, your business could end up having to close down as a result of missed payments.
Is A Loan Alternative Right For Your Business?
While there are definitely alternatives to traditional bank loans available to e-commerce businesses, you do still need to take some time to ensure that they are right for you and your business. If you aren’t able to get a bank loan as you don’t meet the strict criteria they have, then a loan alternative could be a potential way of getting the money you need into your business to help it run successfully.
Sometimes though, traditional bank loans might be the best option for you. This is particularly true if you need to borrow a large amount of money. If you’re able to meet the criteria set by a bank to get a loan from them, you’ll likely experience cheaper interest rates, lower monthly repayments, and a trusted lender offering you the funds your business needs. The main problem with traditional bank loans is that fewer and fewer businesses are able to get approved for them.
If your business falls into this category then you need to make sure you choose the right alternative. It’s usually a very good idea to research multiple alternative lending options to find the one that best suits you and your business.
As beneficial as bank loans are (if you can get approved for them), alternative lending options do have some advantages over them. This is why a lot of business owners aren’t resorting to loan alternatives as a result of being refused a bank loan, they are actually applying for the alternatives as their first port of call.
There could be many reasons why business owners are looking at these alternative lending options instead of bank loans but it’s likely that the speed of application, the increased chances of being approved, and the greater flexibility all play a part in their decisions.
When you’re running a business, money is one of the most important things that can have big impacts on the success you achieve. If you can get your hands on the money you need very quickly, it can drastically increase your chances of business success.
Other Loan Alternatives
There seem to be more and more loan alternatives becoming available to businesses of various sizes. Other loan alternatives include options such as angel investing, venture capitalist funding, government funds, revenue-based financing, and crowdfunding.
All of these could be viable funding options for your business. As a business owner, you should be in the best position to decide which one is best for you. With so many funding options to choose from, it’s worth taking your time and considering all of them in good levels of detail before deciding to pick one over all of the others.
It’s also worth bearing in mind that you may only be likely to be approved for a few alternative lending options. If you’re uncomfortable with this, it might be sensible to wait (if possible) before borrowing any money to fund your business growth.