Published Nov 26, 2021

e-Commerce Financing: Options to Finance Your Online Business

Table of contents

Global e-commerce is thriving.

According to e-Marketer’s Global E-commerce Forecast, $3.351 trillion retail sales were made online in 2019, and the number is expected to rise to $4.921 trillion in 2021, representing a 46.9% increase in e-commerce market size in just two years.

That being said, lack of capital remains a major challenge in starting and running an e-commerce business.

In view of a substantial financing gap, this article explores different options of e-commerce financing, their respective pros and cons, and how you can choose a suitable financing option for your online business.

  • What is e-commerce financing?
  • Why do e-commerce companies need extra capital?
  • What are the ways to finance an e-commerce business?
  • What is the best financing option for e-commerce companies?
  • Some last words

What is e-commerce financing?

E-commerce financing refers to providing (non-dilutive) capital to e-commerce companies, which are engaged in the buying or selling of goods or services over the Internet.

Why do e-commerce companies need extra capital?

Why would you need an extra $10K, $1M or even $10M?

While there is no standard answer to this question, here are some common reasons why e-commerce companies need additional capital:

  1. Your company is looking to accelerate growth, hence needing more cash for ad spend or new hires; or
  2. You are planning on business expansion, such as launching a new product line, opening a brick-and-mortar store, entering a new market or acquiring another company; or
  3. Your business is about to carry out some resource-intensive activities, such as website revamp or mobile app development; or
  4. Peak season is around the corner, or you just received a huge order, both of which require purchase of a large amount of inventory.

In each of these scenarios, cash flow could be tight for your business activities. It is possible that financial constraints would inhibit growth, or you may miss out on a lucrative opportunity to boost sales. Therefore, e-commerce financing is often a critical ingredient in the recipe for online success.

What are the ways to finance an e-commerce business?

1. Revenue-based financing

How does revenue-based financing work?

As an ecommerce-friendly financing option, revenue-based financing (RBF) has gained popularity among e-commerce companies in recent years.

In essence, revenue-based financing is an alternative financing method in which companies receive funding based on future revenue. After putting in an application for revenue-based financing, risk assessments will be conducted on your business. If you are eligible for funding, capital will be remitted in as soon as 48 hours. Contrasted with borrowing from banks and repaying fixed amounts regularly, revenue-based financing gives you ample flexibility in repayment.

Under the RBF approach, revenue-based financing platforms (which provide funding) will share a small percentage of your monthly revenue as repayment for the capital provided. If you have a slow month, you pay back less; if business is good, you pay back more. Ultimately, repayment is capped at a predetermined amount, which is usually the capital plus a small flat fee.

Pros of revenue-based financing

  • Flexible repayment: No fixed monthly installments. Repayment is based on your company’s monthly revenue. You repay less if you earn less, repay more if you earn more. Total repayment is capped at the predetermined amount.
  • Non-dilutive: You do not need to give up ownership or board seats in return for funding.
  • Grow at your own pace: RBF platforms do not take part in management of your business, nor will they interfere in your decision-making process. RBF platforms do not need to sell their stakes in your company in order to make money. There is no pressure for liquidity events such as merger, acquisition or IPO. No covenants will be imposed to restrict how you use the funding.
  • Easy to apply: Most RBF platforms allow online application. No pitch deck or presentation required. (For example, Choco Up’s online application form only takes a few minutes to complete.) RBF platforms make use of data integration and analytics to assess applicants’ financial performance. There is no need to prepare elaborate financial reports and projections manually. No collateral is needed to ‘secure’ the funding.
  • Low cost of capital: The only cost of capital is a small flat fee. No interest is charged on unpaid amounts. No other fees are involved (e.g. loan facility fee).

Cons of revenue-based financing

  • Pre-revenue companies may not be eligible: You need to have recurring revenue in order to apply for and repay RBF funding.

Is revenue-based financing right for your e-commerce business?

Compared with most other financing options, revenue-based financing is tailored for e-commerce companies in many ways. To begin, RBF platforms’ data-driven risk assessment model eliminates the need for lengthy applications and painstaking paperwork. Not only is the application process expedited, but you will also receive funding more quickly, enabling you to capture growth opportunities as they emerge. Most importantly, revenue-based financing gives you access to capital which may not otherwise be available under conventional financing routes. This is especially so for e-commerce companies which are unable to meet the rigorous standards set by bank lenders.

Learn more: Merchant Cash Advance (MCA): Everything You Need To Know

2. Bank loans

How do bank loans work?

An application for commercial loan typically begins with submission of application forms, along with documents such as your company’s certificate of incorporation and financial statements. Upon collection of all required documents, the bank performs credit analysis on your business, taking into account a number of factors to determine whether a loan should be granted. These include your company’s financial statements, cash flow, business plan and asset coverage ratio, but to name a few.

If your loan application is successful, the bank will provide you with cash, which is to be repaid at a certain interest rate. Normally, you will also need to provide tangible assets as collateral.

In the event of default, these assets will be seized and sold by the bank to recover the debt amount.

Pros and cons of bank loans

  • Clear loan terms: Interest rates and repayment amounts are fixed at the outset, making it easy to plan your budget and predict spending.
  • No equity dilution: Bank lenders do not share ownership of your company.
  • Relatively low interest rates: Interest rates on bank loans are usually lower than that in other financing methods (e.g. inventory and invoice financing).

Cons of bank loans

  • Complicated application procedures: Bank loan applications require collection and submission of lots of paperwork. The process could be taxing and time-consuming.
  • Long turnaround time: The loan approval process could take months.
  • Collateral required: E-commerce companies may not have adequate tangible assets to serve as collateral. In these circumstances, banks may require that the loan be secured against your personal assets.
  • Difficult to qualify: Some bank lenders require that businesses be established for a certain period of time (e.g. 2 years or even more) in order to be an eligible applicant. Credit assessments are not easy to pass.
  • Rigid repayment schedule: Repayments must be made on schedule. Loan default could lead to seizure of collateral. It would also affect your credit score, making it harder for you to borrow from financial institutions in the future.
  • Interests on outstanding balance: Interests accrue on unpaid amounts. Cost of debt could be high if you fall behind on loan repayments.
  • Restrictive covenants: There may be restrictions on how you use the borrowed money.

Are bank loans right for your e-commerce business?

No doubt, banks have played a major role in financing traditional businesses. Nevertheless, bank loans may not be suitable for newer, innovative and fast-growing e-commerce companies. This is because e-commerce companies tend to have fewer pledgeable assets and higher risk-return profiles. With these unique features, e-commerce companies may find it difficult to qualify for loans under the conventional credit assessment model used by bank lenders. Lack of standard financial statements could also be a hurdle to obtaining bank loans.

Furthermore, time is often of the essence in today’s e-commerce landscape. During periods of rapid growth, timely infusion of capital is desirable, if not pivotal to business success. As bank lenders usually require a fair amount of time to review loan applications, bank loans may not be the best choice for you.

Learn more: E-commerce Lending: Loan Options and Alternatives

3. Inventory financing

How does inventory financing work?

Inventory financing is a short-term, asset-based loan (or line of credit) made available for your e-commerce business to purchase inventory. Unlike bank lending, inventory financing does not require pledging of property or assets as collateral. Instead, the purchased inventory serves as collateral, entitling the creditor to seize and sell your inventory if you default on the loan.

Pros of inventory financing

  • No equity dilution: Inventory financing does not dilute equity of your company.
  • Less stringent requirement on collateral: No business or personal assets (other than inventory) are needed to secure the loan.
  • Easier to qualify: Creditors mainly look at the estimated value of collateralized inventory to determine eligibility and loan amount. Business or personal credit ratings are not crucial factors for loan approval. Some lenders require only 6-12 months of company operating history in order for your business to be eligible for inventory financing.

Cons of inventory financing

  • Loan amount limited by inventory value: Creditors would not lend more than what your inventory is worth. The typical loan amount ranges from 20% to 65% of your inventory’s appraised value.
  • Relatively high interest rates: Without ‘valuable’ property or business assets as collateral, inventory financing is deemed riskier than other business loans. Creditors may charge higher interest rates to compensate for added risks.
  • Inflexible repayment: In most inventory financing arrangements, cash generated from inventory sales goes directly to paying off the loan.
  • Lenders may impose loan covenants: Some creditors may restrict the use of borrowed money to inventory purchase only. Borrowers may be required to take out insurance on collateralized inventory.
  • Larger installment payments: Inventory loans generally have shorter terms, hence larger repayment installments.
  • Unpredictable risks tied to sales performance: Repayment of inventory loans is contingent on selling inventory to customers. If sales do not go as expected, repayments could put a strain on your company’s cash flow.

Is inventory financing right for your e-commerce business?

Inventory financing is a funding solution tailored for merchants whose businesses involve sale and purchase of inventory. Particularly helpful during peak seasons, it enables you to quickly respond to spikes in demands and monetise seasonal opportunities. However, inventory financing is by no means an all-purpose financing solution for e-commerce companies that trade goods. For instance, it is not advisable to take out an inventory loan in the following scenarios:

Scenario 1: You need to raise a large amount of capital for market expansion.

As the loan amount is limited to a percentage of inventory value, It is unlikely that you will obtain sufficient capital via inventory financing to support your business needs. Moreover, loan restrictions may prohibit the use of money for purposes other than inventory purchase.

Scenario 2: You plan to expand into a new product category, so sales performance is not predictable.

In inventory financing, your ability to repay the loan depends largely on revenue generated from sale of goods. If sales performance does not meet expectations, you may have a hard time paying off the loan.

All things considered, taking out an inventory loan involves various pros and cons.

Whether this financing option is suitable for your company depends on the nature of your business, purpose of fundraising, sales forecasts, to name but a few.

The bottom line is, weigh the upside potential against the downside risks of inventory financing. Think about what your business needs, and whether inventory financing can serve those needs.

4. Invoice financing

How does invoice financing work?

Invoice financing is a form of asset-based financing which enables companies to get access to funding based on receivables.

The three main forms of invoice financing are:

  1. Invoice factoring: Business invoices are sold to a factoring company at a discount in exchange for immediate funds. When invoices fall due, the factoring company collects money from your customers.

  2. Invoice discounting: Instead of selling outstanding invoices, you use those invoices as collateral for a loan. The lender would charge a fee or interest (or both) on the loan.

  3. Accounts receivable line of credit: In essence, a line of credit gives you access to a set amount of money which you can use as needed and repay later.

    When you draw cash from your line of credit, interest begins to accrue. You may also be charged a service fee for using a business line of credit.

    Similar to invoice discounting, your company’s accounts receivable serve as collateral for your line of credit.

Pros of invoice financing

  • No equity dilution: Invoice financing enables access to capital without diluting equity.
  • Quick access to capital: It gives you access to capital quicker than your invoices’ net terms.
  • Easier to qualify: Your invoices’ values and clientele’s creditworthiness are the major determinants of your eligibility for invoice financing. If your company has reliable customers, getting approval for invoice financing should not be a problem.

Cons of invoice financing

  • High cost of capital: Financiers usually charge higher interest rates than bank lenders. In addition to interest on loan, other fees may be charged.
  • Cash advance limited by invoice value: In invoice factoring, the initial cash advance is usually limited to 80% to 85% of invoices’ face values. Likewise, when your company’s accounts receivable are used as collateral, creditors would not lend more than what your receivables are worth.

Is invoice financing right for your e-commerce business?

In the e-commerce world, B2C businesses often take the route of advance payment, requiring customers to pay before goods are delivered or services are rendered. B2B businesses, on the other hand, may sell to large customers on credit.

For businesses structured with long delays between sales and payment, invoice financing could be useful for overcoming temporary cash flow gaps, allowing you to maintain liquidity or seize growth opportunities prior to customers’ invoice settlement.

What is the best financing option for e-commerce companies?

Just like each individual is unique, no two companies are the same. There is no such thing as the best financing option for e-commerce companies, only a financing option that best serves your business needs.

To help you find the right fit for your business, Choco Up has compiled a table comparing different financing options:

Revenue-based financing Bank loans Inventory financing Invoice financing
Application process Simple Complex and time-consuming Simple Simple
Approval Quick Slow Quick Quick
Fees Flat fee only Interest on loan plus other fees, e.g. drawdown fee, facility fee, early repayment fee, etc.
Interest on outstanding balance? No Yes Yes Usually yes
Available funding Depends on revenue performance Depends on credit score and history Capped at percentage of inventory value Capped at a percentage of invoice value
Collateral Not required Company or personal assets Inventory Invoice
Repayment scheduled Flexible Fixed Fixed Fixed (loans), flexible (line of credit) or none (factoring)
Repayment amount Proportional to monthly revenue Fixed (principal plus interest)
Restrictions on use of funding No Usually yes Usually yes Sometimes

Learn more: E-commerce Funding: A Guide to Your Options

Some last words

Raising capital for your e-commerce company is a major financial decision which should not be taken lightly. Yet, as conventional bank lending is beyond the reach of many fast-growing e-commerce companies, different forms of alternative financing have emerged to bridge the gap.

At Choco Up, we understand the needs of e-commerce companies to obtain funding in a quick and efficient manner — hence our data integration platform and streamlined application for revenue-based financing. In addition to improving accessibility to capital, we also believe in unlocking growth potential through revenue-based financing. Following our ‘grow now, pay later’ approach, companies could use RBF funding to promote business growth and flexibly repay with a small percentage of their revenue down the road. As Asia’s leading RBF platform, Choco Up has provided growth capital to hundreds of businesses across the continent, enabling companies to scale and grow without hefty debt burdens.

To learn more about what we do, check out our client success stories or apply for funding now!