There are many different types of capital and funding mechanisms available to ecommerce entrepreneurs. It’s important to match the right funding with your specific needs and business lifecycle.
Here is a list of different types of funding that may be available to your business:
Most start-ups are bootstrapped, which means they are launched without funding. Start-up costs are kept to a minimum, and the entrepreneur uses savings, a full-time salary from alternative employment, or personal credit cards to fund the business’s basic expenses.
Most conservative estimates are that start-ups need a two-year runway before they break even. This means that you need to be able to cover your costs for two years before the business’s sales are able to cover expenses. This can be accelerated for ecommerce businesses if you are using a drop-shipping or consignment model and do not need to invest in stock.
Bootstrapped businesses experience what is known as organic growth, which means the business can only invest in growth as its profits grow and cash becomes available. However, a successfully bootstrapped business with strong financials can apply for finance once it has been operational for at least 12 months.
Crowdfunding is a reasonably new way of funding start-ups. A large number of individuals invest a small amount of money into the start-up, usually in exchange for a brand new product that the business is developing or selling. Investors tend to be early adopters who enjoy supporting new businesses or ideas, and who want to be the first to access a specific product.
Crowdfunding is made possible through digital platforms, such as Thundafund and KickStarter, that give companies easy accessibility to a vast network.
Debt finance is borrowed money that you pay back with interest within an agreed time frame. The most common forms of debt finance include bank loans, overdrafts, home loans, credit cards and equipment leasing. Interestingly, while debt finance does come at a cost, it is often considered to be the ‘cheapest’ form of funding because it is categorised as a ‘cost of sales’ and because it does not impact equity or ownership of the business. However, this is only true if debt finance is used for growth - it should never be used to cover debt, as this will only lead to a bad debt cycle.
Best for incremental ecommerce expenses before the business has a firm financial history
Most forms of traditional debt funding require some form of surety. If a business is in pre-launch phase or has been operating for less than a year, it doesn’t have the necessary financial history and most likely doesn’t have any collateral to put up as surety for a loan.
Many entrepreneurs therefore opt to access available capital in their existing home loans, or if they have a property that has been paid off, they can take a home loan out on it, leveraging the property as collateral.
Business Lines of Credit
Best for incremental ecommerce expenses
A business line of credit is a hybrid between a traditional business loan and a credit card. These finance solutions allow you to draw against a pre-approved amount of financing, and only pay interest on what you’ve borrowed. Credit lines tend to offer higher limits for a lower interest rate than business credit cards, and can be a great tool for general working capital expenses like marketing campaigns, product purchases or emergencies like system maintenance.
Revolving credit is similar to an overdraft or credit card because it has a limit assigned to it and the lender allows you to draw down against that limit when required. You can use it to fund your business, repay it and then withdraw it again when you need it for the agreed duration of the revolving credit facility’s term.
Overdrafts have limits, and interest is charged against any monies drawn down against this limit. Money can be deposited into or withdrawn from this account at any time. The overdraft limit cannot be exceeded. Normally, the lender charges interest on money drawn from this account as well as a fee based on the overdraft limit. The amount of the overdraft limit depends on the performance of the business, as well as the type and value of the security offered. There is no term assigned to an overdraft facility nor a minimum repayment.
Best for businesses that already have assets they can use as surety for a loan, or businesses that want to invest in assets
Asset finance is a niche, specialist type of finance that is linked to assets. It enables you to access business assets, such as machinery, equipment and vehicles without having to buy them upfront with cash. It can also be used to release cash from the value in assets you already own or use your existing assets as security against a business loan from an asset finance lender.
Asset finance is an attractive financing option for businesses that want to invest in their growth, but don’t necessarily have the cash on hand to put their plans into action. Asset finance also allows you to spread large costs over a longer period.
Depending on the type of asset finance, the borrower can eventually take on full ownership of the asset, return it to the lender or lease a newer version (which is popular in the case of technology that ages quickly).
Best for ecommerce businesses with cash flow problems
Invoice financing is ecommerce funding that can help with cash flow issues. In this kind of business loan, you work with a lender to front you up to 85% of the outstanding invoice. When you collect the invoice, you’ll receive the remainder, minus any lender’s fees. Many small businesses across many industries do this.
Best for ecommerce businesses that are importing or exporting goods
Trade finance covers the financial instruments and products that are used by businesses to facilitate international trade and commerce. These solutions make it possible and easier for importers and exporters to transact, and can help reduce the risks associated with global trade by reconciling the different needs of an exporter and importer.
Import financing includes financial transactions that fund the purchase of goods into one country from another jurisdiction.
Importing and exporting are quite complex transactions. There are a lot of logistics, regional legalities and regulations involved, and there’s usually a long time between the purchase and the delivery of products, which could result in considerable cash flow problems for a business, and also has an impact if exchange rates change between the time a quote is accepted and when payments are made.
Import financing solves this problem by allowing importers to borrow money or get cash advances while they wait for their products to arrive, and most Import Finance products come with a team of experts who can assist with the complexities around exchange rates, regulations and logistics.
When a business exports its goods, the buyer and the seller will agree on a price before the goods are shipped. However, the seller will only pay the agreed-upon price once the goods arrive, which could take weeks (or longer, if there are logistical challenges). This creates a cash flow issue for the seller, which export finance can address.
Based on the purchasing agreement or invoice, export finance allows sellers of products to access working capital before their clients pay for the products purchased.
Short Term Loans
Best for ecommerce businesses that need fast access to cash
A short term loan is a type of loan that is used to support a temporary business capital need. It can be used to boost working capital or for growth purposes (such as purchasing stock or equipment). It can be more expensive than other types of loans, but it is also usually faster to access. Some online short-term lenders can approve and deliver loans within 24 hours. Short term loans usually involve repaying the principle amount with interest by a given due date, which is generally within a year from getting the loan.
Merchant Cash Advances
Best for growing ecommerce businesses that need upfront capital
A merchant cash advance is a relatively new type of lending that supports retailers and ecommerce businesses whose customers pay with credit cards. The amount loaned or advanced is calculated based on the average monthly turnover of your business. The amount loaned is then repaid over a term and the repayments are adjusted based on your monthly takings. This means that if you have a great month, you repay slightly more than normal and when you have a bad month you repay slightly less. This type of finance is flexible, and not much documentation is required to access it because it is based on monthly sales, but it is a more expensive financing option.
Best for businesses that can leverage a property to access a loan
Property finance is a secured business loan. It is one of the most straight-forward funding products available, provided the business (or shareholders in the business) own property.
By accessing property finance, you are securing a loan against a residential or commercial property, or possibly even a property portfolio.
This type of secured business loan is perfect for businesses that have the potential to grow, but due to a lack of capital, have been previously unable to meet their growth targets.
Government Grant Funding
Unlike bank loans that need to be repaid with interest, Government grant funding does not need to be repaid. However, that does not mean it is ‘free money’. Grants are designed to support specific business initiatives to achieve key governmental objectives, such as empowering youth or women, boosting employment or driving technological advances. In South Africa, most grant funding supports black economic empowerment, job creation and developing the economy. Every government grant has a key mandate that must be adhered to.
There are a number of hurdles that businesses need to go through to access full or partial grant funding, and these can be intense:
- Applications are lengthy
- Paperwork must be submitted 100% correctly
- The business must align with a specific initiative
- Government agencies work independently of each other and it’s up to you to do your research to find the best fit
- There are strict guidelines for how money should be spent.
Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills, or they might have a long-term goal and require funds to invest in their growth. By selling shares, a company is effectively selling ownership in their company in return for cash.
Equity financing comes from many sources, including family and friends, angel investors, venture capitalists and private equity firms.
Originally published on Ecommerce.co.za.