post by:
Michael Goldstein
The financing options available for eCommerce businessess are made more complicated by the rapidly shifting nature of the digital commerce landscape, especially when juxtaposed against traditional, more risk-averse financial institutions and banks.
In considering which path you should pursue to secure capital for your eCommerce business, it might behoove you to consider a cash flow loan as a viable method for financing. Depending on the specifics of your company, there are upsides and downsides to pursuing this method of backing, and we hope to illustrate whether or not cash flow loans would be a good option for your eCommerce business.
What are Cash Flow Loans?
In short, a cash flow loan allows creditors to receive capital based on the cash flow generated by your business rather than more traditional methods of determining value.
Within the structure of a cash flow loan, lenders gauge your business’ historical and projected performance to dictate approval, rather than relying on credit scores or assets offered as collateral. Lenders look at future cash flow because that is one of the greatest indicators of liquidity and being able to repay a loan. Future cash flow projections are also an indicator of risk; companies that have greater cash flow are simply less risky because they anticipate having more resources available to meet liabilities.
For this reason, companies may find it harder to secure cash flow-based loans as they must set aside value and cash repayment specifically for the loan, and you must understand that some eCommerce outfits won’t have margin capabilities to do this.
Cash flow loans are often treated as short-term funding solutions due to the higher interest rates. The structure of this process makes cash flow loans more accessible to a greater variety of businesses, including eCommerce platforms and those with bad credit.
Who Benefits from Cash Flow Loans?
Cash flow loans are better suited to companies that maintain high margins, have consistent revenue streams, or lack concrete assets to offer to lenders as collateral.
Additionally, firms that can rely on a steady amount of incoming revenue will benefit more from a cash flow loan; as an example, service companies like a public relations firm (which sources most of their income from set retainers monthly) have the benefit of a consistent flow of cash which will enable you to negotiate for a competitive rate. That being said, however, interest rates are typically higher than traditional loans due to the lack of physical collateral that can be obtained by the lender in the event of default.
What are the Best Uses of a Cash Flow Loan?
Because cash flow loans are often given due to a lack of solid assets, there are several uses for cash flow loans that can solve that problem. For eCommerce owners specifically, starting a business from your computer can prove tricky to finance, and the way you use a cash flow loan can directly impact your company’s ability to grow. In general, there are two categories that most business owners allocate capital from a cash flow loan towards: building assets and covering losses.
Build Assets
There are many examples of this, but for eCommerce owners specifically, this can include buying inventory in bulk, renting out an office space, or upgrading equipment. Alternatively, within the same category, you can use a cash flow loan to add value to your business in less accountable ways, such as hiring a crucial member of your team or funding marketing campaigns. While these items generate higher revenue in the long term, they are not considered “assets” in the same sense.
Cover Losses
Because of the short-term nature of most cash flow loans, it is not uncommon to take out a cash flow loan to pay down outstanding invoices or to cover gaps in revenue during slow sales months. However, using a loan for this purpose should be used with extreme caution: although you will be paying down debt with the capital from a cash flow loan, you are doing so by taking on an increased debt burden.
Who Offers Cash Flow Loans?
Most traditional banks and financial institutions will not offer cash flow loans, primarily due to the risk associated with a lack of collateral and speculation on projected earnings. Most eCommerce owners will be able to borrow from an online lender , although this name is a misnomer. A great deal of online “lenders” aren’t actually lenders but are, in fact, brokers.
The primary difference is that a broker is not the person/company lending you the money, but they serve as a middleman to find lenders and have the cash pass through in that fashion. The downside of this is that brokers have even less accountability, which is coupled with even higher fees.
It goes without saying that having a broker as a middleman adds considerably to the cost of a loan. Businessweek cites an agreement from a subsidiary of CAN Capital that shows the lender expects to be repaid 14% interest on a six-month loan, and “…its most preferred brokers can tack on an additional 17%, making the total cost to the borrower 31% of the loan. On a $50,000 loan under those terms, a small business owner would pay back $65,500.” This is why finding a reliable financing partner and not “just a broker” is crucial.
Merchant Cash Advances
If you are unsure of going full-brunt on a cash flow loan but don’t qualify for other lending structures, you could possibly consider a cash advance. Cash advances are another form of cash flow loans where, opposed to an outright loan, you sell a portion of future sales in exchange for upfront cash. Rather than making periodic withdrawals from your revenue, the advance is paid back by siphoning a percentage off of each sale you make.
One important note to keep in mind for advances: technically, cash advances aren’t legally classified as loans, and because of this, they’re not subject to the usury laws that limit how much they can charge. That leaves you with the responsibility of finding the best deal you can find.
How to Qualify for a Cash Flow Loan?
Cash flow lenders will look at a few figures from your business in order to determine your borrowing status.
- Firstly, they will assess the debt-to-income (DTI) ratio of your company. This ratio determines your ability to take on additional debt and how much, and lower DTI (or less debt in correlation to income) will improve your chances at receiving the loan for which you’ve applied.
- Lenders will use your projected revenue growth to determine whether you will qualify. This is where the heart of cash flow loans are based, as this provides the lender a clear picture on your ability to repay debts. Within this, lenders will also gauge how you intend to use the funds.
- Finally, lenders will inspect your operating cash flow to determine eligibility.
This is a good time to reiterate that, while cash flow lenders do check your credit score, it is not a make-or-break figure as it is with traditional lending.
Why Do Cash Flow Loans Make Sense for eCommerce Owners?
Despite the risks that can be associated with cash flow loans and advances, they present a number of benefits within their structure that appeal to eCommerce owners.
More Opportuneties
To start with, many fledgling eCommerce owners often start their business without any notable assets to offer as collateral. On top of that, by not having a physical space by the nature of the business, the ability to receive a loan without requiring hard-and-fast assets benefits the flexible nature of eCommerce.
Easier to Secure Short-Term Loan
Because there are very few upstart costs associated with starting an eCommerce outfit, it is easy to secure a loan of a smaller amount that will not present too great of a burden to pay off in the long-term. Regardless of the structure of the loan, lenders will be more likely to lend small amounts to first-time borrowers than large amounts.
Quick Financing
For startup eCommerce owners who might not have developed a business relationship with a bank, cash flow loans provide an alternative that allows quicker financing.
Scalability
Because of the scalability of eCommerce operations in comparison to physical businesses, owners will have an easier time projecting sufficient cash flows to obtain a higher loan amount than pursuing a traditional path.
Conclusion
This article is not intended to be a deep dive into the world of cash flow loans, nor should it be considered extensive. However, we hope that this article gives eCommerce owners an overview of the financing possibilities available to them by presenting the upsides, downsides, insides, and outsides of the loan structure. As with any loan, be sure to consult a trusted financial advisor prior to entering a borrowing agreement. Cash flow loans can provide opportunities to eCommerce businesses that wouldn’t otherwise be available due to the lack of collateral and repayment structures based on future revenue generation.