post by:
Carmen Marks
Financing is a big deal for new businesses and experienced companies alike. Finding the right funding is imperative to your business health. With a new startup you will need a financing option that works best for you and your needs.
Inventory financing is a great way for new startup companies to improve their cash flow while obtaining the inventory they need. You don’t need to have thousands of dollars stashed away – and frankly, if you did, you’d already be using that to fund your business, right? Have someone else front the cost, pay a little interest, and mark your product up around 50%, and pay back your debt once your product sells. You get your product and still make a profit.
The Basics of Inventory Financing
To say it in the simplest way possible without any context, inventory financing is how you get funding for your inventory. We know what you’re thinking – you’re a new business owner but that doesn’t mean you don’t understand the basics of financing.
So let’s build on this definition a bit. You have a supplier that is able to ship you a product for you to sell in your eCommerce store. Without the funding you can’t purchase your inventory. You discover inventory financing – which may be offered through your supplier – and get a specific inventory loan to purchase your products and begin making payments upon selling your products.
If you don’t pay back your loan, the lender will seize your inventory as collateral. They will then sell it themselves, or sell it to another business who will purchase it directly from them.
Inventory loans are designed to purchase or manufacture inventory only, so you can’t take that loan to distribute payroll, purchase office equipment, or expand your storefront.
The saving grace you might have as a startup is that you can get by with an online store and a small warehouse (or your garage as long as you don’t live in Phoenix during the summer. From experience we can tell you your stock will melt – or at least parts of it will). So in the beginning you can keep your overhead costs low so you can funnel any profits back into your business.As you increase your sales and your inventory you will need to consider a larger space for your products and may want to look into a fulfillment center.
But what it really comes down to is the following formula:
Your Idea + Inventory Financing Loan = Stocked Shelves, Happy Customers, and Profits.
How Inventory Financing Benefits New eCommerce Businesses
Many experienced companies use inventory financing to clear up out of stock and backlogged items. But for startup eCommerce businesses, inventory financing could be the difference between getting your business off the ground floor and digging yourself into a hole.
Now, you may be concerned about entering into debt so early in your business, but, cliche as it sounds, you need money to make money. So unless you have a trust fund or a rich relative that is in failing health, you’re in the same boat as the rest of us.
But accruing debt doesn’t have to be all bad. In fact there are many advantages that come with taking out a business inventory loan. These types of loans are short term and you can start your business with little out of pocket cost.
The Benefits of Inventory Financing for eCommerce Startups:
- Fulfill a product for you to sell
- Financing when other resources say no
- No need for a good personal credit score
- Increase cash flow
- No personal collateral
Fulfill A Product For You To Sell
Whether your supplier is your financier or you get a loan from a bank, the lender will give you the projected value of the inventory. This is then used to place an order with the supplier or manufacturer. This allows you to cover all costs relating to creating and obtaining the product.
Let’s look at it through two different scenarios:
Scenario A
You decide to forego any debt and pay for everything out of pocket. You save up $1,000 and are able to finance and ship 100 pieces of your product. You then turn around and sell each piece for $20 and you have to put a “sold out” banner on your website. That’s great! (Without factoring in the cost of shipping to your customers) you made $10 profit off each item. So now you have $2,000 in your pocket.
Scenario B
But what if you’d taken out an inventory loan for $10,000? With that extra money you would have been able to procure 1,000 items and you’d have $20k in your bank right now. Keep all other factors the same – each unit costs you $10 and you sell them for $20. After paying back the original $10k loan, plus interest, you’d still be looking at a higher profit than when you only had $1,000 to spend.
Choosing the right product plays a huge part in whether or not your investment is going to pay off. You need to research the market and compare your prices to the competitors. It’s not always about who is the cheapest. Consumers are looking for a reliable seller; someone they can count on to provide their product in a consistently timely manner.
By all means, try the out of pocket way first. Once you realize that out of stock items don’t draw customers to your store, you’ll wish you’d taken out the inventory loan sooner.
Financing When Other Resources Say No
eCommerce is one of the few industries that understands the plight of a new small business. It’s almost like a Tinder advertisement: “Online lenders in your area are looking to meet you,” “Are you a small business owner who wants to fund a hefty ordery? We’ve got what you need.”
They are chomping at the bit to garner more business and increase the amount of money they lend. They still have a relatively high risk of taking on new businesses, but that’s why they use your inventory as collateral. If you don’t pay, they snag your product and sell it to someone else who will pay back their loan with interest. Sure they take a hit on failed businesses, but that’s a risk they’re willing to take to get an interest payout.
Just so you have your ducks in a row, here’s a few reasons why a lender (inventory financing or traditional) might deny your loan:
- Poor credit (we’ll talk more on this in a moment)
- Documentation is not in order (no, not like chronological order – but if it’s difficult to follow and track your information, the lender is going to see that as an example of your business practices and stamp a big red “DENIED” across the middle of your folder).
- No Cash Flow (You want to make sure your invoices are received and paid on time. Get your money and show the lender you don’t just give away your inventory for free. We’ll talk about improving your cash flow in a bit.)
Honestly, as a startup, you may not have all of these aspects right away. That’s okay. It takes time to build a strong portfolio and get all of your assets organized.
Look for lenders who specialize in financing startup companies. Some lenders require that your business operates for one year or more and that you are pdocusing xyz dollars in revenue before they will finance your inventory. This can be difficult when you don’t have any history to offer up to the lender.
You might have to suck it up for the first 6 months to a year by focusing on “scenario A” from the previous example. Trust us, a year in business goes by way faster than you think.
Other options include personal loans and lines of credit in the early stages of your business to slowly increase your revenue so you are more attractive to lenders. We’re not advising any minimum dollar amount that you should take out as personal credit, but paying back a smaller loan improves your credit and increases your revenue over the first year of establishing your business and shows future lenders that you are less of a risk.
For example, and using the metrics from the previous examples, if you take out a $1,000 personal loan plus the $1,000 you saved to purchase inventory, you can double your revenue from “scenario A.” After 6 months to a year with consistent on-time payments, you can then apply and fund your inventory to reach the desired amount of revenue.
No Need For A Good Personal Credit Score
You could have many reasons for not already having a lender. Maybe you don’t like the idea of debt or you can’t find a bank that wants to finance your product. Or, more commonly, you’ve been trying to get a business loan based on personal credit and your credit score is not exactly where you’d like it to be. As a startup, you may not have credit at all, depending on how long you’ve been in business.
Luckily there are lenders who couldn’t care less about your personal credit history. They may still run your Experian or Equifax score to determine interest rates, but ultimately, it’s just another paper in a filing cabinet to some of the lenders.
What they really want is a business plan and a product that sells. Double points if you have a product they can sell to another small business – something hot on the market that they can liquidate quickly should you default on your loan.
Increase Cash Flow
Cash flow is one of those things that we never seem to have enough of in business. Cash flow is basically your money moving in and out of your business. Payroll, debt payments, and general operating costs are negative cash flow (money moving out), while paid invoices and profits generated from investments are positive cash flow (money moving in).
While taking out an inventory financing loan decreases your cash flow temporarily, you still have cash flowing in from your invoices, plus profit, when you sell your product.
American Express states 60% of small businesses have problems with generating enough cash flow and 89% of those businesses say their cash flow problems have had negative outcomes for their business.
As a new business, you are already pretty strapped for cash. Using inventory financing to increase your stock, you can balance your positive and negative cash flow and actually improve your positive cash flow with the increase in sales.
No Personal Collateral
If you take out a personal loan, like a mortgage or an auto loan, those pieces of property become collateral for the bank to seize should you default on your loan. That means you’d be out of a house and car.
Banks have you put up collateral as a way of securing their loan. If you don’t pay your mortgage, the bank can simply kick you out of your house and sell it to someone else (a lot of us are still feeling the effects of the 2008 recession. Also, side note: Britney Spears had her meltdown in 2007, then in 2021 she was freed from her conservatorship. Could Britney drama be predicting the recessions?)
When it comes to inventory financing, your product is your collateral. So you don’t have to worry about losing your house, car, or personal investments. The risk is still high though. Defaulting on your loan and losing your inventory means you can’t sell your product. And if you can’t sell your product, you lose your business. If this business is how you make your living, then the house and car follow right along behind your inventory; repossessed by their respective lenders.
So, not to scare you, but don’t default on your loan. Bankruptcy is not all it’s cracked up to be. *Cue the scene from The Office where Michael “declares” bankruptcy.*
Types of Inventory Financing
Lenders have options depending on how you qualify. Some have a minimum amount that you have to borrow while others put limits on terms, how long you must be in business, and how much revenue your business should be bringing in. Every lender is a little bit different and you need to pay attention to these details. The varying interest rates could affect your ability to pay back the loan in a timely manner.
Just as a heads up to how different each lender is, do a quick Google search to find the interest rates for inventory financing. They are all over the place but usually land somewhere in the wide range of 4-99%.
Three Types of Inventory Financing
- Term loans
- Line of credit
- Revenue-based financing
Term Loans
This is the loan most people are familiar with. Your lender gives you the money up front and you pay back a designated minimum amount every month. Many people prefer this type of loan because it is the most familiar and easy to remember because it never changes. You know what your monthly payment is every month and can factor it in your budget.
There isn’t very much wiggle room with term loans – you either pay it or you accrue late penalties and interest. SBA Loans, traditional bank loans, and online lenders offer term loans with varying interest rates, length of terms, and stipulations.
Typical lengths of term loans are as follows:
Short term loans are usually less than 12 months, but no more than 18 months.
Intermediate/Middle length loans are between 12 months and three years.
Long term loans range from 3-25 years.
As a startup business, you want to stay in the short term category to avoid long-term debt and interest over a lengthy loan. As you grow and are no longer considered a “startup” (around the 3-5 year mark) you can start looking at longer term loans (not specific to inventory) to purchase office space, warehouses, or other property and resources.
Line of Credit
Lines of credit usually follow a similar formula to term loans. You still need to make a designated and on-time monthly payment. However, LOCs have the added benefit of returning credit to you after you’ve paid part of your debt. They work similar to credit cards as both are revolving credit.
So if you take out a $5,000 LOC and you pay back $2,000, that $2k becomes available to you again to use. Some suppliers and manufacturers will agree to a line of credit inventory loan because they can recover the product and find another buyer easier than a traditional bank can because they have the hookup and connections in the industry.
If your supplier has a lending faction, talk to them about setting up an inventory line of credit for their product. The supplier may consider your business for a LOC loan because they can profit off of your initial order and then make money back in interest. For them, it’s a win-win situation.
Revenue-Based Financing
Possibly one of the most genius inventory financing options is the revenue-based financing (RBF) loans. These are inventory loans with a flexible payment plan.
The lender gives you financing to purchase your inventory and then takes a percentage of your revenue each month. This helps small businesses make ends meet because you aren’t saddled with a hefty monthly payment every month. During slow months when you don’t sell as many products, you still make a monthly payment, but it’s not as straining on your business.
Example: You borrow $50,000 from a RBF inventory lender who negotiates a 10% monthly payment. You place your order for supplies or stock and start marketing your product. When you receive your inventory and begin selling, you might only sell $5,000 in the first month. So when that first payment is due you pay $500. Next month you bring in $10,000 in revenue so your next payment is $1,000. But after that you go through a slow period where you only bring in $2000 for the third month. That month you only pay $200 back to the lender.
Keep in mind the financers may require you to pay a minimum monthly payment or x%, whichever is highest. On the other hand, different financers may not require a minimum payment so you need to pay attention to the terms of your loan.
Who Is Eligible for Inventory Loans
The ideal candidate for an inventory loan will have a minimum of a 600 credit score, and produce more than $50,000 revenue per year. Short term inventory loans will be a max of $150,000 paid over 6-18 months.
Longer term inventory loans provided by the Small Business Administration (SBA) have government backing and can dole out up to $5 million. Needless to say, if you are asking for $5 million, you probably have a pretty solid business plan and a healthy cash flow. But keep this information in mind later on down the line when you are no longer in your “startup” phase and are looking to make bigger, more profitable investments.
Alternatives to Inventory Financing for eCommerce Startups
We talked a lot about the pros and cons of inventory financing throughout this article (pro: get money up front for your inventory; con: high interest rates, variable payments, if you default they take your product and you can’t sell). So maybe you are still on the fence about inventory financing, and trust us, we get it. Loans and debt are a big commitment. While we think inventory financing is a god-send to some businesses, we know financing isn’t a one-size-fits-all popcorn t-shirt from the GAP (90’s teen-queens know what we mean).
Other non-loan options include government grants, investors, and good ol’ fashioned savings. These types of financing options and goals can be difficult to reach. Grants are notoriously competitive and, while it’s “free money” some scholarships come with criteria you must meet or you forfeit the money. Taking on investors means those people get a stake – and a say – in your business.
On the flip side, if you are still interested in a loan option with a flexible twist, consider invoice factoring. This is a type of loan where you “sell” a portion of your invoices to a factoring company who will then collect payment from the customer in exchange for financing your business. The downside to invoice factoring is that the factoring company does not collect debt – either the customer pays the invoice or they send it back to you and make you pay the debt. So you’re still on the hook either way.
Another popular, and in many cases, more successful, financing option is merchant cash advances. These types of loans are highly sought after by eCommerce sellers because it makes funding and repayment simple. Instead of using interest rates, MCA companies use a factoring rate of 1-1.6 of the total amount borrowed, depending on your business or personal credit score and your revenue. So you simply take the amount of the loan and multiply it by the factor rate to find out your total cost.
MCAs are easier than traditional loans because you aren’t paying on compounded interest. The MCA will take a predetermined percentage of your daily or weekly total credit/debit sales until the factored amount is paid in full. Applying for an MCA is quick and easy – most applications take no longer than 24-48 hours to process when applying online.
Additionally, MCAs are able to fund your whole supply chain from product to payroll to shipping. Once you have the money in your pocket you aren’t limited to what you can use it on to fund your business. Lenders take into account how long you’ve been in business, your revenue, your credit, and even the industry you are in to determine how much you can borrow. With all of your financials organized, some lenders may be able to front up to $500,000.
Final Thoughts
Inventory finance loans serve a large group of small businesses and startups across the globe by providing the much needed up front financing to purchase and manufacture inventory. While the terms, interest rates, and eligibility criteria vary from lender to lender, it’s more than likely any business can find a financier that suits their business.
But always make sure you research all of your options to choose what is right for you and your business.