So you want to start an ecommerce store. You have a product in mind, maybe a name. And you’ve looked into building an online shop. But how will you pay for it?
The United States Small Business Administration (SBA) estimates that the average small business requires between $10,000 to $80,000 in annual funding—and a lot of those expenses end up front-loaded when you first launch. From buying inventory and registering your business to securing licenses and marketing your new store, you need funding to get started.
So where can you get the financing to start an ecommerce business? There are several ways to raise funding. We’ll outline seven of the most common, viable options for ecommerce entrepreneurs to consider—but first, we’ll talk about what to consider before you look into your financing options.
Step 1: Assessing Your Needs
Before you consider which type of financing will work for your new ecommerce business, you need to have a firm understanding of exactly what your needs are.
For example, some products require a huge sum of initial startup capital to buy inventory. Competitive products may need a large initial investment in branding and marketing to make a name for themselves in the industry. Other ecommerce stores may require little to no upfront financial investment.
To assess what your needs really are, we recommend asking yourself these six questions—and letting the answers help with your evaluation of the seven common funding options you have to choose from:
- How much funding do I need? This includes the funding you’ll need to launch and any financing you’ll need to continue operations through your break-even point.
- When do I need the money? Breaking it down, estimate when you’ll really need financing. If the answer is right away, that narrows down the funding options you have to choose from.
- How will I use the money? Some of the financing options below are limiting in how you can use the money. Plus, most traditional bank loans and venture capital investment require you to detail this information before they agree to give you any money.
- Do I meet common lender requirements to qualify? Again, many of the options below have stringent requirements a business owner needs to meet in order to qualify. If you or your new business don’t meet them, that narrows down the options you need to consider, too.
- How much control or equity am I willing to give up? Some of your options for ecommerce financing will require you to give up varying degrees of equity in your business (or business-to-be), so it’s important to consider if you’re willing to part with any ownership or control.
- Do I need money, strategic help, or both? Sometimes, all you need is a little cash to grease the skids of your new business. Other times, you may need more hands-on strategic help along with the financing.
Step 2: Assessing Your Options
Now that you have a better sense of what you really need to get things off the ground, let’s talk about your options. We’ll highlight seven of the most common ways to finance an ecommerce store and explain the pros and cons that come with each.
The simplest and least involved way to fund your ecommerce store is to dip into your own personal savings. While the amount of financing you can find here is highly dependent on your own savings account, it doesn’t require you to take on any debt or give up equity in the business.
Pros of Using Your Personal Savings
- No debt and no strict repayment schedule: When you use your own money, you won’t saddle your fledgling business with any debt or strict schedules for repaying the amount of funding you use.
- You retain complete control over the store: You don’t need to give up any ownership or equity in your growing business—you remain 100% owner.
- Can be supplemented with friends and family investment: While using your own personal savings can be limited, you can also supplement it with investment from friends and family to stretch things a little farther.
Cons of Using Your Personal Savings
- Can be a limited amount of money: This is really the main drawback to using your own personal savings. There’s a concrete (possibly low) limit to how much you can spend and invest in the business—and you may end up having to secure outside financing down the line anyway.
Business Line of Credit
A business line of credit is a type of financing that allows you to withdraw any amount of capital, up to a predetermined amount. In other words, you’re approved for a certain amount of money, and you take it out (and pay interest on it) only as you need it. According to FitSmallBusiness, up to 47% of small businesses have opened up a line of credit at some point.
Pros of a Business Line of Credit
- You can withdraw funds only as you need them: That means you have access to plenty of funding—but if you don’t end up needing or using it all, you don’t pay interest on it.
- Typically has a lower APR than credit cards: Speaking of interest, most business lines of credit boast a notably lower interest rate than business credit cards.
- Access to cash to help manage your cash flow: Also unlike credit cards, a business line of credit gives you access to cold, hard cash.
- Flexibility: Unlike business loans and some other types of financing, you don’t have to specify how you’ll use a business line of credit in order to be approved. That means you can use the money for anything your business needs.
Cons of a Business Line of Credit
- Limited borrowing amount: The amount of money you can secure via a business line of credit is most often quite a bit less than a traditional long-term loan would allow.
- New businesses may not qualify: Qualifying for a business line of credit can be difficult—particularly if your business is new (without a proven record of success).
- Interest: As you borrow money against your line of credit, you incur interest that you’ll need to pay back in addition to the amount borrowed.
For ecommerce stores that hold a lot of inventory (or inventory that holds a lot of value), you can use inventory financing to borrow money against the value of that inventory. You repay the loan as you sell the inventory. This can be an ideal way to balance seasonal demands and product line expansions.
Pros of Inventory Financing
- Short-term infusion of cash: Inventory financing is a quick way to get value out of your inventory, and the approval process is typically much faster than a traditional loan or line of credit.
- Can enable you to expand product lines: If you need cash to order inventory of a new product line, you can use inventory financing to do it.
- Can help you manage seasonal demand: If you need to stock up on inventory (in advance of the winter holidays, for example), inventory financing can help you bridge the gap between buying the inventory and ultimately selling it.
- Doesn’t count toward debt in your financials: In terms of your debt-to-equity ratio, inventory financing doesn’t count as a debt. This means you can use it as a short-term infusion of cash even while applying for long-term financing like a loan without hurting your chances of getting approved.
Cons of Inventory Financing
- Can involve constant communication with the lender: Since the lender doesn’t get repaid until you sell the inventory, this type of financing typically involves much more communication and reporting back to the lender than other sources of funding.
- Hard to find lenders: Inventory financing is considered a high-risk investment—because there’s no guarantee you’ll be able to sell the inventory and repay the loan. For that reason, many lenders are hesitant to lend this way (or they just won’t at all).
Business Loan (Including Small Business Administration Loans)
Traditional business loans are one of the most popular ways to fund a new or growing business. In fact, traditional banks lent more than $500 billion to US small businesses in 2017 alone—and nearly 40% of business owners in the US applied for a loan that year.
Traditional business loans from a bank are straightforward and can give business owners access to more capital than many of the other financing options on the table. The catch is that they come with a lot of requirements and low approval rates. However, those backed and guaranteed by the SBA can be easier to get approved and require less collateral.
Pros of Business Loans
- Higher borrowing amounts: Traditional, long-term loans offer ecommerce stores access to more capital than many other funding options.
- You retain complete control and equity: Business loans come with a lot of requirements, but giving up equity or control usually isn’t one of them.
- Low collateral requirements for SBA loans: If you apply for an SBA loan (which is, in part, guaranteed by the US Small Business Administration), you can put up much less collateral in exchange for your loan.
- Interest repayment is tax deductible: As you repay the loan, the amount of interest you pay is deductible on your small business taxes.
Cons of Business Loans
- Increases your debt-to-equity ratio: Traditional loans require you to take on financial debt (and often, a lot of it) in exchange for the capital.
- Application processes can be lengthy and cumbersome: Banks require a lot of financial and business documentation in order to apply for a loan. Once you do, the approval process can take several months.
- Non-SBA loans usually require collateral: If your loan isn’t guaranteed by the SBA, you may be required to put up substantial collateral in order to secure the loan.
Business Loan Options
When it comes to securing a traditional business loan, ecommerce store owners have a few big options. You can choose to apply for a loan from:
- A traditional bank
- Your local bank
- A credit union
- An online lender
Traditional banks can typically net you the largest borrowing amount, but they have rigid qualification requirements and low approval ratings (often as low as 26%). Local banks boast much higher approval rates (up to 52%) and can often be more flexible with the interest rate, collateral, and repayment terms.
Getting a loan from a credit union is typically similar to getting one from a small or local bank—the difference is that you often need to be a member of the credit union in order to get approved.
Online lenders are the most flexible of all business lenders. Their approval processes are typically much faster—but you usually can’t borrow as much from them as you can from a large bank.
Business Credit Cards
A business credit card is pretty similar to the personal credit cards you likely already use. The key differences include:
- Opening, spending, and paying off your business credit card affects your business’ credit score
- You can usually get a higher credit limit on a business credit card than a personal one
- The rewards you earn can be different
Pros of Business Credit Cards
- Easy qualification: Qualifying for a business credit card is substantially easier (and usually faster) than applying for a loan or line of credit.
- Flexible, on-demand funding: You can spend on your business credit card only as you need to—and pay it off as you can afford to.
- Repayment builds your business credit score: Similar to personal credit scores, your business has a credit score, too, and it can affect your ability to secure other types of financing, get approved for a commercial, and more down the line. As you pay off your business credit card in a timely way, you’re building up this score.
- You can earn rewards: Unlike other types of business financing, a credit card allows you to earn rewards as you spend. That can include cash back, points to spend on wifi or office supplies, and more.
Cons of Business Credit Cards
- Interest rates can be high: Business credit cards aren’t technically covered by the Consumer Financial Protection Bureau (CFPB), so your interest rate can be high, and it can fluctuate.
- No (or expensive) access to cash: If there are bills you need to pay in cash, a business credit card typically can’t help you cover them. If it can (through a cash advance), the interest rate is often even higher than it is on typical credit purchases.
- Security issues: With credit cards opens up the possibility of credit card fraud.
Over the last several years, crowdfunding has emerged as a potent force for raising startup capital and funding new ecommerce businesses. While it’s better suited to some industries than others, crowdfunding is a good option for most ecommerce owners to consider.
Pros of Crowdfunding Your Ecommerce Store
- You get market validation and customer feedback: In addition to funding, crowdfunding presents an opportunity to test out your product and your pitch, giving you market validation and access to invaluable customer feedback as you fundraise.
- The sky's the limit when it comes to funding amounts: At least in theory, you can earn an uncapped amount via crowdfunding.
- You have options: In exchange for crowdfunding pledges, you can offer rewards in the form of a future product, pre-sales, traditional loan repayment, or equity.
Cons of Crowdfunding for Your Ecommerce Store
- Getting substantial funding can be a lot of work: From setting up the campaign to publicizing it and convincing people to pledge, it can take a lot of time and effort to see any substantial financing from crowdfunding.
- Some platforms use an all-or-nothing fundraising model: On some crowdfunding platforms, you have to set a dollar amount as your goal for the campaign. If you don’t fulfill (or surpass) that amount, you may not actually get any of the funding raised.
With the rising popularity, crowdfunding websites are springing up everywhere. That said, here are the 3 most popular and reputable crowdfunding platforms:
- Kickstarter (great for tech-based products)
- Patreon (best for creative products)
- Indiegogo (versatile—nearly any product can work here)
Venture capital (VC) is when an investor gives you a sum of capital in exchange for some portion of the equity in your business. It’s one of the only ways to raise a truly substantial amount of funding and often comes with strategic help and access to the investor’s connections (since they have a stake in your business’ success).
Pros of Venture Capital Funding
- You can raise a lot of money this way: Venture capital and angel investment are some of the only ways to raise really substantial sums of capital.
- You often get strategic and network support: In addition to money, you get additional value in the form of the investor’s experience and strategic business support, plus access to their business network.
- You have no obligation to repay VC funds if your business fails: Here’s one of the big benefits—VCs are taking a risk with their own money, so if your business fails, you aren’t obligated to repay their investment.
Cons of Venture Capital Funding
- You have to give up equity: Nearly every venture capital investment requires you to give up some portion of equity in exchange for the capital. That means you have to forfeit some level of control over your store.
- Venture capital funds can be difficult to acquire: Unlike a bank, venture capital investors are more limited in the amount of funding and business support they can provide. VC funding is also notoriously difficult for women and minority-owned companies to secure.
- Rigid reporting structures: Since the investor’s ability to recoup their investment (and profit off of it) is dependent on your store’s performance, there are often rigid reporting structures you have to abide by to keep VCs up to date.
The Right Financing for Your Ecommerce Store
If you’re looking to start an ecommerce store, you have quite a few options when it comes to financing your launch. While it can feel overwhelming at times, this is a good thing. By taking a step back to assess what your store really needs to get things moving, you’ll be better prepared to evaluate your financing options and secure the funding you need to launch and grow your new ecommerce store.