Running an e-commerce business has its pros. You likely have lower overhead costs compared to a brick-and-mortar store, and it may be easier to reach your customer base on the digital front.
It’s likely that you’ve encountered money constraints before. In fact, according to an Intuit survey of 3,000 small business owners, “more than half of U.S. small business owners companies’ have lost $10,000 or more by foregoing a project or sales specifically due to issues created by insufficient cash flow”.
That’s a lot of money. And that’s not even taking into consideration other growth opportunities that might have less of an immediate impact on your bottom line, like launching your own product line or investing in a full-scale social media advertising strategy.
Luckily, there are plenty of options available to help — from SBA loans to invoice factoring to a business line of credit. With business financing, you can take advantage of growth opportunities, without necessarily having the cash on hand.
This guide walks you through common small business loans, and what you need to know to navigate e-commerce financing with confidence.
How to Get a Loan to Grow Your Business In 6 Steps
When it comes to pretty much anything related to your business, it pays off to have a plan. If you’re ready to take advantage of small business funding, here’s a simple blueprint you can follow.
Why Do You Need a Loan?
What would you do with an extra $15,000, $100,000 or even $500,000? How would you put those funds to use to grow your business? The options are endless, but some reasons e-commerce businesses might apply for financing include:
- Expanding to a brick-and-mortar location
- Moving from solo store to multiple marketplaces
- Investing in a marketing campaign (SEO, paid search, blogging)
- Making bulk inventory purchases
- Hiring additional staff
- Smoothing over seasonal cash flow gaps
- Going international
- Paying manufacturers for product orders
- Covering day-to-day operating expenses
- Revamping your website
- Creating a mobile commerce app
- Renting a warehouse
- Upgrading technology
- Refinancing high-interest debt
So, before you get started with anything, think about this: Why do I need a business loan?
Step 1: Figure out how much you need (and how much you can afford)
It’s essential to have clarity on how much funding you need to achieve your growth goals for your e-commerce business. So, before you begin shopping around for lenders, ask yourself these questions:
- How much money will I need to borrow?
- What loan amount can I afford?
- What’s the return on investment (ROI)?
Dig into those numbers — inaccurate estimates could result in a business loan doing more harm than good.
A Scenario to Help Explain
As an example, say you want to take your online retail business and create a physical footprint with a brick-and-mortar storefront.
First, you’d need a full rundown of costs, which might include:
- Hiring (and training) new employees
- Professional and legal fees
- Licenses and permits
- Equipment and technology
- Furniture and decorations
- Ongoing payroll costs
This process will help you determine roughly how much funding is needed to get the job done. And you should always add a little extra financial cushion in your loan request for those unexpected costs, which will inevitably appear.
You will have to compare your estimated expenses to your projected revenue. Comparing these numbers will provide you with a ballpark figure of the return you can expect on a physical storefront. It will also if you can afford the loan amount (in addition to your existing obligations), both in the short- and long-term.
Calculating ROI can really pay off when it comes to considering several different opportunities. You may find that one scenario delivers a better return and that it makes sense to pivot your plan for growth. You can calculate ROI using the following formula:
ROI = (Net Profit / Cost of Investment) x 100
Net Profit = Gross Profit – Expenses
Cost of Investment = Cost of the loan (including principal, interest and any fees)
Determining what you can afford might be a little more tricky. Some lenders use the debt service coverage ratio (DSCR) to evaluate your loan amount request and whether you’ll be able to repay it. DSCR is a metric that compares your available cash to your outstanding debt. You can calculate DSCR using the following formula:
DSCR = Net Operating Income / Annual Debt Obligations
Net Operating Income* = Revenue – [Cost of Goods Sold (COGS) + Operating Expenses)
*You can swap out EBITDA (earnings before interest, taxes, depreciation, and amortization) for net operating income.
Annual Debt Obligation = Amount of money required over the year to repay debts (loan principal, interest and fees, as well as lease payments, if applicable)
A DSCR of 1 means you have just enough net operating income to cover debt obligations. Some lenders will accept a DSCR of 1.15, but a DSCR of 1.25 is generally required.
Step 2: Determine what type of loan meets your needs best
Small business financing covers a lot of ground, and one kind of loan may be a better fit for your needs than another. Below are some typical small business loans that you may want to consider to grow your e-commerce business.
Business term loan
A business term loan is your standard business loan. You receive a lump sum of capital, which you then pay back over a predetermined amount of time. Term loans typically have fixed interest rates, which means a predictable repayment schedule that makes it easier to budget. With loan amounts ranging from several thousand dollars to $1 million, many turn to term loans to tackle big-ticket items or larger projects. But, you can use this flexible form of financing for just about anything.
Term loans tend to offer lower rates than other forms of financing. But that comes with conditions. If you’re just starting a business, you’re out of luck — most term loan lenders require you to have at least two years under your belt. And if your credit score is less-than-excellent, you might not qualify, or at the very least, you should expect higher interest rates.
Business line of credit
A business line of credit is revolving credit that can be drawn against to cover regular, short-term financing needs. Unlike a term loan, you only make payments and pay interest on the funds you borrow. And once you repay the funds you use, you can draw from your line again and again and again.
Here’s an example: You get approved for a $75,000 credit line. You draw $25,000 to cover a bulk inventory purchase. You would still have access to the remaining $50,000, and once you paid back the $25,000 you used (plus interest), you’d have access to the full $75,000 again.
A line of credit is good to have in your back pocket as a safety net. It provides you with continual access to cash to cover any regular, short-term expenses or ongoing project costs.
The Small Business Administration guarantees loans issued by partner lenders. With the 7(a) loan program, you can borrow up to $5.5 million. The SBA offers competitive terms with some of the most affordable interest rates around, but the process is also notoriously time-intensive — on top of massive amounts of paperwork, it can take anywhere from 60 to 90 days to get a decision.
A form of asset-based lending, inventory financing allows you to use the inventory (i.e., assets) you’re purchasing to secure the loan. That’s good if you don’t want to put your personal assets up or don’t have other collateral to offer, and you need short-term financing to stock your virtual shelves.
Keep in mind that lenders typically offer loan amounts between 50% to 80% of the value of your inventory, which means you will need to come up with the additional money to cover the full cost. You also will need at least one year in business under your belt, and you may be required to meet a specific loan amount, which could be as much as $500,000.
Business credit card
A business credit card is quite similar to a line of credit, in that it’s revolving credit. The funds available to you at a given moment depend on what you’ve borrowed and what you’ve paid back. You’re only technically required to make minimum monthly payments. But, if you don’t pay off your balance in full each month, you risk falling into a debt trap. Interest rates are usually higher than other business loans or personal loans. There are also additional charges that could keep you in the red like annual fees, late payment penalties, and variable APRs.
A nice perk of business credit cards is the potential to earn cash back, miles, or points on purchases. Use strategically for short-term financing needs, including smaller purchases and ongoing, day-to-day operating expenses.
Merchant cash advance (MCA)
With a merchant cash advance, lenders advance you money in exchange for a percentage of your future daily credit card sales. MCAs can be easier to get for businesses with fair or poor credit or that don’t have a long operating history. You can get funds in just a few hours, but remember, speed comes at a price. The typical APR for a merchant cash advance ranges anywhere from 40% to 350% depending on the lender.
Invoice factoring allows you to borrow against your unpaid invoices to keep operations running smoothly. The financing company advances anywhere from 60% to 95% of the value of your invoices and takes over the collection process. Once your customer pays the outstanding invoice, you receive the money that’s left (minus factor fees and any other charges). Invoice factoring provides fast funds during cash flow crunches. But borrowers beware — this form of financing can get expensive quickly due to fees, as well as how long it takes your customer to pay up.
When comparing small business financing options, be sure to look at the details, including:
- Time to funding
- Minimum and maximum borrowing limits
- Interest rate range
- Down payments
- Repayment terms
- Collateral and personal guarantee requirements
- Secured or unsecured
You’ll also need to consider how your credit profile matches up with what the lender requires.
Step 3: Check your credit
Credit can make or break your loan application. And generally speaking, a higher credit score translates to a lower interest rate — which means more money in your pocket.
If you haven’t checked your personal or business credit lately, it’s helpful to take a look. Doing so allows you to check for errors or inaccuracies that may be hurting your credit scores. It can also give you a sense of how likely you are to qualify for financing and what interest rates you might be eligible for. You might even find that it’s worthwhile to wait a few months before applying so you can get your credit in top-notch shape.
Step 4: Find out if you’re eligible
Before you jump into applying, it’s a good idea first to check the lender’s minimum qualification requirements. Generally, lenders may set guidelines when it comes to things like:
- Credit scores
- Time in business
- Annual revenues
Remember that your cash flow matters as well since lenders want reassurance that you’ll be able to keep up with loan payments.
Also, see if the lender has specific requirements related to business models or industries they do (or don’t) work with.
Step 5: Gather your paperwork
There are certain documents you’ll need to apply. Some require more than others, but it never hurts to be over-prepared. Before you get started with the application, have the following on hand:
- Personal and business information
- Personal and business tax returns
- Current personal and business bank statements
- Financial statements (profit and loss statement, cash flow statement, balance sheet)
It’s also good to write or update your business plan, although it likely won’t be required. A business plan demonstrates you have done your research and that you have thought through the growth opportunity and how it will impact your bottom line.
Step 6: Apply
After comparing lenders, the final step is applying for the loan. Depending on the lender, you could finish the application and upload your supporting documents online in just a few minutes. It might take as little as a few hours or as long as a few months to get a decision, based on the lender.
Once you’re approved, make sure to review the loan agreement — line by line — to know exactly the terms you’re signing up for. Pay special attention to the APR. APR is the real cost per year of borrowing money.
Why? It takes into account not only the interest rate but also any additional fees or charges tacked onto the loan. It’s the best metric to use as a comparison if you’re evaluating multiple loan offers.
With a well-thought-out plan and the necessary funds in your bank account, you will be ready to move full speed ahead with growing your e-commerce businesses.