This post is by Radoslav Albrecht, the founder and CEO of Bitbond. Based in Berlin (Germany), Bitbond is a peer-to-peer lending platform that specializes in providing loans to online sellers and small businesses. The platform uses bitcoin as a payment network and is therefore available to everyone who has access to the internet. Previous to starting Bitbond, Radoslav was advising banks at Roland Berger Strategy Consultants and has worked for Deutsche Bank in London.
As an online seller you want to spend your time optimizing and growing your sales. Your products and the service you provide to your customers are at the center of your attention. Other administrative activities that don’t relate to making sales directly are often regarded as chores.
Frequently, this also applies to the financing of a retailer’s activities. As a financial product, loans and credit lines are often untried territory for online sellers. To someone who is not familiar with financing, the associated terms and costs might look opaque and not easily understandable.
However, the right financing at the right time can mean a significant competitive advantage. Availability of funds can be the factor that helps you lift your shop to the next revenue level. This guide should bring more light to the matter – you will learn which alternatives exist and how you can compare them.
So let’s start by exploring when you should be thinking about taking out an ecommerce loan or other financing alternatives and when it’s not recommended.
3 occasions when a loan helps online sellers
The decision if and when it makes sense for an online seller to take out a loan is quite similar to other decisions related to online selling. A cost-benefit analysis can help you to assess the situation. Generally there are three occasions when a loan will help you.
1. Finance revenue growth
As you increase your sales, you need to finance more inventory. Despite being a profitable retailer, you will need to get additional funds. The operating cash flow that your shop generates may at some point not be sufficient to finance your growth.
This is a typical situation where external financing can help. When an ecommerce business is healthy and you want it to grow, a loan is a suitable tool. Just like you would use other online seller tools that help you to optimize the categories you are selling in.
When looking at the operations of your selling activities from a financial perspective, there are three important components. Altogether they make up the working capital of a retailer.
Typically you have a certain amount of products and goods you keep in stock – this is your inventory. At the same time you have receivables from completed, but yet to be paid sales. The third component are your payables, this is the money you owe to suppliers or contractors.
When you sum up inventory and receivables (items you need to finance) and subtract payables (implicit short-term financing you get from suppliers) you get the net working capital, the net amount that is financed by you. Here is an example of a retailer who starts out with $8,000 monthly sales and a net working capital of $3,500.
The initial working capital of $3,500 could perhaps be financed by personal savings. However, as the revenue grows, so does the financing requirement. By the end of the year the net working capital in the example has grown to over $5,100 which is an increase of $1,500 or 46%.
Unless either your gross margin increases significantly or your suppliers can give you longer payment terms, you will need to find an external source of financing. A loan or credit line that is tailored to the needs of online sellers is the right tool in such a situation. Without external financing, it will be harder to grow your business.
2. Bridge short-term liquidity gaps and revenue fluctuations
One other thing that is visible from the above chart is that sales don’t follow a straight line. There are months of successful growth and there are difficult months in the life of every retailer. Seasonalities exist in almost every category.
You can take counter-measures when you are aware of certain seasonal effects. You will reduce your inventory and ask your suppliers for more favorable payment terms. But often the effects associated with revenue fluctuations will still cause a short-term liquidity gap.
You have to generate cash somehow. When you have to cope with such a situation, there are usually two options. Either you run a flash sale with the inventory that you have, or you finance the gap externally. Unless you are in a category with extraordinary margins, the flash sale may often be the more expensive option.
Selling below your normal price means that your are effectively taking a loss on foregone profit. If you buy yourself time and finance the gap with a loan, the costs can be potentially lower.
Let’s assume you bridge a gap of $4,000 that you financed with an instalment loan over 6 months. At an interest rate of 15% p.a. and equal monthly instalments your total expense can be less than $300 (go to Repayment type further below to see the payment schedule of this example).
If you had to generate revenues worth $4,000 fast in a matter of days, you would likely have taken a larger loss. Let’s say again that the average gross margin on your items is 50%. You are prepared to go down to 20% gross margin for the flash sale which is a price reduction of 37.5% for your customers. This is what the price reduction looks like for a single item with a purchase price of $10.00:
|Per Item analysis||Normal price||Flash sale price||Difference||Difference %|
If you need to generate total additional revenues of $4,000 through the flash sale, the calculation looks as follows:
- 200 units at normal price give $4,000 x 50% = $2,000 in gross profit
- 320 units at flash sale price give $4,000 x 20% = $800 in gross profit
- Foregone gross profit on this price reduction is $2,000 – $800 = $1,200
The loss on foregone profit of $1,200 is substantially more than the cost of the loan of less than $300.
This example assumes that if you keep your inventory on stock you can sell it at normal prices over time. True, this might not always be the case. But normal price reductions are usually factored into the lifecycle of your stock. A 75% reduction of gross profit per sold item usually is not.
In any case, it’s worth considering financing liquidity gaps externally and undertaking a proper comparison of the costs and benefits of all available options.
One ‘soft factor’ to also consider here is your reputation. If you are trying to build a brand you have to make sure you maintain a certain price level and do not dilute your USP. You don’t want to get known for the cheapest items but for best quality, service, selection and other factors that are important to your customers. Letting your customers become accustomed to frequent flash sales will decrease the chances of them buying when you decide to return to a normal price level again.
3. Finance large orders and buying opportunities
Sometimes things evolve rapidly and come as a surprise. You might find a new business partner who will allow you to list more products on the condition that you achieve a higher sales volume.
Or you might find an opportunity to buy inventory at discounted prices with no change in quality.
Such opportunities are the lifeblood of being a retailer. Those who react quickly to market demand and opportunities achieve the best results for their shop and their customers. If you want to move quickly, you need financial flexibility.
Short-term opportunities are the opposite of the liquidity gaps described above. But the financial side is similar. You need to consider the foregone profit if you don’t have the funds to take advantage of an upcoming opportunity. A cost-benefit analysis needs to take both the cost of financing and the gained gross profit into account.
Loans are not suitable to finance losses
While external financing is a great tool to help you grow as a retailer and to obtain the financial flexibility you need, debt is not a suitable solution to every challenge. One thing that should be highlighted here is the financing of losses.
If you sell in categories where your margins are not sufficient to cover all your costs plus your living expenses, then you must find a solution within your core operations first. Funding a low or negative margin business with cash from a loan is too risky.
You don’t know how long it will take you to switch to a more profitable niche. At the same time the payments on your loan will still be due. Even if you can prolong them, the accrued interest becomes more and more of a financial burden. This is a situation that you always want to avoid.
The first thing to do would be to start reducing costs and analyze margins of all your products and categories. Don’t get financing until you have turned your business around.
6 factors to consider when taking out a loan
Loans and other financing options can differ substantially. At the same time the interest of a loan is not the only factor to consider by far. This comprehensive overview shows which aspects are relevant in evaluating which is the right financing for you.
The cost of financing is typically measured by the interest rate p.a. (per annum or yearly) or APR (annual percentage rate). Additionally to the interest you often also have to pay various fees.
If the lender of your choice is transparent, they will account for the fees in the calculation of the effective APR. If they don’t account for fees, make sure to consider all interest and fee payments when comparing different offers.
Why is the APR so relevant and why don’t we simply look at total cost in monetary terms? This is because we need to make different financing options comparable. The APR is a uniform measure of the price to borrow money. It makes the cost of loans with different terms and repayment types comparable.
Additionally to the APR you should be aware of the total cost in monetary terms (USD, GBP or other currency). While the APR is your primary measure, the total cash cost of borrowing is nonetheless important.
2. Repayment type
Amortizing loans are repaid in equal monthly instalments. Each instalment contains an interest portion and a repayment of principal. This loan is suitable if you generate a continuous income from which you make the monthly loan payments. Amortizing loans are also called instalment loans or term loans.
The principal amount of a bullet loan is typically repaid at the loan’s maturity in one payment. There are either multiple interest payments throughout the lifetime of a bullet loan or the interest is also paid in just one payment at maturity.
A credit line is a commitment by a lender to lend you money up to a certain pre-defined amount at the time when you demand it. You get access to cash at your convenience. The repayment of a credit line is often bound to a payment schedule similar to that of an amortizing loan.
However, there are also credit lines where the repayment is flexibly determined by the borrower. Interest is paid during the time when the credit line is drawn. The additional flexibility of the credit line usually costs extra interest versus other loan types.
The term of the loan influences the repayment. The longer the term, the more interest you pay. In this respect borrowing money is similar to renting a car. Effectively you pay interest on a per day basis. Interest rates also tend to increase with longer terms because a longer time period adds more uncertainty for the lender. Typical terms can range from a few weeks up to around 5 years.
On the other hand a longer term reduces your monthly cash outflow. The monthly repayment amount is smaller when the repayment of a loan is stretched out over a longer period of time.
It is also worth checking if and how you can repay a loan early. Sometimes this is not possible at all or only under certain conditions. Some lenders charge an early repayment fee. Other lenders require you to repay the full loan amount plus interest as if the loan wasn’t repaid early but kept until maturity. In that case an early repayment doesn’t save you money.
It may also be that a large portion of interest payments happen early in the lifetime of the loan. In such cases it might make more sense to keep the capital as long as possible because you already paid for it. It’s as if you paid for 7-day car rental but return it after the first day.
When you need a loan you will want to have it as quickly as possible. Therefore you should consider how long it will approximately take the lender of your choice to complete the whole process. This time spans from your initial application and loan approval until the actual payout of the loan.
This can vary between a day and up to a couple of weeks. Lenders that specialize on online retailers usually complete the whole process in a few days. Banks can take multiple weeks to approve you, which in many cases will be too late to grasp an opportunity.
5. Credit impact
Every loan application can impact your credit. The first thing to check is if the application includes a “hard” credit inquiry and a credit score pull. If it does, only apply at a time when you really want to take out a loan.
Research multiple providers of online seller loans (more about this in the next section) before you actually apply. This is time well invested. Your research will help you to reduce the total number of your applications dramatically. When you know that the provider of your choice matches your criteria plus you match their qualification requirements, it will be sufficient to apply to just one or two lenders. Thereby you reduce the amount of time you spend applying and you minimize the impact on your credit score that multiple applications would have.
When looking at the credit impact, there is also a difference between taking out a loan on behalf of the legal entity under which you might run your business, or taking out a loan as an individual person. In most cases you are held liable for the loan personally. In that case it would not make a difference which entity takes out the loan. But you should always check who is ultimately held liable because this has an impact on your individual credit score or the score of your company.
Most loans for online seller loans are unsecured. However, if you fail to meet your due payments, the lender could in most cases start liquidating assets you own. Some lenders also have direct access to your PayPal or debit account in which case they will deduct payments automatically before you get access to them. Therefore it is strongly advised that you understand what happens in case of late payments before selecting a loan provider.
As outlined previously the best thing to do though is to only take out a loan when you can afford it. Being subject to debt collection which can ultimately happen if you default on your payments is the most severe credit impact that can happen to you.
6. Loan amount
The maximum amount you can borrow depends on two things: your credit quality and your income. The loan amount that you should take out depends on your needs. Taking out a larger amount than needed will only cost you extra in interest.
Set up a cash flow forecast to analyze how much liquidity you need and what amount you can repay monthly. This cash forecast will also help you to project for which term you need the loan.
Cash flow forecasting might sound more complicated than it is. Basically all you need to do is set up a spreadsheet with planned incoming and outgoing payments and sum them up. Larger corporations plan cash flow on a daily basis. As an online retailer it’s usually sufficient to set up a rolling forecast for the next 2-3 months on a weekly basis. The most important items to consider in the cash forecast are:
Incoming funds in a given week:
- Revenue from completed sales
- Tax refunds
Outgoing funds in a given week:
- Purchase of inventory
- Recurring payments for subscription services like accounting software, marketing tools etc.
- Travel and other operating expenses
- Invoices for professional services like lawyers and tax advisors
- Tax payments
- Loan repayments
Net cash flow in a given week = incoming funds – outgoing funds
Lenders with tailored products for online sellers
When you apply for a bank loan the bank will ask you for a large number of data points. However, it’s unlikely that they will have a look at your Amazon or eBay account history or other ecommerce platforms where you might be selling. Since banks don’t access this data, it’s more difficult for them to assess your creditworthiness. This results in longer approval times and higher rejection rates.
Lenders who specialize in online retailers consider the particular needs of their borrowers and jump in to fill the gap that banks leave in this segment. The table below shows ecommerce loan providers who are tailored to meet the needs of online retailers. On all of these you can connect one or more of your online accounts to prove your creditworthiness. Interest rates tend to be higher than for bank loans. At the same time these providers are faster and more convenient to apply to.
Quote by a UK-based online retailer:
A loan helped me to buy additional inventory for my eBay and Etsy shop. It would have been nearly impossible for me to get a loan from a bank in just 3 days. I haven’t seen any bank consider data from my online accounts. In my view this proves far better that I’m capable of repaying the loan. My last tax assessment is 15 months old and I was making a fraction of the revenue then compared to today. I don’t think a bank would approve me based on such outdated information. With my online accounts I can show how my revenue went up in the last 6 months and that my selling activities generate sufficient revenues.
|Loan type||credit line||credit line||credit line||credit line||amortizing loan|
|Repayment||monthly||deduction from daily sales through PayPal||monthly||monthly||monthly|
|Terms||1-6 months||no fixed maturity, repayment is completed as a partial deduction of daily sales through PayPal||1-24 months||1-6 months||6 weeks to 5 years|
|Time to payout||1-3 days||same day||1-2 days||1-2 days||2-15 days|
|Loan amounts||2k-100k USD
1k – 40k GBP
|1.5k-85k USD (4% to 15% of your annual sales through PayPal)||1k-120k GBP||1k-50k GBP||0.1k-10k USD|
|Data used for credit check||credit score pull, eBay, PayPal, Amazon, online bank account and other business accounts||PayPal transaction history||credit score pull, Paypal, eBay, eBay, Shopify or Bigcommerce shop, other business accounts||credit score pull, eBay, Amazon, PayPal, Magento and other business accounts||eBay, PayPal and other business accounts|
|Countries available||UK, US||AU, UK, US||UK||DE, ES, PL, UK||global|
|Qualification requirements||min. USD 2,500 monthly revenues over last 3 months, min. 1 year in business, min. personal credit score of 550 (US)||min. 20,000 USD per year in payments through PayPal||1 year in business with a UK registered company, min. annual revenues of||min. 10,000 GBP annual revenue as a UK-based business (sole-trader, partnership or limited company)||min. 1 year in business as an online seller on one of the platforms available to connect|
Loans can help online sellers grow their shop and to acquire additional funds to take advantage of opportunities. External funding is part of the toolset that can help a retailer to optimize operations and to run a successful shop.
Similar to any other tools you might use, it’s worth comparing different alternatives and to evaluate which provider is the right one for you. Like other services, a loan costs you money. Therefore you should only get one if you can afford to meet the monthly payment requirements. This guide should help you to make a well informed decision in regards to when to take out a loan and what factors to consider. If you have further questions, I look forward to hearing them in the comments.