Most online businesses need access to financing at some point to help with cash flow. You can use it to cover normal (or unexpected) expenses, fund marketing initiatives, purchase inventory, access your own money faster, or invest in that next level of growth.
The bottom line is that securing the right funding could be the difference of keeping your business open or not. Or growing your business or not.
But, the challenge is choosing the best strategy. Every business is different — one financing solution could be a better fit than another. Every option has their own approval rates, different lengths of time it takes to get financing, and various repayment terms.
Unfortunately, most SMBs feel confused or unsure when comparing their financing options though. This can lead to poor choices (or not making one at all!) To help demystify funding for online businesses, this guide walks you through need-to-know finance terms, different financing solutions, and the pros and cons of your options.
Need-to-Know Financing Terms for Online Businesses
Here’s a list of important terms to familiarise yourself with. You’ll see these terms used in the pros and cons below when comparing your options.
Capital: Cash
Debt: Capital that is owed or due
ROI: Return on Investment (ROI) is a ratio that compares the gain or loss from an investment relative to its cost. A high ROI means you gained a large return on a small investment.
Collateral (or assets): Financial assets you own like your house or car. Collateral can be used to secure financing as you pledge to give your assets up if you can’t repay it.
Level of Risk: The likelihood that an investment’s actual gain will differ from an expected outcome or return. In other words, the level of risk that the customer (i.e. the business) will not be able to pay back the capital provider.
Credit Score: Providers often use credit scores (based on your credit history) to determine your level of risk when deciding to fund you. A higher credit score should indicate that you’re more trustworthy to pay back the funds.
Note: When a capital provider pulls your credit report, they will either do a soft or hard pull. A soft pull doesn’t impact your credit score, while a hard pull does (usually by two points per pull). Be sure to ask before allowing a funder to pull your score.
Personal Credit Score: FICO is one of the most common tools capital providers use to evaluate risk. Scores range from 350-900 and are generated from the top three credit bureaus: Experian, TransUnion, and Equifax.
Note that FICO is not a good indication of your business’s creditworthiness — it only says how creditworthy you are as an individual.
Pro Tip: If you’re looking for your business credit score, Tillful is an innovative company that can provide you with a fast, free, and transparent credit score in minutes. Even better, the score is updated daily and comes with tips on how to improve your score. Once your score is sufficiently good, Tillful will pre-approve you for financing from their partners.
Unsecured: Funding that is issued based on the customer’s creditworthiness, rather than by any type of collateral.
Secured: Funding backed by collateral that is used as payment to the capital provider if you don’t pay back the capital.
Equity: Ownership of assets that may have debt or other liabilities attached
Underwriting: Underwriting is how capital providers determine the level of risk for an investment, and whether to accept or reject an applicant for financing.
Purchase of Future Receivables: A third-party funder provides financing by buying your future earnings or sales at a discount.
Factor Rate: A multiplier representing the total amount the merchant/business will have to pay back. For example, if a merchant receives $10,000 in funding from a capital provider, and it’s paid back at a 1.3 factor rate, the merchant will pay back $10,000 X 1.3 = $13,000.
Interest: The rate you repay for the amount borrowed. For example, if a merchant receives $10,000 in funding from a capital provider, and it’s paid back at 2% interest, the merchant will pay $200 in interest ($10,000 X 0.2) + $10,000 for $10,200 total.
APR: Annual Percentage Rate, or the annual rate of interest charged to borrowers to pay back to a lender. APRs should only be applied to loan products that have an amortization schedule, as it can often poorly reflect the true financing cost for short-term financing.
Rebate: A partial refund for an overpayment or a discount for paying off earlier than expected.
Fees: A payment made to the funding company in exchange for financing.
Working Capital: Money available used to cover all a company’s short-term expenses like inventory, payroll, etc.
Capital (or Cash) Advance: A third-party funder provides an upfront sum of cash for a purchase of future sales or receivables at a discount. This is not a loan as the capital provider is actually purchasing a portion of your future sales outright.
FinTech: Financial technology (or FinTech) is innovative tech that aims to improve and automate the delivery and use of financial services.
How to Choose a Funding Strategy for Your Online Business
As you compare the differing funding options below, consider the following:
- Amount: What is the maximum amount of funding you can receive?
- Debt: Does the funding require you to take on debt?
- Approval Rate: How likely are you to be approved for the funding?
- Approval method: Is approval based on your personal credit or the health of your business?
- Speed: How quickly will you receive the funding?
- Cost: How much will you repay to the funder?
- Payment Terms: How long do you have to repay the capital provider?
- Risk: Does the financing require you to put up your own assets like your home or car? Are you tying your personal finances into your business?
Depending on the nature of your business, one funding option will make more sense over another.
Funding Options for Online Businesses
1. Personal Loans
A personal loan is capital borrowed from a bank, credit union, or online lender. You most likely pay it back in fixed monthly payments over a few years, which means you usually pay interest rates lower than credit cards. A personal loan can be unsecured (doesn’t require collateral) or secured (requires collateral), and approval is usually based on your personal credit score.
Who it’s best for: New or early stage small businesses without significant time in business or sales history
Pros: Low interest rates, monthly payments, available to businesses at any stage (depending on the owner’s credit history)
Cons: Approval is dependent on your FICO score. Typically, sellers need a FICO above 530 to qualify and above 670 for the best rates. They can require personal guarantee or collateral (typically a vehicle).
Options to Explore:
- Lendvious – A consumer marketplace lender with an array of consumer financing options
- Prosper
- Updrage
- OneMain
2. U.S. Small Business Administration (SBA) Loan Programs
There are different SBA loan programs like 504 for commercial real estate and 7(a) for general business loans. The SBA agency doesn’t lend these loans directly to merchants, instead they set loan guidelines that are made by its partners like financial institutions. Then, the SBA guarantees that these loans will be repaid, which eliminates some of the risk to the lending partners.
Who it’s best for: Profitable and established businesses with good personal or business credit
Pros: Low cost, long payment terms, receive anywhere from $500 to $5.5 million in funding
Cons: Low approval rates, secured (requires collateral). May require you to have life insurance with the lender as the beneficiary.
Options to Explore:
- Wells Fargo/Chase
- SmartBiz
- Fundera
- Celtic
- Newtek
3. Bank Loans
Similar to personal loans, you can apply and receive a loan from a traditional bank. They will usually use your personal credit score, history with the bank, and income to determine your loan amount and annual percentage rate (APR). If approved, you pay back the loan on monthly installments, typically from 3 to 10 years.
Who it’s best for: Larger, established businesses with strong performance history
Pros: Low interest, long payment terms
Cons: Low approval rates for online businesses, as only large, established businesses tend to get approved. Approval can require at least two years time in business, tax history, while also taking a long time to process and rely on outdated underwriting models. They’re also usually secured (requiring collateral).
Options to Explore:
- Talk to the bank that you have your accounts and deposits with. Banks usually require you to have deposits with them in order to consider you for a loan.
4. Cash Advance
A cash advance is not a loan or debt. Instead, a third-party capital provider buys your future receivables (or future sales) at a discount. The cash advance amount is based on the health of your business, and not personal credit or collateral. Then, you pay back the funder a flat fee based on a percentage of your sales.
Who it’s best for: Businesses who need capital quick, have an opportunity to grow, but may not qualify for traditional financing, or looking for a high ROI.
What it is: 3-12 month daily/weekly payments taken directly from a business bank account or processing account.
Pros: Fast and simple application process with no credit checks or required collateral. Higher approval rates for a wide range of businesses. No flat monthly payment terms, instead you pay based on a percentage of your sales — meaning you pay less for months with fewer sales.
Cons: Higher fees, short payment terms, can be a cash flow restraint
Options to Explore:
- Reliant Funding
- GetBackd
- Rapid Finance
5. Equipment Financing / Leasing
A specific loan to purchase a piece of equipment for your business like a vehicle, forklift, etc.
Who it’s best for: Any business looking to finance a specific piece of equipment
Pros: Low interest rates, quick approval, no personal credit needed, long payment terms
Cons: Secured by the equipment, meaning you can forfeit the equipment if you can’t pay back the loan.
Options to Explore:
- Alliance Funding – Low risk (i.e. high credit score)
- NSF – Mid to higher risk (i.e. low credit score or other risk factors)
- Currency
- Balboa
6. Lines of Credit (LOC)
A line of credit (LOC) is a flexible loan from a bank or other financial institution that gives you a maximum borrowing limit that can be used at any time. You can spend the money, repay it, and borrow it again as you need, and as long as you stay within the limit and keep up with payments.
Who it’s best for: A business looking for a safety net for unexpected expenses
Pros: No obligation to use the money. Only make payments on the amount you actually borrow, not your full limit. Lower cost than a cash advance.
Cons: Higher interest if unsecured, requires higher credit score for approval
Options to Explore:
- BlueVine
- American Express
- Headway
- Idea Financial
7. Home Equity Loan
A loan or line of credit for a fixed amount of money that is secured on the value of your home. Like your mortgage, you repay the loan with monthly installments over a fixed term. The amount you can borrow is usually limited to 85% of the equity (market value) of your home and usually based on your income, credit history, and market value of your home.
Who it’s best for: Homeowners with a lot of equity in their home
Pros: Lower interest rates than unsecured LOC. Easily accessible and an advantage for homeowners.
Cons: High risk, you could lose your home or borrow more than what your home is actually worth or what you actually have in equity
Options to Explore:
- Talk to your current mortgage provider to understand what your options are.
8. Payability (FinTech solutions for eCommerce businesses)
Payability is the leading funding solution for Amazon and eCommerce businesses. They provide capital advances of up to $250,000 and accelerated daily payouts based on your sales on Amazon, Shopify, Walmart, Newegg, and more.
Who it’s best for: eCommerce businesses selling on marketplaces and/or their own online store
Pros: No credit checks, fast 24 hour approvals, products designed around the unique needs of eCommerce businesses, works well alongside other financing options, both daily marketplace payouts and capital advances available, unsecured (no collateral), debt-free, equity-free
Cons: Only based on your eCommerce sales (can’t be used to access funds based on sales from your brick and mortar store or other aspects of your business)
Options to Explore:
- Instant Access: Accelerated daily payments for sellers paid on delayed terms by the marketplaces they sell on
- Instant Advance: Capital advance based on your future eCommerce sales
9. Credit Cards
Many businesses use credit cards to pay for general expenses and some inventory purchases. You can rack up reward points and cash back from your operational expenses to invest back into your business.
Who it’s best for: Best used by most businesses for small and everyday purchases or bills that you can pay off easily
Pros: Lower interest rates, easy access to financing when you need it, reward points can help fund small business expenses like marketing
Cons: Quickly outgrow your limits. Maxing out a credit card can prohibit you from making a purchase like inventory when you need it.
Options to Explore:
- Capital One
- American Express
- Chase for Business
- Divvy
10. Venture Capital/ Private Equity / Angel Investors
Venture capital (VC) is a form of private financing from investors for startups and small businesses with long term growth potential. Investors like VC firms or angel investors will put up large sums of money in exchange for equity (assets) in the company. They also expect large and quick returns, putting pressure on brands to meet high performance metrics.
Note: Angel investors are usually wealthy individuals, sometimes friends and family, that provide mentorship and more modest investments in a startup.
Who it’s best for: High-growth DTC brands on the path to becoming the next Casper or Allbirds, and don’t have access to capital markets or bank loans
Pros: Provide large sums of money to startups. Can also provide mentorship, expertise, community connections, and more.
Cons: Require an equity stake in your business and therefore decision-making; Expect large and quick (sometimes unrealistic) return on their money.
Options to Explore:
- New York Angels
- Lightspeed Venture Partners
- Lerer Hippeau
- Bullish
Venture Capital has been a polarizing topic for DTC brands lately. Learn why some high-growth DTC brands are turning their back on VC funding.
11. Point of Sale (POS) Financing
Some POS vendors provide their own cash advances or loans for their merchants. This financing is often easy to access as the vendor uses your transaction and sales history within their POS platform for approval. In some cases, you’ll repay your loan or cash advance from a fixed percentage of your daily credit card sales, too.
Who it’s best for: Restaurants, brick-and-mortar retail, any business doing high POS transactions
Pros: Fast approvals (like pre-qualification loans) and easy to access
Cons: High costs, daily repayments deducted automatically from your account
Options to Explore:
- Square Capital
- Clover
- Toast
Providing online businesses with the funding they need is something we do everyday at Payability. It’s why we know and care so much about entrepreneurs choosing the right funding strategy. We know it can be the difference of growing your brand to the next level or not taking advantage of lucrative opportunities, or even shutting your doors. Choosing the best funding strategy depends on your needs today and your plans for growth.
