Keeping your growing online store running is all about getting cash in the door. Restocking inventory, running marketing, surprise shipping bills and just daily living - all of these things take cash to make happen. Taking your shop to the next level takes money - enough of it that if you can’t find more, things could get tricky real fast.
There are two pretty common options that small businesses have when it comes to financing: loans (term loans, SBA loans, bank loans) and cash advances. It can feel pretty overwhelming to try to make a decision. There’s a ton of info and a lot of misunderstandings.
Once you know your options, you’ll be confident you’ve chosen the right fit for your store, no matter what that turns out to be. And the best choice for your store might not be what you think.
Glossary of Common Terms
Small business finance has its own vocabulary. With a glossary of common terms first, you’ll have the building blocks ready to start comparing products. Finance terms can be confusing for even experienced store owners. You can also fast-forward right to the loan vs. cash advance comparison.
Capital is another word for cash. In this article “capital” and “cash” are used interchangeably.
- Debt: The money that’s owed or due.
- Return on investment (ROI): The ratio between what’s put in compared to what gets back out. High ROI means the return was big compared to the investment.
- Collateral: Something you own, like a house or a car, that’s used as security on financing. You lose it if you can’t pay.
- Credit score: A number lenders often use to help assess risk. It’s based on your credit history. A higher credit score should mean lower risk.
- Unsecured capital: The money that you receive on your creditworthiness, not on collateral.
- Secured: Finance backed by collateral, something the provider takes if you don’t repay.
- Underwriting: How finance providers decide how risky an applicant is and whether to offer them capital or not.
- Purchase of future receivables: Buying tomorrow’s sales today, in other words. A third-party acquires your future sales at a discount.
- Interest rate: The percentage of principal the borrower must pay to the lender on top of the principal. An example would be 2% interest of a $10,000 loan, totaling $200 due in interest and $10,200 in total.
- Capital or cash advance: Upfront payment for your future sales, at a discount. Not a loan because the funder buys a share of your sales, instead of lending cash.
- Fees: What you pay the funder for financing.
A Loan or a Cash Advance
Before taking any funding at all, knowing the differences between each one is essential. Which is better for your company, a loan or a cash advance?
A loan is borrowed money from a bank, credit union or online lender. It’s repaid, monthly, at an interest rate. It’s debt.
Loans, in general, come in all shapes and sizes. For small businesses, they include personal loans, SBA loans, bank loans, lines of credit, and home equity loans.
If a loan is “secured,” the lender asks you for collateral or something of value that it keeps if you don’t make the payments. For example: your home or car. If you do make payments, you get to keep the asset.
The upsides of a loan can be low, low rates, lower than credit cards.
Downsides of a loan: can be a liability to put up your house for. It’s risky, mixing personal and business money in this way. A loan can be difficult to get approved if your credit history is bad. Takes a long time to get the money, even up to several months. New businesses aren’t likely to get a loan.
And how much you get depends on your personal credit score. Banks still underwrite the old-fashioned way. If things go wrong, you’re the one carrying the risk, not the bank.
A cash advance isn’t a loan. Nor is it debt. It’s an agreement where you sell a portion of your future eCommerce sales at a discount to a funder for upfront cash. Then you pay back a percentage of sales as they come in to the funder plus a flat fee.
A cash advance for eCommerce stores is a quick and simple way to get money upfront with a straight-forward online application. It’s not based on your personal credit history - most of the time - but on how well your business is performing. No collateral required.
It might not make sense to repay a fixed monthly amount when your sales ebb and flow. An advance is more flexible: you pay back a percentage of sales as they come in. So if you’re having a slow month, you pay less. Risk also moves to the funder. Cash advances can be combined with other financing.
Downside of an advance: Costs can add up, especially if your time to pay it back is short. With every sale, a percentage goes to the funder, reducing your cash flow.
How does a cash advance work? One example from outside the eCommerce industry shows how it’s different from a loan.
Imagine you own a car dealership. You have 100 new cars to sell at $20,000 a piece - for $2 million. Buyer comes to you and offers to pay $1.8 million in cash for the whole lot, today. You get cash upfront and the buyer picks up one car a day from your lot for the next 100 days. It’s like you’re getting paid in advance for the coming months of car sales.
But after day five, a tornado comes and destroys the other 95. The buyer takes the loss, not the dealer. Because the buyer takes on the risk, the dealer gives a $200,000 discount, and would likely take the deal. If they didn’t carry the risk, the price would probably not be so low.
What happens if the car dealer surrounds the lot with barbed wire, and locks the buyer out? Unfair! The buyer already bought the lot’s worth of cars at a discount. It would be unacceptable if, once sold, the buyer couldn’t access the cars.
Similarly, when you fund with an eCommerce cash advance, you sell a chunk of your future online sales at a discount to a funder. They carry the risk the sales won’t happen (hence the discount.) The funder collects its share of sales, that it owns. It’s not a loan, it’s a purchase of future sales at a discount, and the funder is entitled to collect on them.
What’s a common myth about cash advances? That they’re only for struggling business owners or ones with bad credit. That’s not true at all.
If a sales season’s selling faster than expected, you can’t waste time waiting to restock. If an application at a bank is dragging on and taking weeks to come back with an answer, or getting a “no,” that’s time you’ve lost getting inventory. Time is money.
An online cash advance application may be as little as 24 hours to approval. Minimal disruption to business.
If you run a new eCommerce store, it can feel like nobody wants to fund you. Banks are looking for longer-than-2-years of business history, tax returns or collateral when underwriting new applicants. They’re old school. Their underwriting’s outdated. Most of the time, banks prefer big, established players. A young eCommerce store? That’s rarely going to be a good fit for them.
Meanwhile, a cash advance provider doesn’t always care about the past - they’re more flexible. It’s more about how your eCommerce business is doing right now. If it’s healthy, you’ll likely be approved even if you have bad personal credit.
An existing loan or credit line might just need a small boost to be the perfect funding fit. An advance can add some cash without having to double down on paperwork.
Why keep personal and business cash separate? Putting up your house as collateral is like tying it to the fate of your business. If your business fails, you could lose it and the effects could follow you for years. With an eCommerce cash advance, there’s no collateral on the line. You avoid mixing personal with professional.
Advances cost more than loans and generally run shorter terms. The provider takes a higher risk - it collects on no collateral and only gets a piece of real sales. That’s the trade-off for leaving your house out of the picture.
Not always does a loan with a longer term make sense. The best way to think about how long a loan or cash advance you apply for should be, is to match length to investment’s life. Vehicles and buildings aren’t cheap, and they last years. So a longer loan isn’t the worst choice for matching these costs. Selling inventory in three weeks or an ad campaign isn’t what a 24-month term loan should fund. You’d still be paying off the expense long after you’re done selling it - or it stops increasing traffic. You might do better with a short term advance that matches the “life” of whatever you’re investing in.
Don’t make the mistake of thinking just because you have 24 months to repay, a loan is always a better idea than a cash advance. First consider what you’re paying for.
The Main Factors to Weigh
What’s right for you is based on your own needs. Here are the main factors to weigh:
- Amount: The maximum amount an applicant could be funded for, depending on qualifications. Sometimes that’s way more than what’s needed.
- Approval: How likely are you to be approved? New business applicants usually have a hard time of it.
- Basis for approval: What’s your funder looking for when applying? Personal credit or your business’s health?
- Speed: How long does it take to fund and how long can you wait for the cash to arrive? Weeks? Months?
- Total cost: A reflection of interest and fees. How much you’re paying in total to borrow cash. And over how long.
- Personal risk: Are you putting up your own home or car? Is it worth tying up personal and business finances?
- ROI: Return on investment. It’s how much more money the investment could bring.
In the end the only best choice is what your store needs today and where you plan to take it tomorrow.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
