Last updated on June 7th, 2023 at 05:35 pm
By Anthony Santomo, Founder and CEO, Ampla
Most growing brands seek outside funding to support their growth. Often, they use this capital for everything from producing inventory to increasing marketing efforts. Capital becomes the backbone of their growing business.
Unfortunately, traditional lending solutions are not built to support emerging brands longterm. Last year, The Federal Reserve Bank reported that only 30% of small businesses in the U.S. received the total financing they were seeking from their bank. Traditional asset-backed lending solutions may have drawbacks such as extra fees, warrants, and zero flexibility or scalability – and require several conditions to receive capital.
Choosing the right debt financing option is critical to a brand’s profitability and success. When determining which option is best, there are a few factors to consider.
1. Merchant Cash Advance (MCA)
MCAs provide a single cash advance in exchange for a flat fee, with principal and fees paid back out of a percentage of future sales. With a less intense underwriting process, an MCA is a fast and easy choice for eCommerce-only brands that conduct most of their business on platforms like Shopify and Amazon.
There’s a downside, though. MCAs typically must be paid back in full prior to borrowing additional funds. As a result, brands often borrow additional capital from other MCAs to meet their needs, which can ultimately lead to overleveraging. In addition, the flat-fee structure may appear attractive on the surface, but is typically significantly more expensive,depending on the payback period.
2. Invoice or Accounts Receivable (A/R) factoring
A/R factoring lets brands turn unpaid eligible invoices into cash to help fulfill new orders or restock inventory. This option relies on a physical retail presence and a credit-worthy buyer, so is more appealing to larger businesses and can be a challenge for D2C brands.
3. Inventory financing
Inventory financing helps businesses borrow capital using inventory assets as collateral. As a result, the total dollars provided by the lender equate to only a small percentage of the total cost of that inventory. Furthermore, as inventory levels fluctuate, the total dollars available to the borrower may vary meaningfully. Lenders also take a lien – a claim on property as a form of security interest – on the brand’s inventory. In order to stay compliant with this type of financing, costly inventory audits are typically required as part of the agreement.
4. Venture debt
Venture debt is a financing option offered to VC-backedbusinesses that have large cash balances. Lenders who offer this type of financing typically offer lower interest rates in exchange for warrants. Warrants give the right to purchase company stock at a specified price, diluting existing shareholders and increasing the all-in cost of the debt.
In addition, venture debt includes covenants that require specific actions or benchmarks to maximize their probability of getting paid back. Breaching these terms will put a brand at risk of default.
5. Traditional Line of Credit (LOC)
This debt financing option offers capital against collateral in the form of physical assets, like accounts receivable and inventory. Lenders provide a fixed credit limit that borrowers can draw up to. Most traditional LOC lenders have a manual underwriting process that can take weeks of paper passing. For many asset-light eCommerce brands, this option can be limiting as lenders mostly lend against retailer and wholesale revenue channels.
6. Growth Line of Credit
This option is unique in that it considers all revenue streams and provides a scalable credit limit that increases as the borrower’s business grows. This maximizes capital for any type of brand – whether eCommerce, retail, or omnichannel strategies are utilized.
With early access to affordable capital and financial tools, a Growth Line of Credit creates a sustainable debt financing strategy. Lenders are repaid as sales grow – so if sales slow, so do repayments. The elimination of maturity or fixed repayment dates allows for additional flexibility. Unlike other options with flat fees – like MCAs – transparent annual percentage rates (APRs) are provided upfront to ensure brands don’t end up paying more than expected.
Choose debt financing that meets a brand’s unique needs
The eCommerce and omnichannel retail sectors are showing no signs of slowing down. And debt financing is critical to growing and scaling these businesses.
By understanding the benefits and drawbacks of the debt financing options available, brands can choose what works best for their individual businesses. With the right option, they can focus on what matters most to them – serving their customers an exceptional experience.
