Debt vs. Equity: A Founder’s Guide to Ecommerce Debt Financing

Entrepreneurs have many options when it comes to financing their businesses. If you put it into two buckets, you really have two choices: debt and equity.

Most founders understand equity pretty well. Debt, on the other hand, tends to feel opaque, risky, and overly complicated.

That’s a mistake.

What people often fail to realize is that the folks supplying the global debt markets are actually quite creative, and you have far more vehicles to choose from than you might think. The reason there are so many different kinds of debt is simple: every business is different, and there is so much money in these markets that competition constantly brings new products to life.

To help demystify the world of debt financing, I want to walk through a handful of popular ecommerce debt instruments and explain a few reasons why each one may or may not be right for your business.

I’ve broken these down as simply as I can. If you find this useful, let me know and I can dig into more detail in a follow-up.

Disclaimer: Debt can be a dangerous tool. This content is for informational purposes only.

The Asset Backed Loan (ABL)

The ABL is the old-school loan that is secured by your assets. In other words, the lender gives you money, and if you can’t pay them back, they take your stuff.

The important thing to understand is that the amount they are willing to lend you is a percentage of your assets, which is referred to as your borrowing base.

So let’s say you have $1M of finished goods inventory sitting in a warehouse. You could go to an ABL lender and, in a best-case scenario, get a facility for around 50% of that value.

Congratulations. You now have a $500K asset backed credit facility to draw on.

The Pros of Asset Backed Loans

• Cheaper APR: These loans are typically cheaper from an interest rate perspective because they are secured.
  
  
  

• Stability: Asset backed lenders have been around forever. You can generally count on them still being around.
  
  
  

• Non-dilutive: You are not giving up equity or ownership.
  
  
  

The Cons of Asset Backed Loans (and there are a lot for startups)

• Vague definitions of “eligible assets”:
  ABL lenders often find frustrating ways to declare assets ineligible. Inventory at Amazon may not count. Non-finished goods may not count. The result is that lenders can effectively refuse to advance capital while continuing to charge monitoring or unused line fees.
  
  
  

• Hidden fees:
  If you read nothing else, pay attention to this. ABLs can have an insane number of fees. Monitoring fees, closing fees, termination fees, unused line fees, and sometimes even warrants. The quoted interest rate almost never reflects the true blended cost of capital.
  
  
  

• The chicken and egg problem:
  You need assets to borrow money, but you need money to buy inventory. You will lose this chicken and egg problem every time.
  
  
  

• Inventory turnover:
  If you are a hyper-growth startup, you sell inventory quickly. When inventory turns quickly, your asset base shrinks. That can put you out of formula with your lender and, in some cases, force repayments at the worst possible time.
  
  
  

• Highest liquidation priority:
  These lenders are first in line to get their money back if things go south.
  
  
  

In summary, ABLs are usually a tough fit for startups growing quickly and can be sneakily expensive. Secured loans can also create very ugly outcomes in downside scenarios.

Venture Debt Term Loans

Venture debt is a bit more straightforward.

There is a market of lenders willing to lend to you based primarily on whether they believe you will raise another equity round. This typically takes the form of a standard term loan.

A term loan is principal plus interest, paid back over a defined period of time. If you raise the next round, you pay them back.

If you think of debt and equity as a spectrum of risk and reward, venture lenders sit somewhere in the middle.

Fun fact: many funding announcements are actually part equity and part venture debt. You might see a $20M Series B announcement, but behind the scenes it was really $15M of equity and $5M of venture debt. That extra $5M can buy meaningful runway without additional dilution.

The Pros of Venture Debt

• Cash is confirmed: The money hits your bank account.
  
  
  

• Win-win structure: They do better when you do better.
  
  
  

• Less dilutive: Still dilutive via warrants, but less so than issuing more equity.
  
  
  

The Cons of Venture Debt

• Senior liquidation preference: First in line for repayment.
  
  
  

• Higher APR: Typically expensive from a pure interest rate standpoint.
  
  
  

• Warrants: Lenders usually want meaningful equity exposure to make the fund economics work.
  
  
  

Small Business Administration (SBA) Loans

SBA loans are guaranteed by the government and administered by banks. The most popular version is the SBA 7(a) loan, which offers flexible repayment terms and relatively affordable rates.

Generally speaking, I would avoid these as a VC-backed founder.

Why? Personal guarantees.

If your business fails, you are personally liable for the principal.

Pros

• Flexible repayment terms
  
  
  

• Government-backed, which improves approval odds
  
  
  

Cons

• Personal liability
  
  
  

• Slow approval process
  
  
  

• Misaligned with venture-backed risk profiles
  
  
  

Merchant Cash Advances (MCA)

The MCA is my personal favorite tool for financing working capital in a hyper-growth ecommerce business.

A merchant cash advance is a relatively new concept. At its core, it is an open-market receivables sale. You sell future revenue, receive cash upfront, and pay a fee for getting the money sooner.

MCAs get a bad reputation, often from people who don’t fully understand them. It is true that they can be extremely expensive if structured poorly. This is because repayment is based on a remittance rate, or a percentage of your sales.

If sales grow quickly, the loan gets paid back very quickly. If you repay principal plus 10% in two months, your effective APR can be north of 60%.

In my opinion, this problem exists because MCAs are still relatively new and many lawyers do not know how to model or negotiate them properly. As a result, founders end up massively overpaying.

The good news is that there is an incredibly simple fix.

The Fix

Negotiate remittance caps.

A remittance cap controls how quickly the loan can be paid back, which directly controls your effective APR. My last MCA came in at barely double-digit APR, fully unsecured, and available to draw at any time.

If you understand how repayment speed impacts cost, MCAs can be very effective tools.

Pros

• Often unsecured
  
  
  

• Strong capital availability
  
  
  

• Extremely fast underwriting
  
  
  

• Reasonably priced when negotiated correctly
  
  
  

Cons

• Very expensive if mispriced
  
  
  

• Short payback periods without caps
  
  
  

Consider All the Tools Before Making the Jump

When it comes to financing, founders have more options than they think, especially on the debt side.

The mistake is not using debt. The mistake is using the wrong debt without understanding how it actually behaves.

If you take the time to understand the tools available to you, you can finance growth, avoid unnecessary dilution, and make much more intentional capital structure decisions.