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What is the true cost of your loan?

In the US 53% of all new businesses are destined to fail. Start-up failures for e-commerce retailers are even higher at 80%. And yet, the odds do not seem to discourage hundreds of thousands of entrepreneurs that will launch their products on Amazon this year. Why is that? Why do we believe in our own success?

Entrepreneurs are by nature optimists. We plan, dream, set goals, and conduct our affairs as if we have full control of our destiny. We are the main characters in capitalism’s play of innovation and creative destruction which in its latest act has brought e-commerce sellers to the forefront. In the fast-paced world of e-commerce, merchants borrow money to purchase inventory based on rosy forecasts that are shaped by their gut feelings. Their narratives appear intuitively sound while their spreadsheet analysis adds a touch of rationality. If their wager on a better future materializes, the sellers will be in a much better position but if they fail, the loan installments will still be there.

When we forecast the revenue of our Amazon store, we tend to be bound to a single number – a baseline prediction – and we fail to consider the range of uncertainty around our numbers. We rely on past sales to predict future performance and construct the best possible narrative from the data set available. Our brain is pre-programmed to construct a much simpler version of reality because it primarily relies on emotion rather than rationality. This puts us at a disadvantage to make predictions about the future in unpredictable environments such as the business world. We delude ourselves that we understand the past and we compound our fallacy by injecting too much optimism into the future.

Adding debt to your Amazon business makes you fragile. Why? Because you increase the uncertainty of an already uncertain venture. Let’s put some basic numbers to our story.

Paul borrows $1,000 at 12% per annum and needs to repay $1,069 in equal twelve-monthly installments. The product retails at $5.00 with a x5 mark-up and a 30% net profit margin. All of the borrowed funds are invested in new inventory at a $1.00 purchase price per item. Even though Paul’s plan rested on sound pillars, twenty percent of the merchandise ended up not selling. The profit margin decreased by $0.25 since the actual cost of each item sold increased by 25% (200 unsold units / 800 sold) and debt servicing became harder. Note that the cost of financing the 20% unsold merchandise will fall, just like the purchase cost, on the remaining sold inventory. Paul will barely break even and will most probably need to use some of his own equity to cover the loss.

What was the effective cost of the $1,000 loan? Definitely not 12%.  From a cash flow perspective Paul utilized $800 of the $1,000 while he needs to pay back $1,069 which translates into a $269 of ‘interest’ for $800 of actual ‘principal’ deployed.

This is a crude scenario to illustrate that the nominal rate is a mirage. The effective cost of capital is determined by the success of a plan where even slight deviations from your predictions will impact your financing cost. Most sellers run globalized e-commerce business with many moving parts and leave themselves open to operational risks. Things like supply chain disruptions, price discounts, unsold merchandise, account suspensions, delays in marketplace payouts are not infrequent and can impact in multiples your globalized value chain. During the COVID-19 pandemic all of the above made themselves blindly apparent. Many sellers faced supply and shipping delays forcing them to deliver orders late and incur account suspensions coupled with A-to-Z claims. Sellers carrying debt were at a disadvantage compared to sellers who run their stores with their own equity. When everything goes as planned debt can boost your growth; however, in the very likely scenario of small or large (pandemic) deviations, leverage can introduce nothing but fragility to your business. 

The question here is, if there is a financial product – other than debt – that can unlock capital without making your business more fragile.

Daily payments, also known as factoring of receivables, have been around since the time of Ancient Rome for a reason. They can unlock your capital without increasing the fragility of your business. Nowadays, API-driven technologies allow financiers like Storfund to read real-time your existing receivables across numerous marketplaces and advance payments in multiple currencies instantaneously. The benefits of such a service are multifold:

  • Daily payments for your marketplace balances will accelerate the growth of your e-commerce store by taking the minimum risk possible.
  • Daily payments are an insurance against uncertainty. Since you are not using other people’s money your business is robust against forecasting errors and so-called fat tail risks.
  • Daily payments finance the scale-up of your e-commerce business and grow in tandem with your liquidity needs – seamlessly.
  • Daily payments do not appear on your balance sheet as a liability. Carrying debt will impact the valuation of your private label business.
  • Large e-commerce sellers cobble together financing from multiple sources – equity, banks, suppliers – and having on-demand access to daily payments across their e-commerce marketplaces is fast and non-dilutive.
  • Using Storfund for financing does not impact the company’s debt service coverage ratio. Daily payments will help a company raise debt at a lower cost.

Events that are perceived as improbable and hence lie outside our expectations are not taken into account when we plan for the future. Putting other people’s money to work requires careful scenario analysis, an experienced management, and preferably high cash reserves. Daily payments against your marketplaces’ balances make your e-commerce business robust; they protect you against overconfident plans and against the impact of regular and extreme events. E-commerce sellers have the option to accelerate their own funds to grow before seeking debt capital. After all, the ancients said it best:

Why shouldst thou go and make thy court to a banker or a merchant? Borrow from thine own table. Thou hast tankards, dishes, and basins of silver. Make use of them for thy necessity…

Plutarch, The Moralia

Note: The ideas presented in this whitepaper are not new. Scholars like Kahneman, Tversky, Gigerenzer, Taleb have written in depth about cognitive limitations, the blind spots of human decision making, and the impact of regular and rare events.

Storfund accelerates your marketplace payouts across multiple geographies and allows you to manage your finances in one place. Storfund helps e-commerce sellers drive sales and increase profitability by shortening their cash cycle, thus allowing them to purchase additional inventory and never run the risk of being out of stock. Our clients receive their sales the same day, irrespective of the marketplaces’ actions, be it rolling reserves or 14- or 30-day payment cycles. Storfund is available in 17 Amazon marketplaces and in the French marketplace Cdiscount. We work with companies registered in the European Economic Area (EEA), the United Kingdom, the United States, Canada, Australia and New Zealand.

For more information contact our Head of Business Development:

Costas Anastassiadis

Tel: +442070972292

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