Why is it so hard for e-commerce companies to get credit?

Just like most businesses, e-commerce firms need capital to get off the ground. But did you know they have a harder time getting loans through banks than through fintech companies?

Many e-commerce entrepreneurs often have to get personal loans and take on personal liability to finance their companies, as even online retailers with sizable revenue are routinely declined by banks.  There are a variety of reasons banks may be uneasy about lending to e-commerce companies, but here are four common ones:

1. Banks are unfamiliar with e-commerce.

“Banks have created a formula for underwriting a business that is 50 to 100 years old,” said Jeremy Solomon, Chief Capital Officer at Affirm.

E-commerce is still a new industry to banks, with many unknowns and little robust credit reporting. Banks are extremely risk-averse and apprehensive about entering a new space where its procedures are untested. Banks have safer, more familiar options to offer lending and generally choose those more traditional avenues.

2. E-commerce companies have higher fraud and security risks.

E-commerce companies have much higher fraud rates and more holes for security breaches compared to traditional brick-and-mortar stores. In LexisNexis’ 2017 True Cost of Fraud report, they identified “more fraudster focus on the anonymous purchasing environment, particularly leveraging the no-card-present opportunities compared to EMV chip barriers at physical points of sale.” In the 2018 report, e-commerce businesses reported an average of 619 fraud attempts per month, with a 50% success rate. Credit card fraud and identity fraud are mainly an online phenomenon. Banks account for these increased risk factors and, again, prefer to work in industries with less exposure.

3. Banks have limited insight into the customer base.  

Typically, bank branches are hyper local and extremely knowledgeable about their markets. When a business opening in the same town applies for a loan, the bank’s underwriters can evaluate if a business will resonate with the town’s residents, who are also its customers. The bank can see residents’ bank accounts and transactions, and can deduce if the business is fulfilling a need in the neighborhood. They can forecast success or failure for the company with confidence.

“E-commerce companies are the opposite of local, and banks often aren’t familiar with the global trends,” said Rob Pfeifer, Chief Revenue Officer at Affirm. “On the internet, even a niche product like a unicorn phone case can find customers.”  

When a bank’s underwriters feel they can’t accurately assess where the customers for the business will come from, they don’t feel they can predict an outcome. This leads banks to reject many e-commerce loan applications.

4. E-commerce is asset-light.

If an e-commerce business goes under, there aren’t many assets  the bank can use to recoup its losses.

Bill D’Alessandro of RebelCEO.com told eCommercefuel.com, “Banks are not comfortable with e-commerce; they’re not comfortable with these asset-light businesses that [are] e-commerce. If you wanted to buy a restaurant, you could probably get a ... guaranteed loan.”  

Besides inventory, which could be small, an e-commerce business has little for the bank to repossess. Brick-and-mortar businesses, on the other hand, may have enough inventory to fill the store, along with furniture, cash registers, other items, and possibly the building itself. All this gives the bank a safety net if the business goes under, but e-commerce companies often can’t provide this.

So where do I get money for my business?

Several niche financial products and alternative funding models have cropped up to fill the vacuum of working capital for e-commerce companies. (Ironically, many of these solutions are funded by traditional banks.)  Brex recently launched a credit card with a 60-day interest-free payment window aimed at burgeoning online retailers who have short-term financing needs. There are a few other modern fintech companies like Kabbage, Square, Amazon, and Paypal that have less antiqued loan policies and are willing to lend to e-commerce brands. Even shipping companies, like Flexport, have gotten into the financing game for small business.

E-commerce businesses have had to be innovative—often in more ways than one—in countering the banking industry’s legacy resistance to lending.

“The resilience and innovation from e-commerce companies facing these difficulties is to be admired,” Pfeifer said. “We can only wait to see if banks will catch up.”

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