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For small business owners and entrepreneurs, understanding the different business funding options available for their business is key to making the best decisions for the success of their business. Among the most popular funding options are merchant cash advances (MCA) and loans, but it is not always clear which of these options is the right one for a particular business. We’ll explain the differences between merchant cash advances and loans, helping you decide which one is right for your business.
- A merchant cash advance is an alternative form of financing for businesses that can provide quick cash with flexible repayment options.
- A loan is a traditional form of financing that involves a fixed repayment period and interest rate.
- MCAs are beneficial for businesses that need a large influx of capital quickly and those that have difficulty securing a loan from a bank.
- Loans are suitable for businesses that need a more consistent repayment plan and are comfortable taking on long-term debt with a fixed interest rate.
What is a Merchant Cash Advance?
A merchant cash advance is an alternative lending option that allows business owners to access working capital quickly and often without a credit check. In exchange for a lump sum of cash, you’re selling a portion of your future credit or debit card sales. These sales are typically a key factor in determining the size loan you can get, rather than your credit score.
The loan process is relatively simple and fast, often taking just a few days. The lender assumes the risk that the business may not make enough sales to pay back the advance, in exchange for some hefty fees and a short repayment term.
Pros of a Merchant Cash Advance?
- You get quick access to capital. Merchant cash advances are a great tool for businesses that need access to capital quickly. The process is fast and simple with minimal paperwork.
- Repayment terms are often flexible. Merchant cash advances offer businesses more flexible repayment terms than traditional loans. The repayment is usually based on future credit card sales or other business cash flow, allowing businesses to easily adjust to changing economic conditions.
- There’s no personal guarantee or collateral necessary. Merchant cash advances don’t require a personal guarantee, meaning the business owner's personal assets are not at risk if the loan is defaulted on.
- Poor credit borrowers can qualify. Business owners with less than stellar credit often have a difficult time securing funding. Merchant cash advances don’t consider credit so much, instead focusing on the volume of credit or debit card sales the business has.
Cons of a Merchant Cash Advance?
- There’s a very high cost. From factor rates and other fees, MCAs are among the most expensive forms of financing. This means that, depending on the amount borrowed, businesses could end up paying back huge amounts in interest.
- Cash flow issues can arise. When businesses take out a merchant cash advance, they’re required to make daily payments to the lender. This can disrupt the businesses' cash flow and can be difficult to manage.
- This is short-term financing. Merchant cash advances typically have very short repayment periods. This means that businesses need to be able to repay the loan quickly, which can be difficult if the business is struggling financially.
- Not all lenders offer MCAs. Merchant cash advances aren’t offered by all lenders.
- They’re largely unregulated. MCAs aren't loans so they aren’t held to the same federal regulations that loans are.
What is a Loan?
A loan is a sum of money that’s borrowed from a lender, often with some form of collateral or security against it, usually a personal or business asset. The borrower is required to pay back the loan over a period of time with interest. The term of a loan can vary, depending on the amount and the lender, but it’s generally expected to be paid over a period of several months to several years.
Loans can be secured or unsecured, meaning that the lender can require a form of collateral, such as the business’s property or assets, that can be repossessed if the loan is not repaid. Generally, it is more difficult to obtain an unsecured loan, since the lender has no collateral to recover should the borrower default on the loan, so you’re instead relying on your business and personal credit score for approval.
Pros of a Loan?
- They’re often lower cost. Loans typically have substantially lower costs associated with them than merchant cash advances, making them more affordable in the long term.
- Loans tend to have longer terms. Loans can be obtained with longer terms, which can help businesses spread out their payments in a more manageable way.
- Some loans have tax benefits. Some types of loans, such as those obtained through the Small Business Administration, may offer tax benefits that merchant cash advances do not.
- You’re more likely to have predictable payments. With a loan, businesses know exactly how much they must pay each month and can plan accordingly. With merchant cash advances, payments may vary depending on sales.
Cons of a Loan?
- Loans can have higher interest rates. Business loans can come with high interest rates, especially if you have a bad credit score.
- Collateral may be required. Most traditional lenders require some form of collateral (e.g. property, equipment, inventory, etc.) in order to secure a business loan.
- Complicated application process. Applying for a loan can be a more complicated process than a merchant cash advance, with a substantial amount of paperwork, high credit score requirements, and a lengthy waiting period.
- There are strict credit requirements. Traditional lenders often have strict credit requirements and may require a personal guarantee from the business owner if the business's credit score isn't high enough. This means the business owner is personally responsible for repaying the loan if the business defaults.
Comparing Loans vs. Merchant Cash Advances
|Loan||Merchant Cash Advance|
|Loan Amounts||$1,000+ - many lenders offer in the millions||$2,500 - $1 million+|
|Funding Time||Weeks to months||24 hours-48 hours|
|Payments||Paid to your lender directly||Automatically deducted from your business’s debit and credit card sales daily.|
|Annual Percentage Rate (APR)||4.90% to 9.83%, on average||Up to 350%, but factor rates are standard for MCAs. Factor rates of 1.09 to 1.5+ are typical.|
|Repayment Period||1-10 years||Based on your sales, but typically 3 months to two years.|
|Fund Usage||Any purpose||Any purpose|
|Liability||Possible collateral required||No personal liability or collateral required|
The amount you can typically receive from a traditional lender may be more than what you would receive from an MCA provider. With a loan, you can take out a larger amount of money than with a merchant cash advance, depending on the lender’s requirements and your creditworthiness. Plus, since loans have longer repayment terms, lenders can afford to offer you more funding.
The requirements for a loan are typically much more stringent than those for an MCA. Lenders may require you to present items such as financial statements, tax returns, a business plan, and other documents to show that you have the ability to repay the loan. For an MCA, the requirements are often less stringent, and in some cases, you may not be required to submit any documents aside from a detailed description of your business.
The time it takes for a loan to be approved and funded is usually much longer than for an MCA. The lending process for banks and other traditional lenders can take weeks or months to be approved, while an MCA can usually be approved and funded in a few days.
Loans usually require you to make fixed payments each month, while with an MCA you’ll be required to make payments daily or weekly. The payment amount for an MCA is based on a percentage of your daily sales, so it will fluctuate depending on how well your business is doing. Loans have fixed payments, so you can be sure you’ll have the same monthly payment the entire length of the loan.
The APR (annual percentage rate) for a loan can vary depending on the lender and other factors, such as your creditworthiness. If you have good credit, the interest rate you could get may be fairly low, while those with lower scores face higher interest rates.
MCAs have “factor rates”, aka a multiple of the amount lent. Additionally, they have incredibly high APRs that vary from 25% - 350%.
There may be additional costs associated with a loan, such as origination fees, late fees, and prepayment penalties. MCAs also have plenty of fees as well, including origination and processing fees.
The repayment period for a loan can vary depending on the lender, but it’s typically substantially longer than the repayment period for an MCA. With an MCA, the repayment period is often just a few months, but business loans can last upwards of 10 years.
You can typically use the funds from both loans and MCAs for any purpose you want. This will vary by lender, though.
A loan may require collateral to secure the loan, which means the lender can take possession of the collateral if you default on the loan. With an MCA, no collateral is required and there is no risk of personal liability.
When is it Best to Use a Merchant Cash Advance vs. a Loan?
When deciding between a merchant cash advance and a loan for your business’s needs, consider the timeline of the cash needed as well as the interest rates and fees associated with each option.
When a Merchant Cash Advance Is Best
An MCA can be a great option for some businesses, especially those that are unable to qualify for a loan or need fast access to capital. MCAs can provide quick access to cash, which can be used for a variety of purposes such as funding a short-term project, purchasing inventory, and more.
The repayment terms of an MCA are usually much more flexible than a loan as repayment is usually based on a percentage of a business’s daily credit card sales, instead of based on a fixed repayment schedule with monthly payments. This is particularly useful for businesses that have fluctuating income, as they can more easily manage cash flow when their repayment is tied to their incoming income.
MCAs also typically have fewer and less stringent eligibility requirements than a loan. For example, many MCA providers don’t require a credit check or a lengthy application process. You might like to learn more about the best merchant cash advance offers we have reviewed.
When a Loan Is Best
A loan is best when you need a specific amount of money to finance a large purchase or project. Loans generally have fixed repayment terms and require collateral, so if you’re able to provide security for a loan, you may find lenders willing to offer better terms and lower interest rates.
If you’re able to manage larger monthly payments, a loan may be the better option for financing. Additionally, keep in mind that a loan can be used for a variety of purposes, from purchasing new equipment to building out a space.
Another factor to consider is the time you need to pay back the loan or cash advance. With a loan, you’ll have a set repayment period that never changes. With a merchant cash advance, however, you must make daily payments that are based on a percentage of your future sales. This may work better for your cash flow needs, but be aware that you may end up paying more in the long run.
How Can Loans and Merchant Cash Advances be Used Together?
Using loans and merchant cash advances together can help business owners maximize the benefits of both offerings. With loans, business owners can receive larger sums of capital upfront and spread out the payments over a longer period of time. On the other hand, merchant cash advances provide a more liquid funding option, but at a higher cost.
When used together, loans and merchant cash advances can be beneficial to a business by allowing access to larger sums of money while also offering more flexibility and immediate liquidity. This can help businesses cover their operations and unexpected costs in the short and long term.
Resources for Small Business Owners
There’s a lot to being a small business owner. You have to run your business, hire employees, and figure out financing needs as they come up. For some help, here are a few organizations worth checking out:
- Small Business Administration. Provides resources and financing to small business owners.
- SCORE. A non-profit dedicated to helping entrepreneurs start and grow small businesses.
- Small Business Development Centers (SBDC). A network of business assistance centers located throughout the United States that can help you open and/or grow your business.
- Women's Business Centers. A network of centers offering advice and resources to women-owned businesses.
- American Express OPEN. Provides advice and information on launching and running a small business.
The decision between a merchant cash advance and a loan can be difficult to make. Every business has different needs and different circumstances and there is no one-size-fits-all answer. While a merchant cash advance may be the right choice for a business needing quick access to capital, a loan may be the better option for those looking for higher borrowing limits, a fixed repayment amount, or longer repayment terms.
Ultimately, the best way to determine which product works for you is to review your business needs and research the different options available. With the right information, you can make an educated decision that will get your business the funding it needs.