Both a merchant cash advance and a business loan are financial tools that can help business owners gain access to the business funding they need. Whether you’re a seasoned owner or looking to start your own business, choosing between a cash advance and a term loan can be difficult. Here’s what you need to know about the merchant cash advance and how it differs from an average business loan.
What Is A Business Loan?
A business loan can come in a variety of forms, such as small business term loans, equipment loans, and auto loans, to name a few. The funds applied for are provided in one lump sum to be used for a variety of purposes to both start and grow a business, such as buying equipment, paying vendors, paying employees, and covering the cost of a lease.
Secured vs. Unsecured Business Loans
Depending on the exact type, business loans can either be secured or unsecured. A secured business loan means that the loan is collateralized by an asset of value, such as equipment or vehicles. An unsecured business loan means the loan does not have any collateral to back up the loan, and as such, the loan can be considered a higher risk for the lender.
Regardless of the type of business loan you apply for, the lender may require a personal guarantee to be signed, which is a promise to pay back the loan even if your business is unable to.
Common Characteristics Of A Business Loan
Term business loans typically have the following characteristics:
- Full loan amount is given upfront
- Loan amount is repaid in regular installments
- Loan amount must be repaid by a specific term date
- Interest rate is charged on top of the loan amount
What Is A Merchant Cash Advance?
A merchant cash advance or MCA works differently from a traditional term business loan. In fact, a merchant cash advance is not technically defined as a loan at all. Instead, it’s an advance of funds based on a business’s future credit and debit sales. After applying for a merchant cash advance, you’ll be advanced a specific amount into your business account to be used to cover business expenses.
There’s no collateral, but rather the lender will have access to your merchant account while the advanced funds are still outstanding
How Does An MCA Work?
Rather than paying back the advanced funds in regular installment payments, an agreed-upon percentage of your daily credit and debit card sales will be withheld to repay your merchant cash advance, which is referred to as a “holdback.” This process will continue until the entire advance is repaid.
The advance amount, payback amount, and holdback share will all be determined before the merchant cash advance takes place. Once a contract is signed, the advance is transferred to your business’s bank account, and the future percentage of credit card receipts or accounts receivables will serve as repayment.
Repaying A Merchant Cash Advance
Repayment is based on a share of your merchant account’s daily balance, so the more transactions you make, the faster you can repay the cash advance. Conversely, the lower the number of transactions on a specific day, the lower the withdrawal from your merchant account.
The holdback percentage is usually based on the revenues your business generates, the size of your monthly receivables, and how long the advance repayment period is.
The payback percentage of a merchant cash advance can be anywhere from 20% to 40% on average, though it could be more or less depending on the lender and the specific arrangement made.
Holdback vs. Repayment
It’s important to differentiate between the daily holdback amount — which is the percentage of your accounts receivables — and your repayment amount for the advance.
For instance, you may be required to pay a holdback of 10%, and a repayment of 25%. If you applied for an advance of $10,000, that means your payback amount would be $12,500.
You’ll then be required to allow 10% of your credit card receipts to be withheld by the advance company until they collect the full $12,500. For instance, if your business averages about $15,000 per month on credit card transactions, that means about $1,500 would be withheld by the advance company every month.
Listen To Paul Pitcher From SharpShooter Funding Discuss MCAs
Merchant Cash Advance vs. A Business Loan
The following chart provides a side-by-side comparison of a merchant cash advance versus a business loan.
|Merchant Cash Advance||Business Loan|
|Loan Amount||$5,000 – $150,000||$5,000 – $500,000|
|Average Interest Rate||80% – 120%||14% – 50%|
|Repayment Schedule||Percentage of daily credit card transactions||Principal & interest|
|Fees||– Administrative fees|
– Underwriting fees
– Origination fees
– Closing fees- Servicing fees
|– Origination fees|
– Application fees
– Administrative fees
– Late payment fees
|Eligibility Requirements||History of credit card sales and credit score||Annual revenue and credit score|
|Time to Receive Funds||1 – 3 days||1 – 3 days|
Advantages Of A Merchant Cash Advance vs. A Business Loan
There are several perks to both merchant cash advances and business loans that make either one a great option to financially supplement your business.
Merchant Cash Advance
- Accepts bad credit. Whereas a business loan may require a strong credit score in order for you to get approved, merchant cash advance providers usually accept those with credit profiles that are less-than-perfect.
- Quick application and approval process. You won’t have as many documents to go through and sign with a merchant cash advance compared to a business loan application.
- No collateral. There’s no need to put up an asset of value to obtain a merchant cash advance. Instead, your lender will assess your business’s credit card transactions.
- Various loan options. You can choose from several business loan options, including SBA loans, equipment loans, or vehicle loans, to name a few.
- Low-interest rates. Business loan interest rates are typically lower than they are for merchant cash advances, making business loans a more affordable option.
- Stable payments. Business loans are repaid through regular installments, making these bill payments easy to budget for compared to a merchant cash advance.
- Flexible repayment options. Your lender may offer a handful of repayment options with your business loan to help fit in with your financial situation and budget.
Disadvantages Of A Merchant Cash Advance vs. A Business Loan
In addition to the benefits that merchant cash advances and business loans offer, there are also a few drawbacks to consider before choosing one over the other.
Merchant Cash Advance
- High-interest rate. The factor rate — which is the rate that you pay on your advance — can be quite high. In fact, these rates can be as high as 40% or more, depending on the lender and your financial and credit profile.
- Less regulated. You’ll need to be a bit more careful when scoping out lenders who offer merchant cash advances. Since these financial products are not classified as loans, they are not regulated by the stringent lending laws that exist with business loans. As such, you could more easily fall victim to a predatory lender if you’re not vigilant.
- Long and complicated application process. There are usually far more documents to have to go through and sign when applying for a business loan compared to a merchant cash advance.
- May require collateral. Unlike a merchant cash advance, collateral may be required to get approved for a business loan, such as real estate or equipment.
- Good credit score required. In order to qualify for a business loan at a good rate, you’ll likely require a good credit score of at least 700 or more.
When Should You Get A Merchant Cash Advance?
Considering that both a merchant cash advance and business loan have advantages and disadvantages, which one should you choose over the other?
The answer comes down to your specific situation. If you meet any one of the following criteria, then a merchant cash advance may be worth considering.
You Operate A Seasonal Business
Seasonal businesses are usually characterized by very busy and high revenue months followed by much slower months in terms of sales. If you had to make regular installment payments to repay a business loan, you might end up with payments that are larger than your revenue for that month. Which, ultimately can negatively impact your cash flow.
But a merchant cash advance repayment structure works with your revenue. So in slow months, your repayments are lower.
You’re An Online Business
If most of your sales are online and payments are typically made through credit cards, then a merchant cash advance might make more sense for you. That’s because you’ll be able to receive a higher advance amount in exchange for a smaller share of your daily credit card receipts.
You Have Bad Credit
Merchant cash advances don’t typically require a strong credit score. If your score could use some improvement, you might have more luck applying for this product compared to a business loan, which usually requires a higher credit score.
When Should You Get A Business Loan?
You may want to consider applying for a business loan if any of the following apply to you.
You Prefer Predictable Payments
A business loan is repaid through regular payments on a fixed schedule. Payment amounts do not change, which makes them more predictable and therefore easier to budget for.
You Need A Large Sum Of Money
Maximum loan amounts are typically much higher with business loans compared to merchant cash advances. Furthermore, if you need a large sum of money to cover startup costs, then a business loan is your best bet.
You Have Good Credit
If your credit is over 700, you’ll have a better chance of getting approved for a lower interest rate with a business loan.
Requirements For A Merchant Cash Advance vs. A Business Loan
In order to get approved for either a merchant cash advance or a business loan, you’ll need to meet specific criteria.
Merchant Cash Advance Requirements
- Completed application. This includes your personal and business information, Social Insurance Number (SIN), business GST number, and other relevant information about your business.
- Several months’ worth of credit card payments and bank statements. This information will help the advance provider estimate the amount they can expect from your daily credit card receipts.
Business Loan Requirements
- Detailed business plan. Your lender will want to see that you’ve done your homework in terms of what the loaned funds are needed for as well as what your company’s objectives are. They’ll also want to see some proof that your business is viable and capable of being profitable into the foreseeable future.
- Cash flow statements. A healthy cash flow shows that your business is in good financial condition and means you’ll have monetary resources available to make regular payments.
- Personal income and tax returns. This information will give the lender some insight into how strong your personal finances are and your ability to repay a loan.
- Statement of business assets and liabilities. Your business’s assets and debts will also help the lender determine your financial strength to hold a loan. If your business liabilities are too high relative to your business assets, this may present a higher risk for the lender.
- Credit score, both personal and business. Your credit score will give your lender a good idea of the likelihood that you’ll make regular payments to repay the loan in full by its due date.
- Collateral. An asset of value may be used to secure your business loan. The lender will assess the value of the collateral relative to the loan amount you’re applying for to make sure its value is enough to back the loan.
Where can I get a merchant cash advance?
Can I get a business loan with bad credit?
What is a business credit score?
If your business is in need of some financial assistance, a business loan or merchant cash advance may be viable options to consider. The product you inevitably choose will depend on the type of business you run, your cash flow, how you typically collect payments from customers, and the funds you require.
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