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.
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.
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.
Term business loans typically have the following characteristics:
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
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.
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.
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.
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 |
| Repayment Term | Variable | Fixed |
| 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 |
There are several perks to both merchant cash advances and business loans that make either one a great option to financially supplement your business.
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.
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.
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.
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.
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.
You may want to consider applying for a business loan if any of the following apply to you.
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.
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.
If your credit is over 700, you’ll have a better chance of getting approved for a lower interest rate with 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.
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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Lisa has been working as a personal finance writer for more than a decade, creating unique content that helps to educate Canadian consumers in the realms of real estate, mortgages, investing and financial health. For years, she held her real estate license in Toronto, Ontario before giving it up to pursue writing within this realm and related niches. Lisa is very serious about smart money management and helping others do the same.
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