By Content Team
Updated on: March 7, 2024
As a small business owner, finding the right business financing option is crucial to support growth and maintain healthy cash flow. Two popular financing options for small businesses are merchant cash advances (MCAs) and business loans. MCAs and small business loans each have their place, so it’s important to understand the contexts that work best for each of them before you seek business funding.
Merchant cash advances (MCAs) can be an attractive financing option for businesses, particularly for those needing quick access to working capital. This alternative funding solution provides businesses with an upfront cash infusion in exchange for a share of their future revenue including credit card sales and debit card transactions. The repayment period* is flexible, with payments fluctuating based on sales volume, making it more manageable during slow periods.
For many small businesses, the fast approval process and minimal documentation requirements make MCAs appealing, as they can receive funds within days without needing an excellent credit score. This allows business owners to take advantage of time-sensitive opportunities, such as purchasing inventory at a discount or investing in marketing efforts to grow sales. If you’ve only got 48 hours to take advantage of an opportunity, you’ll want that lump sum to hit your bank account as soon as possible.
On top of that, MCAs do not require real estate collateral, reducing the risk for business owners in case of default on the advance amount. This feature can be particularly advantageous for eCommerce businesses that may not have physical assets to offer as collateral.
The use of funds is also flexible, allowing business owners to allocate the cash advance to any aspect of their business operations, from hiring additional staff to upgrading their eCommerce platform. Overall, a merchant cash advance can be a valuable financing tool for businesses seeking fast, flexible funding with minimal barriers to entry.
Factor rates and interest rates are two different ways of calculating the cost of financing. Interest rates are expressed as a percentage of a loan amount and represent the cost of borrowing over a set period of time (or annual percentage rate), typically a year.
Factor rates, on the other hand, are expressed as a decimal or fraction and represent the total payment amount. Factor rates are typically determined upfront and remain fixed throughout the loan term.
While interest rates are commonly used for business bank loans, factor rates are often used for merchant cash advances. It’s important to understand the differences between these two rates and how they impact the overall cost of borrowing before choosing which funding option to pursue.
Flexible repayment terms: Many merchant cash advance companies offer flexible repayment options, as the repayment amount is based on a percentage of daily revenue. This means that the repayment amount is smaller during slow sales periods, easing the strain on cash flow.
Quick approval process: The application process for MCAs is relatively fast and simple, requiring minimal documentation such as bank statements. Approval is often granted within a few days, providing businesses with quick access to working capital.
No real estate collateral required: Unlike business loans, MCAs do not require real estate collateral, making them more accessible for small business owners with limited assets.
Credit score flexibility: MCAs focus on sales rather than credit history, making them an accessible option for businesses with bad credit or limited credit history.
No impact on credit score: As MCAs are not considered loans, obtaining an MCA does not impact your business credit score.
Traditional business loans are a common form of financing provided by banks, credit unions, and other financial institutions to help businesses meet their financial needs. These loans can be used for various purposes, such as purchasing equipment, funding working capital, expanding operations, or refinancing existing debt.
The application process for business loans typically involves submitting a comprehensive business plan, financial statements, tax returns, and other relevant documents that demonstrate the business’s financial health and stability. Lenders evaluate the applicant’s creditworthiness, business model, and potential for growth before approving the loan. A solid credit score, strong financial history, and a well-crafted business plan increase the chances of securing a loan.
Interest rates for small business loans can be fixed or variable, depending on the lender’s terms and the borrower’s creditworthiness. Fixed interest rates remain constant throughout the loan term, while variable rates may change based on market conditions. The repayment terms for these loans can range from short-term (less than a year) to long-term (several years), depending on the loan purpose and amount.
Business loans often offer lower interest rates compared to alternative financing options, making them a cost-effective choice for many businesses. However, they may have more stringent qualifying requirements, and the application process can be time-consuming and complex. Additionally, businesses may need to provide collateral to secure the loan, which can be risky if the business struggles to repay the loan.
There are also multiple forms of loans: business lines of credit, traditional bank loans, SBA loans, and more all fall under the umbrella of lending. The exact type of loan that’s best for your business will depend on your company’s needs, credit, and desired intent for the funding.
Lower interest rates: Business loans often come with lower interest rates compared to MCAs, resulting in a lower total cost of financing.
Predictable repayment schedule: Business loans have a fixed repayment schedule, allowing businesses to plan and manage their finances more effectively.
Wide range of loan types: There are various types of business loans available, such as term loans, SBA loans, and lines of credit, catering to different business needs and financial situations.
Builds creditworthiness: Repaying a business loan on time can help improve your business credit score, increasing your creditworthiness for future financing.
Suitable for long-term investments: Business loans often offer longer repayment terms and larger loan amounts, making them suitable for long-term investments, such as purchasing equipment or real estate.
When comparing the benefits of merchant cash advances and business loans, it’s essential to consider your business’s unique needs and financial situation. Here are some factors to consider when choosing the right financing option:
Business needs and goals: Assess your business’s financial needs and objectives. If you require quick access to funds for short-term needs or have fluctuating sales, an MCA may be a suitable option. For longer-term investments or larger loan amounts, a business loan might be a better fit.
Credit history and score: If your business has a strong credit history, you may be able to secure a loan. If your credit is less than stellar, an MCA may be a more accessible financing option.
Repayment flexibility: Consider your preference for repayment terms. If you prefer a predictable repayment schedule with fixed monthly payments, a business loan is likely the better choice. If you’re comfortable with variable repayment amounts based on daily sales, an MCA could be a good fit.
Cost of financing: Calculate the total cost of financing for both options, taking into account interest rates, factor rates, and any additional fees. Choose the financing option that offers the most cost-effective solution for your business needs.
Cash flow and sales volume: Evaluate your business’s cash flow and sales volume. If you have consistent, high-volume revenue from credit card sales, an MCA could be a viable option. However, if your cash flow is irregular a loan might be more suitable.
Both merchant cash advances and business loans offer unique benefits for small business owners. MCAs provide flexibility, quick access to funds, and accessibility for businesses with limited credit history or fluctuating sales. On the other hand, business loans offer lower interest rates, predictable repayment schedules, and the opportunity to build creditworthiness.
By carefully considering your business’s unique needs and financial situation, you can choose the financing option that best supports your business’s growth and success. Remember to always thoroughly research potential lenders or merchant cash advance providers and ensure that any agreements or contracts align with your business goals and objectives.
*Repayment in this context describes the process of repurchasing a merchant cash advance. It does not describe the process of repaying a loan. MCAs are legally distinct from loan products.