When your business needs funding, there are many financing options to consider, each with its own pros and cons. Two common options are merchant cash advances (MCAs) and traditional business loans. While both provide businesses with needed capital, they work in very different ways, and choosing the right option can significantly impact your business's financial health.
In this post, we’ll break down the key differences between merchant cash advances and business loans, exploring how each works, their benefits and drawbacks, and which option may be best suited for your business.
What is a Merchant Cash Advance (MCA)?
A merchant cash advance is not technically a loan. Instead, it is an advance on your future credit card or debit card sales. With an MCA, a lender provides you with a lump sum of capital in exchange for a percentage of your daily or weekly credit card sales until the advance, plus fees, is fully repaid.
Key features of a merchant cash advance:
- Repayment is flexible: Since repayment is based on a percentage of your daily credit card sales, your payments fluctuate with your revenue. This means you pay more when sales are strong and less when business is slow.
- Fast approval and funding: MCAs are typically approved more quickly than traditional loans, with funds often available in just a few days.
- High costs: MCAs tend to be more expensive than traditional loans. Instead of interest, you pay a factor rate—usually between 1.1 and 1.5—multiplied by the advance amount. This can make the total cost of an MCA much higher than a standard loan.
What is a Business Loan?
A business loan, on the other hand, is a traditional form of financing where a lender provides a set amount of money that is repaid over time with interest. Business loans can come in many forms, including term loans, lines of credit, or SBA loans.
Key features of a business loan:
- Fixed repayment terms: Business loans have structured repayment terms, typically with fixed monthly payments over a set period (e.g., 1-5 years). This makes it easier to plan for and manage payments.
- Lower interest rates: Traditional business loans generally have lower interest rates compared to MCAs, especially if you have a strong credit history.
- More stringent approval process: The application process for business loans can be longer and more complicated, often requiring financial documentation, business plans, and a credit check. Approval may take weeks, and not all businesses qualify.
Comparing Merchant Cash Advance vs. Loans
Both merchant cash advances and business loans offer businesses a way to access capital, but they have important differences that can influence which option is best for you. Let’s break down the main points of comparison.
1. Approval Process
- MCA: One of the main advantages of merchant cash advances is the fast and easy approval process. MCAs typically don’t require a detailed credit check or extensive documentation, and approval is often based on your business's monthly revenue and credit card sales volume. Businesses with poor credit or short operating histories can still qualify for an MCA, making it an accessible option for many.
- Loan: Traditional business loans, especially those from banks, have a much more rigorous approval process. Lenders usually require a strong credit score, detailed financials, and a solid business plan. Approval can take weeks, and businesses with poor credit or inconsistent revenue may have trouble qualifying.
2. Repayment Terms
- MCA: Repayment of a merchant cash advance is flexible since it’s based on a percentage of your daily or weekly credit card sales. This means if your sales slow down, your repayment amounts will decrease as well. However, there’s no set end date for repayment since it’s tied to your sales, making it harder to predict exactly when the advance will be fully repaid.
- Loan: Business loans have fixed repayment terms, which usually consist of monthly payments over a predetermined period. The regularity of these payments allows for better financial planning, but it also means that your payment amount remains the same even if your sales dip during a slow month.
3. Cost
- MCA: While MCAs offer convenience and fast access to funds, they come with a higher cost. Instead of a traditional interest rate, MCAs use a factor rate, which can be significantly more expensive. For example, if you take out a $50,000 advance with a 1.3 factor rate, you would owe $65,000 in total ($50,000 x 1.3 = $65,000), regardless of how long it takes you to repay the advance. This can result in an effective annual percentage rate (APR) that is much higher than what you would pay with a loan.
- Loan: Traditional business loans tend to have lower interest rates, especially if you have strong credit or can qualify for government-backed loans like those offered by the Small Business Administration (SBA). The fixed nature of the loan's terms makes it easier to understand your total repayment costs upfront.
4. Flexibility
- MCA: Because MCA repayments are based on your sales, there’s inherent flexibility built in. When your business is thriving, you pay more, and when business is slow, you pay less. This can provide some relief during low-revenue periods, though it also means it could take longer to pay off the advance.
- Loan: While traditional loans have fixed payments, they often come with longer terms, allowing you to spread out your repayments over several years. This predictability is ideal for long-term planning, but it does mean you need to ensure you can meet the payment amounts during periods of slower sales.
5. Business Impact
- MCA: One of the potential downsides of an MCA is that the daily or weekly repayment can strain your business’s cash flow, especially if your sales are inconsistent. Since payments are deducted directly from your credit card sales, there’s less money available for daily operations. If your business operates on tight margins, this could present challenges.
- Loan: A traditional loan, with its predictable monthly payments, may have less of a day-to-day impact on your cash flow. However, if you miss a payment or run into financial difficulties, the lender may charge penalties or even place a lien on your business assets.
Which Option is Right for Your Business?
Choosing between a merchant cash advance and a business loan depends on your business’s unique financial situation and needs. Here are some factors to consider:
- When to Choose a Merchant Cash Advance:
- You need fast access to cash (within a few days).
- You have poor credit or a short business history and may not qualify for a traditional loan.
- Your business has consistent credit card sales, and you’re comfortable with the flexible repayment terms.
- When to Choose a Business Loan:
- You prefer a lower-cost option with fixed interest rates and predictable payments.
- You have a good credit score and can wait for a longer approval process.
- You need larger amounts of capital for long-term investments, such as equipment purchases or expansion.
Both merchant cash advances and traditional business loans have their place in the business financing world. If you need quick capital and can handle fluctuating payments, an MCA might be the right fit for your business. However, if you’re looking for lower costs, fixed payments, and long-term funding, a business loan could be the better option.
Understanding the differences between the two options will help you make an informed decision based on your business’s needs and financial health. Always review the terms carefully, calculate the total costs, and consult a financial advisor if needed before making a decision.
If you’re unsure which option is right for you, contact us at InfoMerchant for expert guidance on securing the funding your business needs. We can help you explore your options and find the best financing solution to keep your business growing!
