Merchant Cash Advances vs. Loans: A Guide for Small Business Owners
Access to quick funding can be a lifeline for small business owners. Whether it’s a critical piece of equipment breaking down or suppliers offering an unexpected discount on bulk orders, unforeseen situations can arise at any time. In moments like these, you may need the money immediately and might be weighing business financing options such as merchant cash advances vs. loans.
Merchant cash advances (MCAs) are not as popular as traditional loans, but they can help businesses that don’t have a strong credit history or credit score. Knowing how these two types of financing differ will help you make the right decision based on your business needs.
In this article, you’ll learn:
The differences between merchant cash advances vs. loans
What a merchant cash advance is and its use cases
What traditional small business loans are and their use cases
Merchant Cash Advances vs. Loans: The Key Differences
In general, a merchant cash advance is a different type of funding than a traditional loan. Here are their major differences:
An MCA is not a loan; it’s financing based on weekly or daily debit or credit card transactions.
An MCA has flexible repayment terms depending on your sales, while business loans have fixed repayment schedules (typically monthly payments).
An MCA has a shorter repayment period.
An MCA has a factor rate, while traditional business loans have interest rates.
Fees can be much higher for an MCA, while bank loans can offer more competitive rates.
An MCA has easier requirements and application processes.
An MCA has a higher approval rate and faster processing time.
An MCA has a lower loan amount than traditional loans.
Now that you know their differences, let’s take a closer look at both funding options to understand them better.
What Is a Merchant Cash Advance?
An MCA, also referred to as credit card receivables financing, gives a lump sum upfront in exchange for a percentage of your future credit or debit card sales. This percentage is called the holdback.
The payback or repayment amount has a factor rate, which is a multiple of the loan amount that includes costs and fees. This can range from 1.2 (or 120%) to 1.5 (or 150%). The payback amount and the factor rate combined are called the purchase amount.
Let’s say you were given an advance of $100,000 with a factor rate of 1.5. Your purchase amount would be $150,000 (1.5 x 100,000).
Once the advance is credited to your business bank account, the provider will automatically deduct the holdback from your card sales through your card processor. The good thing is that your payments depend on your sales, so you’re not forced to make payments you can’t afford.
For example, if you agree to pay 10% of your future credit card sales, your payments can look like this:
Week 1: Your sales hit $5,000, so you’ll pay $500.
Week 2: Your sales hit $1,000, so you’ll pay $100.
Week 3: You did not have any sales, so you’ll pay $0.
Aside from flexible payments, another benefit of this alternative financing is that their eligibility requirements are less strict than bank loans. These requirements can vary among providers, but typical application documents can include bank statements, credit card processing statements, and proof of identity. No collateral, personal guarantees, or credit scores are needed.
Pros of a Merchant Cash Advance
More stable cash flow due to flexible payments
Faster application and approval process due to less paperwork
Faster release of funds
No risks of losing your personal assets
No restrictions on how the funds are used
Cons of a Merchant Cash Advance
High fees and costs, which means you can end up paying more than loans
Extended payment period if you have slow sales
Not as regulated as bank loans
Will not help you build (or rebuild) your credit since it’s not a loan
Limited to businesses that accept card payments
Types of Businesses That Benefit From a Merchant Cash Advance
Growing startups that need funding for operational expenses
Businesses with fluctuating sales that heavily rely on card payments, such as retailers, restaurants, and other service-based companies
Companies that don’t have a credit history, or have a low credit score or bad credit
Small Business Use Cases for a Merchant Cash Advance
An MCA can be used if you need working capital for short-term, immediate expenses or if you want to address a cash flow issue or emergency. For example, a potential invoice delay will make it challenging for you to pay for utilities or wages, so you’re in need of financing to cover the gap.
This business funding can also be for seasonal expenses or bulk purchases, such as an increase in inventory during sale periods.
What Are Business Loans?
Business loans are conventional term loans mainly provided by banks, credit unions, and other financial institutions. Lenders that are not associated with banks and credit unions offer private business loans.
Business loans are given as a lump sum upfront and are repaid over time through fixed monthly installments. This form of financing may require a down payment, depending on the lender and the type of loan.
Loans have an interest rate, which is the annual cost of borrowing the principal amount (expressed as a percentage). This rate can be fixed or variable, with the latter changing based on market conditions.
The interest rate plus additional fees — like origination fees (or the cost of processing the loan) — is called the annual percentage rate. This number shows you the total amount you’re paying as a borrower.
Because they are heavily regulated, traditional banks implement very strict underwriting processes. They require a lot of documentation, including business and personal credit scores, collateral, and tax and financial statements. The higher your credit score is, the better terms you’ll get, such as higher loan amounts or lower interest rates.
The approval process can take weeks, or even months, because traditional lenders screen for borrowers with the lowest risks of defaulting. But since applicants are heavily vetted, there’s more room to extend repayment terms (up to 25 years for long-term loans).
Aside from bank loans, one of the most common examples of a business loan are the Small Business Administration (SBA) loans. These are partially backed by the government, which means that the government pays the lender if the borrower defaults. These loans have some of the most competitive interest rates and repayment terms in the market.
Pros of Business Loans
Lower fees and costs
Regulated by the government
Higher loan amounts and better repayment terms
Allows you to build your credit history and score
Cons of Business Loans
Strict requirements, which can include detailed business plans and financial statements prepared by accountants
Complicated and lengthy application process
Not always accessible to new businesses
Risks of losing your personal assets if you pledge them as collateral
Can have restrictions on how you use the funds
Types of Businesses That Benefit From Business Loans
Established companies with predictable income
Businesses with sound financials and high credit scores
Firms that have many physical assets, like those in manufacturing and real estate
Small Business Use Cases for Business Loans
If you’re planning to buy expensive investments like real estate properties or a service vehicle fleet, you may benefit from long-term repayment plans.
If you’re trying to build your credit score so that you can take out a much bigger loan in the future, business loans can help you achieve this goal.
Business loans can give you much higher funding amounts if you’re looking to invest in research and development, including expanding into new markets.
Get the Funding You Need Through Backd
Deciding between getting a merchant cash advance vs. a loan ultimately depends on how you’ll use the funds. There are also other short-term, alternative financing options that may be a better fit for your needs.
For example, Backd offers up to $2 million through our Working Capital Advance and up to $750,000 through our Business Line of Credit. We also do a soft credit pull so applying doesn’t affect your credit score. Once you submit your application, a decision can be made within 24 hours.
Eligibility requirements include:
$100,000 in monthly revenue
A credit score of 625+
Established business credit
Based in the U.S. with a brick-and-mortar address
Been in business for one year for Working Capital Advance and two years for a Business Line of Credit
Apply now for funding that works on your terms.
