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Updated: April 16th, 2020
Both term loans and merchant cash advances (MCA) can give business owners quick access to financing. However, in many cases, when comparing a merchant cash advance vs a loan, a term loan is going to be a better option.
With a small business term loan, you’ll often receive upfront funding and then repay the loan in predetermined monthly installments over time. MCAs also offer upfront funding, but you typically have to pay a portion of your debit and credit card sales or a predetermined amount on a daily or weekly basis. The frequent payments and potentially unpredictable amounts can make it challenging to plan and maintain a positive cash flow.
Still, businesses may turn to a merchant cash advance when they have trouble qualifying for another form of financing. Or, they might not realize how online lenders have created quick application and funding processes for small businesses.
A term loan is a common type of business loan, but it can come in many forms. For example, equipment loans and auto loans are term loans that you take out to buy a specific type of machinery. Ordinarily, the equipment or vehicle secures the loan, and the lender can take that collateral if you stop making payments.
Or, some lenders may offer a loan that you can use for almost anything. Your business’ assets can secure these, or some lenders offer unsecured term loans. In either case, the business owners may have to sign a personal guarantee — a pledge to repay the loan even if the business cannot.
In either case, term loans normally share a few similarities:
The structure of term loans makes them a good fit for large purchases, as they allow you to receive a large amount of funding and repay it in small monthly payments. You can also budget with confidence because you can predict the repayment amount, although some term loans have a variable interest rate, which can lead to rising or falling payments.
Lenders have different requirements, and the loan amount and rate you’ll receive can depend on your business’ finances and credit. With small businesses, the owner’s personal credit can also be essential.
There’s a distinct difference between a merchant cash advance vs loan: An MCA technically isn’t a loan. Instead, the company is purchasing part of your future sales. It may seem trivial, but this is an important difference because it means the laws that govern small business lending don’t apply to MCAs. It’s also why you largely won’t see an interest rate or annual percentage rate (APR) with an MCA, which can make it difficult to compare the cost of financing between a merchant cash advance vs a loan.
With an MCA, the company will usually give you an advance up to a multiple of your expected monthly sales. It also charges a factor rate, which often ranges from 1.1 to 1.5, on the advance amount.
For example, if you receive a $10,000 advance and have a 1.2-factor rate, you’ll need to repay $12,000. Early repayment won’t save you money because interest isn’t getting added to your loan over time. However, some companies charge additional fees, and you may be able to avoid some of these by quickly repaying off the advance.
You’ll repay the advance in one of two ways. Traditional merchant cash advance repayments involve your credit card processor taking a portion of your credit and debt sales and sending them directly to the MCA company. Or, you’ll redirect your credit and debit sales to an account that the MCA company controls, and it will take a cut before forwarding the remainder to your account.
Another option is to pay a fixed amount with an Automated Clearing House (ACH) transfer from your business bank account to the MCA.
With both the traditional and ACH options, the payments often happen on a daily or weekly basis. The frequent repayment schedule is one reason that MCAs can strain a business’ cash flow.
|Business Term Loans||Merchant Cash Advances|
|Loan Amount||Several thousand to over $1M.||Up to 250% of your expected sales.|
|Payments||Almost always, monthly payments for a predetermined amount.||A daily or weekly payment for a portion of your sales or a fixed amount.|
|Repayment Period||Choose your term, from several months to many years.||Often ranges from three to 12 months, but it can depend on your sales.|
|Annual Percentage Rate (APR)||Fixed-rate loans may have an APR of around 5% to 35%.||Factor rates often range from 1.1 to 1.6. The equivalent APR can range from around 40% to over 100%.|
|Requirements||Lenders may have different requirements. Qualifying can depend on your business and personal credit and finances.||It’s on the whole easy to qualify based on your cash flow rather than creditworthiness.|
|Additional Costs||Lenders sometimes charge origination, application, administrative fee, late payment, or prepayment fees.||MCA companies may charge administrative, underwriting, origination, closing, and servicing fees.|
|Liability||Lenders may require collateral and a personal guarantee.||MCAs are overall, unsecured.|
You should compare various types of business financing to figure out what will work best for your business in different scenarios.
For example, if you want to hire a new employee to keep up with growing demand, a term loan could be a good option. But if you’re struggling with cash flow, a term loan might not make as much sense as a line of credit or business credit card.
If you don’t have enough credit to qualify for a loan or line of credit, you may have to turn to an MCA. But if you sell to other businesses, invoice financing could be a good alternative. With factoring, you can get paid immediately on your outstanding invoices in exchange for the factoring company taking a portion of the invoice amount.
Here’s an overview of a merchant cash advance vs loan and when each may make sense:
An MCA is often the last resort for a business that needs quick funding and can’t qualify for anything else. In examining the contrast between a merchant cash advance vs loan, different types of term loans can come into play to help business owners start, run, and grow their business.
Businesses that have term loans, such as an equipment loan or commercial real estate mortgage, may also turn to an MCA for fast financing. And, if you took an advance with an MCA and can now qualify for a low-rate term loan, you may want to use the funds to pay off your merchant cash advance. While you won’t save money on the advance fee, you may avoid some of the additional fees and can lock in a monthly payment rather than continuing to make daily or weekly payments.
If you’re looking for a term loan, you’ll want to find a lender that offers a loan that matches your business’ needs.
For example, a dentist may work with a bank’s medical practice team to secure several hundred thousand dollars in dental equipment financing with a 10-year term loan. Or a business that has several weeks to go through the application and funding process could look for a low-rate loan through one of the government-back Small Business Administration loan programs.
However, a small manufacturer or retailer presented with an opportunity or challenge might need to act more quickly. Or, the owner may prefer an easy application process that won’t eat the time they spend running the business. In these scenarios, a specialized online lender that works exclusively with small businesses could be a good fit.
As with other types of financing, you’ll want to compare the loan amounts, rates, repayment terms, and fees before accepting an offer. Sometimes, you can quickly submit an online application to see estimated loan offers without impacting your credit.