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Merchant Cash Advance vs. Business Loan: What’s Best For Your Business?

Business Finance

Merchant Cash Advance vs. Business Loan: What’s Best For Your Business?

Updated: Apr 16, 2020

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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.

What is a small business term loan?

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:

  • Receive the full loan amount upfront. 
  • Repay the loan in regular installments. Sometimes term loans are called installment loans.
  • Repay the loan over a specific and agreed-upon term. The repayment term can range from several months to many years.
  • The loan has an interest rate, and interest accrues on the principal balance. Repaying the loan early can help you save money, although some lenders charge a prepayment penalty. 

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. 

What is a merchant cash advance?

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. 

Merchant cash advance vs loan: How do the two compare?


Business Term LoansMerchant Cash Advances
Loan AmountSeveral thousand to over $1M.Up to 250% of your expected sales.
PaymentsAlmost always, monthly payments for a predetermined amount. A daily or weekly payment for a portion of your sales or a fixed amount.
Repayment PeriodChoose 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%. 
RequirementsLenders 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 CostsLenders sometimes charge origination, application, administrative fee, late payment, or prepayment fees.MCA companies may charge administrative, underwriting, origination, closing, and servicing fees.
LiabilityLenders may require collateral and a personal guarantee.MCAs are overall, unsecured. 

What are the benefits and drawbacks of term loans?

Pros

  • A creditworthy business can qualify for a large loan with a low rate. 
  • Predictable repayment amounts and terms can help you plan your business’ future. 
  • It’s easy to calculate the total cost of borrowing before you take out a loan. 
  • Online lenders can offer a quick application and funding process. 

Cons

  • You may need good credit to qualify for a hefty loan with a low-interest rate. 
  • Can require collateral and a personal guarantee. 
  • You need to compare and beware of lenders’ fees. 
  • Not the right solution for ongoing cash flow problems. 

What are the benefits and drawbacks of merchant cash advances?

Pros

  • You don’t need good credit to qualify. 
  • You can quickly get your advance. 
  • With a traditional MCA, your payment amount decreases when sales are low. 
  • You won’t need to offer collateral or sign a personal guarantee. 

Cons

  • You may have unpredictable repayment amounts that eat into your cash flow. 
  • It can be hard to understand all the terms and compare your options.
  • May be expensive compared to other types of financing. 
  • You don’t necessarily save money by paying off the advance early. 

When is it best to use a term loan or merchant cash advance?

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:

Term loans are best when:

  • You can qualify for a low rate: Businesses that have a solid financial footing and good credit history may be eligible for a sizable loan with a low-interest rate. Otherwise, you might be offered high APRs and could be better off with alternative financing. 
  • You want to make a large purchase: Term loans can give you the money you need to buy equipment, hire an employee, expand your business, start a new marketing campaign, or prepare for a busy season. You can also use a low-rate term loan to pay off higher-rate debts. 
  • You want to choose your repayment amount and terms: After you apply, the lender may offer you several loans with different repayment terms and monthly payments. A longer term can lead to lower monthly payments, but you’ll also pay more in interest over time. 
  • You don’t have an ongoing need: Term loans can give you a lot of upfront financing, but you only receive the loan once. If you need additional funding, you’ll need to apply for another term loan. 

Merchant cash advances are best when:

  • You can’t qualify for other forms of financing: It’s generally easy to get approved for a merchant cash advance as you don’t need good credit or collateral. If you can qualify for a term loan or business line of credit, those may offer less expensive financing. 
  • You can take the cash flow hit: Make sure daily, or weekly payments won’t hurt your business more than the financing will help it. Otherwise, you may wind up in a debt cycle, taking out a new loan or advance to pay down previous obligations. 
  • You carefully read over the terms: MCA agreements may be filled with unfamiliar terms and aren’t strictly regulated like loans. Do your research and understand what you agree to before signing up. 

How do term loans complement merchant cash advances? 

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. 

What should you look for in a small business lender?

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. 

Louis DeNicola

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