When you start searching for business financing to fund your next move or pay for expenses that can’t be covered by your current earnings, the market can feel overwhelming. You have to understand interest, factor rates, repayment schedules, and a dozen other things. But once you get the hang of how these products are packaged, two options will stand out for your business: a small business loan and a merchant cash advance.
Both these solutions help finance your business, but their details are entirely different, and a business owner must choose wisely. If you pick the wrong financing method, you might spend months paying for that mistake. Therefore, this article explains how these two financing solutions differ and their salient features. Keep reading and plan your next step while being fully informed.
Comparing a Small Business Loan and a Merchant Cash Advance
Before we get to the specifics of these business financing methods, let’s see how they are structured:
Small Business Loan
A small business loan is a fixed amount of money borrowed from a bank, credit union, or online lender. You repay it over a set period through regular monthly installments, and interest is applied to the outstanding balance. When you sign a deal, the exact loan amount, its interest rate, and repayment schedule are agreed upon upfront and stay the same throughout the life of the loan. All in all, it’s a set agreement, and a set amount goes out of your account each month until the loan is paid off.
Merchant Cash Advance
As the name hints, a merchant cash advance (MCA) is not technically a loan. It’s an advance on your future receivables. When you need quick access to business capital without the requirements of a typical loan, you get an advance against your future sales from a lender. In return for that amount, you agree to repay a larger fixed amount (the amount borrowed plus its cost).
Let’s now compare these two methods’ speed, flexibility, and cost:
Cost
The cost of borrowing is one of the most important things to understand. For instance, if it’s a costly loan, it can eat into your margins.
That said, small business loans are generally affordable. Although their interest rates depend on your credit profile and the loan type, they tend to be lower than other short-term financing options. Since you pay interest on the remaining loan balance, the total cost goes down over time as you repay.
On the other hand, merchant cash advances are considerably more expensive. Instead of an interest rate, MCAs use a factor rate. The lenders require a factor rate ranging from 1.1 to 1.5.
Here is how it works:
If you borrow $50k at a factor rate of 1.3 (the loan amount multiplied by the agreed-upon factor rate), you will repay $65,000 in total. You usually repay the borrowed amount as a percentage of your daily (or weekly) credit card receivables.
Speed
When you want a cash injection for business expenses, the process should go fast. If the funding process is slow, you could miss out on an opportunity or not be able to make payroll on time.
Small business loans are infamous for being slow, especially if they’re from banks. During the application process, you have to submit financial statements, business plans, and other documentation. And once the documentation is done, the approval can take a few days to several weeks, and funding will follow shortly after.
That’s why businesses prefer MCAs when they’re in a time crunch, because their approval is based primarily on your sales history rather than a full credit underwriting. As a result, the whole application and approval process is much faster, and many MCA providers can send you the funds within 24 to 72 hours.
Flexibility
Some business loans require you to use the amount for a particular purpose. For instance, you can use equipment financing only to obtain business equipment, which means you can’t use it for operational expenses or payroll. That’s why flexibility matters.
If you opt for a small business loan, you can use the funds for any business purpose. Most lenders don’t place restrictions on what you do with the money, but they want the repayment schedule to be structured and predictable. Missing a payment can affect your credit and trigger penalties, so the repayment schedule is important.
On the other hand, merchant cash advances are more flexible on the repayment side because of their revenue-based model. For example, during a low sales period, the repayment amount also goes down, and you get some leg space to manage other operational expenses.
MCAs also typically do not require collateral for loan security, which lowers the barrier to access for small businesses. However, that does not necessarily give you more control over the arrangement because the amount you receive and owe is still dictated by the lender’s terms, and you don’t have room to negotiate.
Conclusion
Businesses often run out of liquid cash and require financing to continue operating. Both small business loans and merchant cash advances are meant for businesses in a financial crunch. But the solution you opt for depends on your unique situation, so it’s best to take advice from experts at ROK Financial. We’ll make sure you don’t agree to a risky deal!
FAQs
What is better for a business that has been open for less than a year? A business loan or MCA?
Most lenders require 1-2 years in business before approving a small business loan. So if you are under that threshold, a merchant cash advance is more accessible since approval is based on your sales.
Is a merchant cash advance considered debt?
Technically, no. An MCA is a purchase of your future sales, not a loan. That means it does not always show up on your credit report as debt. However, you are still obligated to repay it, so treat it with the same seriousness as you would any financial commitment.
Can I pay off a merchant cash advance early to save money?
No, that doesn’t help. With an MCA, the total repayment amount is fixed from day one using a factor rate. If you pay early, that does not reduce what you owe, and you will repay the full amount regardless of how fast you clear it.