When it comes to securing funding for your business, there are plenty of options on the table. But, two of the most commonly discussed types of financing are merchant cash advances (MCAs) and traditional business loans. While both can provide you with the capital you need, they function in vastly different ways, each with their own pros and cons. Understanding these differences is essential for making the best decision for your business. So, let’s dive into the details and break down the key points.
What Is a Merchant Cash Advance?
A merchant cash advance isn’t technically a loan. Instead, it’s an advance against your future sales. In other words, a lender gives you a lump sum of money upfront, and you repay the loan by giving the lender a percentage of your daily or weekly credit card sales.
One of the main draws of MCAs is the flexibility. The repayment is tied to your sales performance, which means that if your sales drop, your repayments drop as well. On the flip side, when your sales are high, the repayment amount increases. This makes MCAs an attractive option for businesses with fluctuating income.
Traditional Business Loans: The Classic Route
Traditional business loans, on the other hand, are exactly what they sound like—a loan that you borrow from a bank, credit union, or other financial institution. These loans are typically repaid on a fixed schedule, whether monthly, quarterly, or annually, depending on the terms of the loan agreement. The loan is based on factors such as your credit score, business history, and cash flow.
Traditional loans come in many forms, but the most common are term loans, lines of credit, and Small Business Administration (SBA) loans. These loans often have fixed interest rates, and the repayment amount is predictable, which makes it easier to budget. However, obtaining one of these loans can be more challenging. Traditional loans require extensive paperwork and a lengthy approval process, and many small businesses struggle to meet the eligibility criteria.
The Key Differences Between Merchant Cash Advances and Traditional Business Loans
1. Approval Process
One of the biggest differences between these two financing options is the approval process.
MCAs typically have a much faster approval process, sometimes taking just a few days. Because the loan is secured by your future sales, the lender is more concerned with your sales volume than your credit score. This can be a major advantage for businesses with less-than-perfect credit but strong sales.
Traditional business loans, on the other hand, have a much longer approval process. You’ll need to provide a lot of documentation, including tax returns, financial statements, and proof of collateral. On top of that, if your credit score isn’t stellar or your business doesn’t have a strong history, your chances of approval can be slim. This can be frustrating if you need funds quickly.
2. Repayment Terms
When it comes to repayment, merchant cash advances are quite different from traditional loans. With an MCA, you repay the lender through a percentage of your daily credit card sales. This means that your repayments will vary based on how well your business is doing. If sales are strong, you’ll pay off your advance quicker. If your sales dip, your repayments will decrease accordingly.
In contrast, traditional business loans typically come with fixed monthly repayments. While this makes it easier to plan and budget, it also means that you’ll need to make consistent payments, regardless of your sales performance. For businesses that are growing or experiencing fluctuations in sales, this can sometimes feel like a burden.
3. Loan Amounts
Merchant cash advances usually offer smaller amounts of money compared to traditional loans. The amount you’re able to borrow depends on your sales volume, and while it can be substantial for some businesses, it often won’t be enough for large-scale operations.
Traditional business loans, however, can offer much larger amounts of financing. Depending on your business’s size and financial standing, you could qualify for a loan that runs into the six-figure range. If you’re looking to fund major projects or expand your business significantly, a traditional loan is likely the better choice.
4. Interest Rates and Fees
One of the major drawbacks of a merchant cash advance is the high cost. MCAs are often considered one of the most expensive ways to borrow money. The effective interest rate can be as high as 30-40% or more, depending on the terms of the agreement. While the flexibility of repayment is appealing, the overall cost can make it a less-than-ideal option for some businesses.
In contrast, traditional business loans tend to have lower interest rates, typically ranging from 6% to 10%. SBA loans, in particular, tend to have some of the best rates for small businesses. The lower interest rate makes traditional loans a more affordable option in the long run, especially if you have the means to repay the loan in a timely manner.
5. Eligibility Requirements
Another factor to consider is the eligibility criteria for each type of financing.
With merchant cash advances, the main factor is your sales volume. The lender will likely look at your credit card processing history to determine how much you can borrow. This means that if you have a strong, steady flow of credit card sales, you’re in a good position to secure an MCA—even if your credit score isn’t great.
Traditional loans, on the other hand, often come with stricter requirements. Lenders will look at your credit score, business history, cash flow, and collateral. If you’re a new business or have poor credit, qualifying for a traditional loan can be difficult. However, if you have a strong financial history, you’re more likely to qualify for a better rate and terms with a traditional business loan.
6. Impact on Cash Flow
In terms of impact on cash flow, an MCA can be a bit of a double-edged sword. On one hand, the flexible repayment structure allows you to adjust payments based on your sales. On the other hand, you might find that a higher percentage of your sales are being taken as repayments during peak sales periods, which could limit your ability to reinvest in the business.
Traditional business loans are a bit more predictable in this regard. You know exactly what your repayments will be each month, which can help you plan your cash flow more effectively. However, the fixed repayment schedule can sometimes feel like a strain on your cash flow, especially during slow periods.
When to Choose a Merchant Cash Advance
A merchant cash advance can be a great option for businesses that have strong daily or weekly credit card sales but struggle with traditional financing. If your business is in need of quick cash, and you’re able to repay based on your sales volume, an MCA could be the right fit.
This option is ideal for businesses that:
- Have inconsistent income or seasonal fluctuations.
- Need quick access to funds without waiting for lengthy approval processes.
- Have trouble qualifying for traditional loans due to a low credit score.
When to Choose a Traditional Business Loan
On the other hand, if your business is well-established with a stable income and a strong credit profile, a traditional business loan might be the best route. The fixed interest rates and predictable repayments make it easier to plan your financial future.
Traditional loans are a better fit for businesses that:
- Are looking for larger loan amounts for expansion or major projects.
- Can handle a fixed repayment schedule without putting a strain on their cash flow.
- Have a strong credit history and can secure favorable terms.
The Bottom Line
Choosing between a merchant cash advance and a traditional business loan depends on your specific business needs, your financial situation, and how quickly you need the funds. Both options come with their own set of advantages and disadvantages. While an MCA offers quick access to cash with flexible repayment terms, it comes at a high cost. A traditional business loan offers lower interest rates and predictable payments, but securing one can be a lengthy and challenging process.
Ultimately, you’ll need to weigh the pros and cons of each option and determine which one is right for your business. With careful consideration, you can find the right financing solution that helps your business thrive.