Merchant Cash Advance Financing vs. Small Business Loans

by Justin on June 21, 2016

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Business financing tools can’t be compared based on cost alone, so here’s a closer look at the pros and cons of merchant cash advances and small business loans. What you learn about the advantages each of these financing tools offer might make one a better option for your business’s financial needs.

What is a Merchant Cash Advance?

Merchant cash advances aren’t loans, although they share similarities, which you’ll see in the pros and cons that follow. A merchant cash advance is a lump sum of working capital which a business owner can use for a wide variety of business purposes, at their discretion.

The amount of money a business might be qualified to receive in a merchant cash advance is based on the company’s sales history, specifically, sales where customers used a credit or debit card to make a purchase. The amount of a merchant cash advance is often calculated as a percentage of the business’s average monthly credit and debit card sales. It’s also repaid automatically from future debit and credit card sales as a small percentage of each transaction that occurs over a set period of time, usually over 6-18 months.

What is a Small Business Loan?

A small business loan also makes a lump sum of working capital available to a business which must be repaid over time. Some small business loans are SBA-guaranteed, which extends an additional layer of protection to the bank making the small business loan should the business be unable to repay the amount.

The amount of a small business loan is generally going to be determined through a fairly stringent underwriting process wherein the lender determines the credit worthiness of the company and its officers. The lender’s terms will generally restrict use of funds to specific purposes and may even require reporting and oversight, especially in the case of SBA small business loans.

Comparing the Pros and Cons of Merchant Cash Advances and Small Business Loans

  1. Cost

Small business loans usually have lower interest rates, and therefore, a lower cost of financing. Borrowers can also save money by repaying the amount ahead of schedule.

Merchant cash advances are not currently regulated and at the high end, fees could be as high as 38 percent of the amount of an advance. Some programs have fixed financing fees where there is no financial benefit to the borrower when repaying early, other programs offer some benefit for early repayment.

One thing to remember when comparing the APR of a small business loan to the financing cost of a merchant cash advance is that bank fees are compounded monthly; if you take a long time to repay the amount you may find that you have also paid a significant amount in financing fees, vs. the small percentage rate it appeared to be. Additional fees may also be applied if you miss payments or make late payments, all of which affect the real cost of financing and may bring the cost of these two financing tools closer together.

  1. Application Process

It can take several days to apply for a small business loan and after you have submitted all application forms you may wait several weeks for an answer. Usually you will be required to submit a significant amount of paperwork and supplementary documents such as financial statements, tax records, bank statements, proof of collateral, etc. Plus, your personal and business credit history will also be reviewed and you may be asked to explain any irregularities of concern to underwriters.

The merchant cash advance application process is very fast by comparison. Since merchant cash advances are calculated based on your company’s sales history, you may be able to apply online or complete a short form in minutes, submitting your application and bank statements showing a few months’ worth of credit and debit card transactions for review. Cash advances may be awarded as quickly as the same day you apply for financing.

  1. Use of Funds

Small business loans will often be strictly regulated in terms of use of funds, may be monitored and your business may be required to submit reports over time. Merchant cash advances can be used for any business purpose at the discretion of the business owner.

  1. Repayment

Small business loans are repaid over time, often over the course of several years. Early repayment reduces the ultimate cost of financing, and it’s important to look at the total estimated repayment amount in order to compare it to that of other financing options.

Small business loans may have fixed rates, adjustable rates or even require business owners to come up with a large balloon payment at the end of the repayment term. Payments can usually be set up for automatic withdrawal (and sometimes the lender requires this). Late payments or missed payments will usually result in additional fees being charged to the borrower.

Merchant cash advances are also repaid over time, often over the course of 6-18 months, depending on the amount. They are paid back as a small percentage of credit and debit card transactions by the card processor, making them extremely easy to calculate and manage. If your company makes more credit and debit card sales than anticipated, you will repay the amount even more quickly.

When considering the advantages of merchant cash advances and small business loans, it’s important to understand how these financing tools are different from one another. Their distinctions can help you determine when one or the other would better-suit the financial needs of your business.

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