If you’re in need of capital for your small business, two of the primary options are merchant cash advances and business loans. In this article, we’ll explain the differences between a merchant cash advance vs business loan and how to determine which is the right choice for your business. We’ll cover the following:
- Merchant Cash Advance vs Business Loan: How They Work and Primary Differences
- How to Determine If a Merchant Cash Advance or Business Loan is Right for You
- Qualification: Is It Easier to Qualify For a Business Loan or MCA?
- Cost: Which is More Expensive?
- Speed: Which is Faster?
- Where to Apply for a Merchant Cash Advance or Business Loan
Merchant Cash Advance vs Business Loan: How They Work and Primary Differences
A business loan works like a mortgage or a car loan. You get access to a specific amount of money and pay a little bit back each month (or each week or day, depending on which lender you work with). There are fixed payments at each installment, and there’s a fixed maturity date by which you have to pay back the loan in full.
A merchant cash advance (aka business cash advance) is technically not a loan. Instead of loaning you money, merchant cash advance providers purchase your credit/debit card receivables at a discount. They will advance you an amount of money that you pay back, with interest, by handing over a portion of your business’ daily credit or debit card receipts. The exact amount of money that you pay back varies each day based on your sales for that day. There’s no fixed due date for paying back the advance, though most MCAs are paid back in 4-12 months. Deductions are made from your sales receipts each day until the advance is paid back in full.
Here is a breakdown of the primary differences between a merchant cash advance and a business loan:
|Business Loan||Merchant Cash Advance|
|How It Works||Specific amount of money that you pay back in fixed installments||Specific amount of money that you pay back with a portion of daily credit/debit card sales|
|Fixed Maturity Date?||Yes||No|
|Fixed Repayment Schedule?||Yes||No (payment is a percentage of whatever sales you make that day)|
|Will It Show Up on Your Credit Report?||Generally Yes||No|
|Ease of Qualifying||Harder||Easier|
|Approximate Cost||5 to 60 % APR||30 to 120 % + APR|
|Speed||Traditionally slower than an MCA, but there are many fast loan options today||Faster|
Example of Business Loan: You receive a 5-year $50,000 loan with an annual interest rate of 10 %. You make monthly payments of $1,062.35 for 5 years until the loan is fully paid back (assuming no origination fees or monthly servicing fees).
Example of Merchant Cash Advance: You receive a $50,000 merchant cash advance, and the merchant cash advance provider tells you have to pay back $65,000 in total. The merchant cash advance provider deducts 10 % of your daily credit card sales until the advance is paid back in full. If you make approximately $50,000 per month in credit card sales, you will pay approximately $5,000 per month to the MCA provider. The MCA will be paid off in approximately 13 months.
How to Determine If a MCA or Business Loan is Right For You
Now that you know how MCAs and business loans work, which one should you use?
At first, a merchant cash advance can seem very appealing for a small business–no maturity date and flexible repayment based on your sales. What’s the catch? Merchant cash advances are typically extremely expensive. They can trap you in a debt cycle that may eat significantly into your profit margins. This can be financially stressful for a small business, especially a new, growing business. For these reasons, in the majority of cases, we don’t recommend that small businesses get a merchant cash advance.
When to Consider a Business Loan
For most small businesses, a business loan is going to be the better choice. Here’s when it makes sense to choose a business loan:
- You have decent credit and are looking to grow your business. If you have a profitable business, your credit score is over 500, and you don’t have a recent bankruptcy or tax lien on your credit report, there’s a pretty good chance that you’ll be able to get approved for a business loan. You may not get bank interest rates if your credit isn’t excellent, but there are several alternative lenders nowadays that are willing to work with lower credit business owners and newer businesses without charging an arm and a leg.
- You need a large amount of capital. The amount of money you can get with a MCA is tied to the level of your credit and debit card sales. If you have get revenue from different sources, you may be able to get more capital with a business loan.
- You want control over your cash flow. While some small business owners appreciate the flexibility of a merchant cash advance, it doesn’t give you much control over cash flow. Based on how your sales are for the day, you’ll pay a different amount to the merchant cash advance provider. Business loans have predictable installment payments, so you can plan better for business growth.
When to Consider a Merchant Cash Advance
In a few cases, a merchant cash advance may be appropriate:
- You have a FICO score under 500 or red flags on your credit report, such as a bankruptcy or tax lien in the last 3 years. If you have a very poor credit history, you may not qualify for a business loan even at an alternative lender, so it may be worth looking into an MCA.
- You don’t want a loan on your credit report. If you’re trying to rebuild your credit or are planning for a big purchase, such as buying a home, you may not want a business loan showing up on your credit report. An MCA doesn’t generally show up on your credit report.
- You’re an online merchant that wants a small amount of capital. If you sell on Square or PayPal, you could qualify for Square Capital or PayPal Working Capital. These are merchant cash advances specifically designed for Square and PayPal sellers, and are a fast, convenient source of small amounts of capital (less than $10K in most cases). They are also much more affordable than a typical merchant cash advance.
Unless one of these applies to you, a business loan is generally the much more cost effective choice. Be especially cautious about a merchant cash advance is you have a new business. You don’t want to commit to handing away a portion of your daily sales receipts when you haven’t even gotten up and running yet.
In addition, if you can’t qualify for a business loan, that may be a sign that you shouldn’t be borrowing money at the moment. Ellen Cunningham, Marketing Manager at CardFellow, says, “Business cash advances are not a good idea in most cases if a business is struggling to make ends meet and hoping that a cash injection will help. Unfortunately, some businesses in that situation get denied for a loan, but are eligible for a cash advance, and end up in a worse situation than before.”
AJ Saleem, the owner of test prep company Suprex Private Tutoring in Houston, TX, faced a choice between a business loan and a merchant cash advance. He was attracted to the merchant cash advance because it wouldn’t show up on this credit report, but at the same time he was worried about the high cost.
Ultimately, Saleem ended up choosing a business loan because it was more reliable; he could more easily predict his monthly cash flow. He had fair credit (a 630 FICO score) but was able to find a loan with pretty good terms. Saleem says, “I believed that my company would succeed so risking a credit score wouldn’t be so bad. In addition, I did not have any other loans already so the risk vs reward was nice.”
Qualification: Is it Easier to Qualify for a Merchant Cash Advance or Business Loan?
A merchant cash advance is generally easier to qualify for than a business loan, but there are many business loan options nowadays which are also quite easy to get approved for, so don’t write off a business loan simply because your credit is low or because you’re a new business.
Most merchant cash advance providers won’t check your credit score when you apply. They care first and foremost about your volume of credit and debit card receivables. Most MCA providers will lend 85-250 % of your monthly credit/debit card sales volume (maybe less if you’re a startup).
When applying for a business loan, credit score is more important in determining whether you will qualify. It follows a predictable course:
- Credit score below 500: You probably won’t qualify for a business loan.
- Credit score between 500-650: You may qualify for an alternative business loan, such as an online short-term loan or P2P loan. Kabbage, OnDeck, and BlueVine are good examples of companies that provide business loans to small business owners with average credit. Expect to pay relatively high interest rates but generally much lower than a merchant cash advance.
- Credit score above 650: You may qualify for a bank loan or an SBA loan with the lowest interest rates and longest terms.
Bottom line on qualification: it’s easier to get approved for a merchant cash advance, but there are many alternative business loan options these days that are also relatively easy to qualify for.
Cost: Merchant Cash Advance vs Business Loan
In 99 % of cases, a business loan will be much less expensive than a merchant cash advance.
Here’s a breakdown of typical costs:
|Business Loan||Merchant Cash Advance|
|Average Annual Interest Rate (APR)||5-60 % APR||30-120 % + APR|
|What Impacts Cost?||Origination fees (1-5 %)|
Packaging, referral, servicing, or application fees
Prepayment penalties (1-5 % of outstanding loan balance)
|Factor rate (total amt. you have to pay back the lender) - 1.2x to 1.5x borrowed amount
Discount rate (percentage of your credit card sales that are deducted daily for repayment) - 5 to 20 %
|Least Expensive Options||SBA loans|
PayPal Working Capital
|Most Expensive Options||Online short-term lenders||All Others|
Business Loan Cost
As you can see from the chart above, the APR of a business loan is generally in the neighborhood of 5-60 %. At the least expensive end are bank loans and SBA loans, whose rates range from about 6-9 %. After that you get into Peer2Peer and Marketplace loans, which are in the 15-20 % range. Lastly are alternative business lenders, which are more expensive and can have APRs as high as 50-60 % sometimes.
With business loans, you have to watch out for fees. There could be origination fees, an application or packaging fee, servicing fee, etc. There may be also prepayment penalties if you pay back the loan early.
Merchant Cash Advance Cost
Merchant cash advances usually have APRs ranging from 30-120 % or more! Why is the APR is so high? Payments are deducted from your account everyday, so you pay back the money in a fairly short amount of time. That makes the APR really high.
With merchant cash advances, there aren’t generally any fees. The two primary factors that impact cost are the total payback amount and the percentage of your credit card sales that go towards repayment.
The total payback amount is described as a factor rate. For example, if you get a MCA for $20,000, and the merchant cash advance provider tells you that you have to pay back $30,000, that’s a factor rate of 1.5 (20,000*1.5 = $30,000). Factor rates generally range from to 1.2 to 1.5. The percentage of credit card sales that is deducted each day for repayment is called a discount rate. The discount rate usually ranges between 5 and 20 %.
Want to estimate your cost? Give these APR calculators a try:
Nav has additional APR calculators for specific business loan products, such as an OnDeck APR Calculator and Kabbage APR Calculator. See them all here.
Speed: Is it Faster to Get a Business Loan or a Merchant Cash Advance?
It used to be that getting a merchant cash advance was a much faster process than getting a business loan. Nowadays, there are equally fast or faster business loan options where you can get funding the same day or in 1-3 business days.
It generally takes under 1 week to apply for and get a merchant cash advance. The paperwork is simple, consisting primarily of recent tax returns, recent bank statements, and recent merchant credit card statements.
With business loans, the timeline and paperwork depends on the type of loan you apply for. SBA loans require a great deal of paperwork and can take about 1 month or longer. Marketplace loans, P2P loans, and short-term loans are much faster; you can get funding in just a few business days sometimes with very little or no paperwork. For an overview of the fastest business loans, click here.
Where to Apply for a Merchant Cash Advance or Business Loan
Once you decide if you want a merchant cash advance or business loan, here’s a look at where you can apply:
Traditional Merchant Cash Advance: RapidAdvance
Merchant Cash Advance for Square Merchants: Square Capital
Merchant Cash Advance for PayPal Merchants: PayPal Working Capital
Merchant cash advances and business loans are two ways to get capital for your small business. For most small businesses, a business loan is a less expensive and more suitable option. In some cases however, especially if you’ve exhausted other less expensive options, a merchant cash advance could be the solution.