Merchant cash advances (MCAs) and business loans are both financing options that provide small businesses with working capital. While either product can be a good financing option, the way these borrowing methods are structured differs greatly. To understand these differences better, we compared and contrasted the two, including a detailed example of each financing option.
A good solution to short-term working capital needs is a term loan, since the rates tend to be significantly lower than for a merchant cash advance. With BlueVine, you can receive funding up to $250,000 with rates starting at 4.8%. Prequalify online in minutes and receive funds in as fast as 1 business day.
Merchant Cash Advance vs Business Loan: How They Work & How They’re Different
Merchant cash advances and business loans are both working capital loans. These financing options help businesses purchase equipment, expand operations, meet payroll, deal with seasonal issues, and more. Even though both of these options can be used for the same purposes, there are many differences between the two including cost of financing, repayment terms, and qualifications.
Merchant Cash Advance vs Business Loan
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How Business Loans Work
Short-term business loans are a common financing option for working capital. A business loan works just like a mortgage or auto loan. A lender loans your business a specific dollar amount in return for fixed, regular payments. Payments are typically amortized over the term of the loan and have interest rates ranging from 9% to 50%.
The repayment schedule on a business loan can be daily, weekly, or monthly. However, there’s always a fixed maturity date with a business loan, and you’ll always repay the loan in full by that maturity date. Typical loan amounts for business loans are between $5,000 to $500,000, and the time it takes to receive those funds is often one to three days.
How Merchant Cash Advances Work
A merchant cash advance is technically not a loan, but an advance on your future credit card sales. Merchant cash advance providers “purchase” your future credit card receivables at a discount and charge you a factor rate in place of an interest rate. Factor rates generally range from 1.1 to 1.5 times of the amount advanced.
The MCA provider advances you a lump sum payment that you repay with a percentage ― called the holdback percentage ― of your daily credit card receipts. While the holdback percentage is fixed, the amount you repay daily is variable, resulting in a variable repayment term. Due to the variability of the term length, typically between four and 18 months, the APR can vary widely ― generally between 80% and 120%.
With a merchant cash advance, you can typically expect to receive funding within one to three days. Lump-sum payments are advanced between $5,000 and $500,000 and can’t exceed 50% of a company’s annual credit card sales.
We spoke with Ryan Rosett, CEO of the merchant cash advance provider Credibly, who told us:
“Cash advances are a great solution for businesses with less consistent cash flows as payments are always based on what you can afford. For seasonal businesses, the fixed payments of a term loan can be difficult to keep up with in slower months. Because cash advance payments are remitted from future receivables, businesses can borrow with confidence knowing that their obligations will never exceed revenue.”
While this is a good example of when a merchant cash advance is a good option, it is important to assess your specific qualifications and needs before deciding which option is best for your small business.
How to Determine If a Merchant Cash Advance or Business Loan Is Right for You
Understanding how both a merchant cash advance and a short-term business loan work is important in determining which option right for your business. If you have a seasonal business or don’t otherwise qualify for a business loan, a merchant cash advance might be the option for you, although business loans will cost less overall.
When to Consider a Business Loan
Businesses that are established have good credit, need a large amount of capital, and want stable repayment terms, should consider a small business loan. The overall cost of business loans is significantly less than that of a merchant cash advance. If you qualify for a small business loan, you should consider this option first, based on these four scenarios.
1. You Have Good Credit
If your credit score is 640 or more (check yours for free), and you don’t have a recent bankruptcy or tax lien on your credit report, you’re in a good position to get approved for a business loan.
2. You’re an Established, Profitable Business
If you’ve been in business for more than one year and are profitable, your business likely has more traditional borrowing options available.
3. You Need a Large Amount of Capital
The amount of money you can get with a merchant cash advance is tied to the level of your credit card sales. Term loans can offer higher funding levels because of the longer repayment terms, such as alternative business loans, have terms up to three years, peer-to-peer business loans have terms up to five years, and Small Business Administration (SBA) loans have terms up to 25 years.
4. You Want Stable Repayment Terms
While some small business owners appreciate the flexibility of a merchant cash advance, the repayment schedule is variable. Business loans, on the other hand, have predictable installment payments making monthly budgeting easier.
When to Consider a Merchant Cash Advance
Merchant cash advances are a good choice if you don’t want your credit report pulled, you operate a seasonal business, or you are an online merchant. Due to the relatively high cost of MCAs, so you will want to evaluate other alternatives prior to deciding to accept a merchant cash advance.
A merchant cash advance is likely the best option in these three scenarios.
1. 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, you may not want a business loan showing up on your credit report. A merchant cash advance doesn’t generally show up on your credit report.
2. You Run a Seasonal Business
Due to the repayment terms, a merchant cash advance is a good option for seasonal businesses. This is because the monthly payment amount is less when a business is making less revenue and increases when the business makes more revenue. This is in contrast to business loans that have fixed monthly payments regardless of business performance.
3. You’re an Online Merchant
Online merchants and other businesses that conduct a majority of their sales online are prime candidates for a merchant cash advance. Since businesses of this nature receive payment primarily via credit card purchases, they will be able to receive a high advance amount in return for just a portion of their daily credit card receipts. If you earn revenue via check or cash, an MCA probably isn’t right for you.
Qualifications: Merchant Cash Advance vs Business Loan
The qualifications for merchant cash advances and business loans are quite different. MCA qualifications are heavily focused on your credit card sales while qualifications for a business loan are focused on your total business revenues. Both merchant cash advances and business loans are typically easier to qualify for than other working capital loans.
Qualifications: Merchant Cash Advance vs Business Loan at a Glance
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Business Loan Qualifications
A business loan typically looks at three major factors when assessing a borrower’s business loan application. These factors take into account both the performance of the business as well as the creditworthiness of the business owner.
The average qualifications needed for a business loan are:
- Annual business revenue: $100,000 or more
- Time in business: 12 months or more
- Minimum credit score: 500 (check your credit score for free)
Merchant Cash Advance Qualifications
Qualifications for a merchant cash advance are primarily focused on a company’s credit card sales. This is because MCAs are based on a company’s annual credit card sales and are repaid using a percentage of the company’s daily credit card receipts. The creditworthiness of the business owner is also considered.
The typical qualifications for a merchant cash advance are:
- Monthly business revenue: $15,000 or more
- Time in business: 6 months or more
- Minimum credit score: 500 (check your credit score for free)
To receive a merchant cash advance, you will need to have an account with an approved credit card processor. Depending on the MCA provider and their agreements, this may mean that you will be required to change your credit card processing company.
Costs: Merchant Cash Advance vs Business Loan
Merchant cash advances and business loans have different costs associated with them. Business loans charge an interest rate on the remaining principal balance after each payment is made. MCA providers charge a “factor rate” (a multiple of the advance amount) and collect a “holdback percentage,” both of which alter the effective APR on the advance.
Costs: Merchant Cash Advance vs Business Loan at a Glance
1%-5% Prepayment Penalty
Business Loan Costs
Business loans typically have an interest rate ranging from 9% to 50%. While prime borrowers can sometimes receive rates as low as 9%, standard borrowers should expect to be offered interest rates closer to 40%. Additionally, most business loans will also have origination fees that range from 1% to 5% and may include prepayment penalties.
The typical fees associated with a business loan are:
- Origination fee: 1% to 5%
- Prepayment penalty: 1% to 5%
These fees are typically taken directly out of the loan proceeds, so you won’t need to have cash in hand to get these loans. If you’re interested in a business loan with low costs, both Kabbage or OnDeck offer loans from $5,000 to $500,000 with interest rates starting between 9% to 15%.
Other types of business loans, such as accounts receivable financing, also have low costs, fast funding times, and base their lending primarily on your current revenue. There are companies like Fundbox that offer both accounts receivable financing and lines of credit ranging from $1,000 to $100,000.
Merchant Cash Advance Costs
A merchant cash advance is unique in the way that the cost of capital is assessed. An MCA provider charges what is known as a “factor rate,” in place of interest. The factor rate, multiplied by the amount of the advance, is the total amount you’ll have to repay over the life of the advance.
For example, if you have a factor rate of 1.20, you’ll need to pay back the entire lump sum plus an additional 20%. If you received $100,000 in a merchant cash advance, with a 1.2 times factor rate, your total repayment will be $120,000.
The typical fees associated with a merchant cash advance are:
- Factor rate: 1.1 times to 1.5 times
- Holdback percentage: 8% to 30%
- Origination fee: 1% to 5%
However, since payments for MCAs are taken directly out of your daily credit card sales, and since those sales fluctuate, the actual term of a merchant cash advance is variable. This causes the typical calculated APR to be between 80% to 120%. Remember, though, that this rate is backed into and your actual cost of capital is dependent on the factor rate.
Depending on the MCA provider that you choose, there may be other fees associated with a merchant cash advance. Some providers charge an origination fee ranging between 1% to 5% of the amount advanced.
The most important costs associated with a merchant cash advance are the factor rate and the holdback percentage. The factor rate is the total amount of capital you’ll have to repay your provider, and the holdback percentage is the percentage of daily credit card sales the provider collects until the factor rate is repaid in full.
“Often, businesses that are struggling financially have been denied for loans and turn to cash advances hoping for a quick cash injection. Since cash advances typically have less restrictive qualifications, they’re easier to obtain. However, they often come with hefty fees and a daily repayment, tightening cash flow even more and leaving businesses in a worse position.”
— Ellen Cunningham, Marketing Manager at CardFellow
Funding Speed: Merchant Cash Advance vs Business Loan
Both MCA loans and business loans offer fast funding compared to other small business financing options, such as traditional bank loans. Business loans and merchant cash advances can be generally be approved and funded within one to three days and, for both financing options, the funds are deposited directly into the business’ bank account.
Where to Apply for a Merchant Cash Advance or Business Loan
After you have decided whether a business loan or a merchant cash advance is the better funding option for your business, you will need to decide where to get that financing from. There are multiple providers for both business loans and MCAs, you will want to compare providers carefully before accepting the financing.
How to Get a Small Business Loan
When looking for a lender for a business loan, you will want one that offers you the best financing option for your situation. Some lenders can fund faster than others, some have higher lending limits, and some have more lenient qualification requirements; look for the lender that best meets your needs and qualifications.
If you are wondering how to get a business loan, three potential small business loan lenders for you to consider are:
- BlueVine: For newer businesses that need a fast loan with low rates, BlueVine offers up to $250,000 to borrowers that have been in business for 6+ months. You can qualify if you have a credit score of 600 or higher, and receive funding within a day. Rates start at just 4.8%, and there are no origination or additional fees. BlueVine is a lender with multiple financing options since they also offer invoice factoring and lines of credit.
- Fundbox: If your business has been operational for at least six months and have outstanding customer invoices that are due within 90 days, you may want to consider invoice financing through Fundbox, which offers funding up to $100,000 at a discount rate starting at 4.66% monthly with repayment terms of 12 to 24 weeks.
- Kabbage: If your business has recurring capital needs, Kabbage offers a line of credit up to $250,000, with terms of six or 12 months, and a fixed monthly fee of 1.5% to 10%, with an expected APR of 30% to 50%; with a line of credit, as the funds are repaid you can borrow them again when your business requires its next financial boost
How to Get a Merchant Cash Advance
There are many different merchant cash advance providers, and not all have the same fees and costs of capital. Because MCAs have the potential to have an extremely high repayment amount, you will want to look for the merchant cash advance provider that will give you the lowest factor rate and lowest origination fees.
Three potential merchant cash advance providers for you to consider are:
- National Funding: If you have been in business for one year and have monthly credit card transactions of $3,000 or more, National Funding offers merchant cash advances of up to $250,000 with an expected APR of 30 % to 150%.
- Credibly: If you have been in business for six months, have a credit score of 500 or higher, and $15,000 or more in monthly revenues, you may be eligible for a merchant cash advance through Credibly; which also offers MCAs ranging from $5,000 to $250,000 at factor rates of 1.15 time to 1.41 times and charges a 2.5% origination fee
- Fora Financial: Fora Financial offers merchant cash advances between $5,000 to $500,000 at factor rates of 1.15 time to 1.33 times and charges a 4% origination fee; Fora Financial only requires that your business has been operational for three months, has $10,000 in monthly revenues, and a credit score of 500 or higher
The Bottom Line
If you run a seasonal business or have a high volume of credit card transactions, then a merchant cash advance might be right for you. Conversely, if you have stable revenues and accept cash and checks, you might want to check out a business loan. Ultimately, business loans are a far more cost-effective way to borrow money for your business. If you qualify, they will be your best choice.
BlueVine offers term loans up to $250,000 with repayment terms of 6 or 12 months. There are no origination or additional fees, and rates start at just 4.8%. Prequalify online in minutes and receive funds in as fast as 1 business day.