A large number of small businesses and startups require supplementary funds to expand, help with overhead, and to refinance at some point. Business owners may need more capital for a promising business venture.
Maybe a startup has exhausted funding options from family and friends and has had to resort to alternative resources. Read on to discover the difference between MCAs and Business Loans.
A lump-sum of money is often the kickstart that small business owners need to help them propel their company into success.
Expansive options for small business loans are available. Whether you choose to take the traditional or alternative lending route, each option has its own requirements and stipulations. It is crucial for you to choose financing that will complement your business model and industry.
Understanding the structural difference between a business loan and merchant cash advance will aid you in making the best financing decision for your company.
Accessibility & Payment
Both business loans and merchant cash advances have their own caveats, but the fundamental difference resides in the difference in accessibility and payment. A merchant cash advance is more accessible than a business loan because there are more requirements and contingencies involved in receiving traditional financing. The payment terms of a business loan are predetermined, but payments with merchant cash advances are contingent on credit card sales.
The application process for a merchant cash advance is more efficient and requires less information than a business loan does. The payment changes with the variance in sales because repayment is a fixed percentage of revenue from sales. MCA approval occurs at a higher rate than small business loans do.
A business loan, with small banks or the Small Business Association, is a predetermined amount of capital that is repaid with additional interest in fixed monthly payments. Small Business loans have an annual percentage rate of anywhere between 7.5% to 10%. Payments are usually monthly, and lenders can repay more than the fixed amount to decrease the overall interest they must pay.
Most businesses take out bank loans for expansion purposes. According to the Small Business Association, owners borrow $600 billion every year. Typically, banks are the first place that small businesses seek out for financing, after requesting funding from family and friends.
According to Forbes, the restaurant and hospitality industry has a 51% approval rate for small business loans. The personal services industry approval rate is 16%. The rates of the remaining industries are between 16% and 51%. It is difficult to get approved for a small business loan because of the tight requirements.
Firstly, banks only approve loans to individuals with a credit score of 700 or above. If your score is on the lower side of that range, then stronger business credentials will be required to even obtain the loan. The business has to be in operation for at least one year and have an annual revenue of a minimum of $50,000.
Your debt-to-income ratio and personal debt will be assessed before approval. Many lenders also require a net operating income at least 1.25 times greater than current expenses. You will likely need collateral, which can be equipment, inventory, or real estate. Lastly, you must disclose how you plan to use the money and the lenders will monitor and limit how you spend that money.
Merchant Cash Advance
A merchant cash advance is the exchange of a lump-sum of money in return for a portion of future sales. This means that the payments will vary with the number of sales weekly or daily, depending on the terms of the loan. There is a 79% approval rate in merchant cash advance financing according to the Federal Reserve. To be approved for an MCA, a business owner needs a minimum credit score of 500, needs to be operating for at least 3 months, and have no more than 5 overdrafts or NSFs. You can learn more about MCAs by reading our MCA guide as well.
There is no regulation on how businesses use the cash advance. The repayment term is under 2 years, typically 18 months, while a small business loan is up to 5 years.
Why Merchant Cash Advance is the Winner
Like previously mentioned, the key differences of these financing options are accessibility and payment. Cash advances have less and laxer conditions for approval while most small business loan applicants are rejected because of the specific conditions that need to be met. The borrowing limits of each resource are different as well. SBA loans can be worth millions of dollars while MCAs can only go up to $500,000.
To summarize, a merchant cash advance is easy to qualify, and there is no collateral needed. Application, approval, and funding occurs within 2 days, there are no monthly restrictions on how the advance is spent, and repayment is flexible and contingent on sales.
While MCAs are the better option, there are drawbacks to all financing. MCAs can be expensive, are not regulated — which could be a good thing depending on the industry of your business — and businesses are forced to use a credit card processor. Business loans have a strenuous application process, require collateral, and require a great credit score. The differences between merchant cash advances and business loans really come down to accessibility and payment.