Business Loan vs. Merchant Cash Advance for Small Businesses

For business owners, having some extra capital on hand is helpful and sometimes necessary to grow the business. Sourcing cash or a business loan can be both easy and challenging, depending on where the business owner is sourcing it.

Unless a business owner has a relative or friend with deep pockets willing to share the wealth, a more formal contract with fine print and very specific terms is required to secure funding.

Small Business Bank Loans

A traditional (or conventional) business loan from a bank or credit union has been the customary method of obtaining financing for many years for businesses in the United States. With a sound business plan in hand, a business owner could confidently walk into a bank with a reasonable chance of walking out with a loan. Today, approvals are not always that simple.

This traditional financing from banks can be in the form of either an unsecured loan or secured loan. The type of loan offered will depend on the business type, business plan and borrower or principal’s personal credit. The bank may also need to review business bank account statements, balance sheets and existing liabilities.

Similar to credit card credit, unsecured loans are not backed by any of the business owner’s assets. If the borrower were to default on the loan, the bank will have a difficult time recovering 100% of those funds. Obviously this is better for the borrower but less favorable to the bank.

Secured business loans are also known as asset-based loans. Borrowed funds are backed by collateral such as personal or business assets and are therefore less risky for banks. Secured business loans are becoming more popular for small businesses because they allow a business to borrow against an array of assets including stock and receivables.

Small Business Merchant Cash Advance

Small business financing got clever several years ago. Lenders developed a program known as merchant cash advance in which they would provide a lump sum payment in exchange for a percentage of future debit and credit card sales from small business.

Because the repayment of financing is based on credit card sales, merchant cash advance loans are often used by retail businesses with physical stores and online retailers.

Typically, the repayment period for a merchant cash advance is 24 months and under.

Repayment for the cash advance is made using one of three methods:

  1. Using ‘lock box’ or ‘trust’, funds from sales are deposited into an account controlled by the finance company. A portion is then sent to the business the next day.
  2. With ‘ACH withholding’, the finance company debits a daily fixed amount directly from the business’s bank account.
  3. In ‘split withholding’, the most popular method, the credit card processing provider splits the credit card sales between the business and the finance company based upon an agreed percentage.

Traditional Small Business Loan vs. Merchant Cash Advance

Business Loan: The Bad

Obtaining a traditional or conventional business loan can be challenging for small businesses, especially if they are just starting and do not have collateral for backing and/or have poor credit.

The application and approval process can be lengthy, leading to slow disbursement of funding. A conventional loan may not be the best solution for businesses in need of quick cash.

In most cases, traditional business loans require a fixed monthly payment. In what can be a sizable payment, this can be painful for businesses with seasonal sales or those experiencing sales slumps.

Small business owners can be restricted in the use of funds. Borrowers must comply with loan terms that may prevent them from purposing funds toward a specific intention.

Business Loan: The Good

Traditional business loans are regulated by state usury laws, which prevent banks from charging excessive rates and fees. Competing banks offer low rates for well-qualified borrowers. Total repayment of the small business loan is usually less costly than a merchant cash advance.

Merchant Cash Advance: The Bad

Merchant cash advances are technically not business loans. These finance companies operate in a less regulated environment than banks, and therefore are not bound by laws that limit lenders from charging high interest rates. Generally, a merchant cash advance will have a higher rate than a conventional loan. Though rates can be as high as 22%, competition among finance companies has driven down rates in recent years.

Merchant Cash Advance: The Good

Receiving financing from a merchant cash advance is often easier for small businesses because the financing amount is determined by the business’s sales rather than a well-developed business plan, assets or credit history.

Cash advances are approved, processed and funded faster than traditional business loans. This option is optimal for borrowers that need quick cash, as funding can take just a couple businesses days.

The flexible repayment schedule that fluctuates directly in line with sales is usually preferred over the fixed monthly payments of conventional loans. With smaller daily remittances that are based on daily sales a business’s cash flow is not negatively affected by seasonality or sales slumps.

Borrower’s have fewer restrictions with merchant cash advances and can usually use funds at their discretion. Whether a business is buying equipment, opening a new store location or paying off existing debt does not matter to the finance company.

What’s Best for Your Business?

In this article, the choice between a small business loan and a merchant cash advance seems to tilt toward the latter as being the favorable one. However, it does not mean that conventional business loans for small businesses are not an ideal choice for certain businesses.

When making the decision to apply for a traditional business loan vs. merchant cash advance, a business owner will have to determine which is best for their specific business model and needs.

If you have questions or would like to learn more about small business loans vs. merchant cash advance, give us a call. Although we specialize in merchant account services, we have experience in all areas of business financial services. We’d love to help!

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Let’s Work Together.

At The Transaction Group, customer satisfaction is our priority. Allow us to show you what we can do for you.

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