Merchant Cash Advances vs. Business Loans

A merchant cash advance is a unique type of financing in which companies can borrow money from a lender and repay it by deducting a set percentage from their credit and debit card sales until the agreed-upon amount is completely repaid.

Unlike merchant cash advances, that pretty much work the same way, despite the lender, business loans are structured differently. In fact, there are seven different types of business loans:

1. Term Loans – are loans in which businesses borrow a specific amount of money and repay it over an agreed upon period of time. Repayment terms usually vary depending on the lender, the purpose of the loan, and the borrower’s credit rating. Interest rates can be fixed or variable depending upon the circumstances surrounding the loan. Term loans are available from both banks and nonbank lenders.

2. SBA Guaranteed Loans – “SBA loans” is misleading because the Small Business Administration (SBA) isn’t a lending institution for small businesses or any other business. The SBA simply sets guidelines for loans made by its lending partners and guarantees that a pre-determined portion of the loan will be repaid with the intention of encouraging lenders to be more willing to lend to businesses. Most SBA guaranteed loans require financial statements, strong credit ratings and collateral to be approved by its partner lending institutions. Although, they include many types of loans:

  • The most popular is the 7 (a) loan for general business needs.
  • A microloan is best for businesses that want to borrow less than $50,000.
  • A CDC/504 loan is best for businesses that want to buy fixed assets such as commercial real estate and/or equipment.

3. Short-term Loans – Are for small businesses in need of working capital in order to temporarily manage issues with cash-flow for items such as payroll, inventory, the refinancing of other debts, and/or paying taxes. These types of loans are closely related to traditional term loans in which businesses borrow a specific amount of money and pay it back within an agreed upon period of time. The disadvantages to these types of loans are they generally have higher interest rates and must be repaid quickly.

4. Equipment Loans – Are similar to auto loans. A borrower takes out a loan to buy equipment and uses the equipment itself as collateral. If a borrower defaults on the loan the lender repossesses the equipment and sales it to recuperate any loses. Equipment loans typically have fixed terms in regards length of time for repayment, fixed interest rates and fixed monthly payments. The maximum term length of this type of loan is the expected life of the equipment purchased with the loan. These types of loans are fairly easy to be approved for if the business has a decent credit rating, business history, and the purchase of the equipment.

5. Lines of Credit – Are the same as home equity lines of credit except for businesses. Business lines of credit can be unsecured or secured by collateral such as inventory or equipment. Lines of credit can be used for things such as working capital. Advantages to these types of loans are businesses aren’t required to make payments or pay interest until they use the funds. A revolving line of credit can be repeatedly used without having to reapply and as long as the borrower makes the payments on time interest rates are typically lower than traditional loans.

6. Invoice Financing – Also referred to accounts receivable financing are typically associated with B2B businesses that have substantial accounts receivables. These types of loans provide fast cash for businesses receiving an advance on a percentage of the value of the businesses accounts receivables. In other words a lender will pay a business, minus any fees, when it collects on the receivables. Invoice financing typically doesn’t require a credit check or collateral, but the fees are typically higher than for traditional business loans.

Both merchant cash advances and bank loans have advantages and disadvantages. In order to determine the best alternative a business owner needs to evaluate the type of business he is borrowing money for, the industry, and the financial history of the business. A few of the pros and cons are:

Speed & Qualifications:

When a business requests a merchant cash advance, they are usually asked to provide bank statements as well as their credit and debit card sales histories. Lenders typically use past performance to determine the business’s ability to cover the cash advance. These types of loans typically have high approval rates and are approved more quickly than traditional business loans.

Bank lenders typically request the aforementioned documents in addition to utilizing credit ratings, collateral, and tax records in their approval processes. The review process can lengthy and these types of loans have lower approval rates

Interest Rates and Repayment Terms:

Merchant cash advances are typically not classified as loans because technically the business isn’t borrowing money they are simply selling a portion of their projected future sales. As a result of this merchant cash advance can be structured a number of different ways. However, they are typically based on a business’s future revenue and regardless of how well the business is doing financially it is obligated to repay the lender a percentage of its sales.

Bank loans are governed by more stringent laws that limit how much lenders can charge, are typically harder to secure, and are generally more affordable in the long run due lower fixed interest rates, fixed loan terms, and fixed repayment schedules.

Financing Availability:

Typically, after a national or the global financial crisis a lot of credit-worthy borrowers are denied access to traditional funding because traditional lending institutions are leery of lending money. Merchant cash advances provide funding alternatives to many of these businesses during such difficult times.

Choosing the right financing approach involves knowing the goals of the business, understanding the revenue and cash flow of the business, and weighing the possible risks involved.