When you need funding for your business, two of the most commonly advertised options are traditional business loans and merchant cash advances (MCAs). While they both promise quick access to capital, they operate in very different ways. And choosing the wrong one can cost you more than you bargained for.
Here’s what you need to know about how business loans and merchant cash advances differ, and how to decide which one fits your business needs.
What is a Merchant Cash Advance (MCA)?
An MCA isn’t technically a loan—it’s a cash advance based on your future credit or debit card sales. You receive a lump sum upfront, and the provider takes a percentage of your daily sales (called a “holdback”) until the advance is paid off.
Additionally, the cost of taking out an MCA is represented by the factor rate, not an interest rate. Factor rates typically range from 1.1 to 1.5, which is multiplied by the amount of the advance. So, for example, if you borrow $50,000 at a 1.4 factor rate, you’ll owe $70,000 ($50,000 advance plus a $20,000 fee) regardless of how fast you repay it. This can result in APRs that exceed 100%.
Understanding Business Loans
There are several types of business loans available, each designed to meet different financing needs. Here’s a breakdown of the most common types:
Term Loan
This is a lump sum of money repaid over a fixed period (typically one to five years) with interest. Term loans are best for long-term investments like equipment, expansion, or working capital.
SBA Loans
These loans are partially guaranteed by the U.S. Small Business Administration (SBA), offered through banks and lenders. They’re best for businesses that need affordable, long-term funding but may not qualify for conventional loans.
Popular programs include:
- SBA 7(a): General-purpose financing
- SBA 504: For real estate and large equipment
- SBA Microloans: Smaller loans up to $50,000
Lines of Credit
With this type of financing, you receive a revolving credit line you can draw from as needed, up to a limit. You only pay interest on what you borrow, and available funds replenish as you repay. Business lines of credit are best for managing cash flow, covering short-term expenses, or dealing with seasonal dips.
Key Differences Between MCAs and Business Loans
Business loans and MCAs are two popular financing options for small businesses, but they differ significantly in structure, cost, and how they impact cash flow. Here’s a closer look at the key differences you should be aware of before applying for business financing.
Loan Amount and Flexibility
- Business loans: Offer a wide range of funding — anywhere from $10,000 to several million dollars — depending on the lender, the borrower’s credit profile, and the business’s financials. Funds can typically be used for a broad range of purposes, from equipment purchases to working capital or expansion.
- MCAs: Usually provide smaller amounts — often $5,000 to $250,000 — based primarily on the business’s daily credit card or debit sales volume. Flexibility in how the funds are used is similar, but the amount you qualify for is often more limited.
Repayment Structure and Terms
- Business loans: Repaid through fixed monthly installments over a set term, usually one to five years. Terms are clearly defined, making it easier to plan for the long term and manage cash flow.
- MCAs: Repayment is made automatically as a percentage of daily or weekly sales (known as the “holdback” rate). There’s no fixed term; the repayment timeline depends on sales volume. The more you sell, the faster you repay.
Cost: Interest Rates and Fees
- Business loans: Generally have lower interest rates, ranging from around 6% to 30% APR. Costs are more transparent, especially with traditional banks or SBA-backed loans.
- MCAs: Use a factor rate, not an interest rate, and the effective APRs can exceed 100%. Since repayment is based on sales, there’s no benefit to early repayment. In other words, you pay the full amount regardless of how long it takes to repay the advance.
Eligibility Criteria and Credit Requirements
- Business loans: Require strong personal and/or business credit, a solid financial history, and documentation like tax returns, bank statements, and profit and loss reports. The application process is more thorough and takes longer.
- MCAs: Easier to qualify for, even with bad credit. Providers focus on daily sales volume and time in business rather than credit scores or collateral. Funding can be approved within hours.
Application Process for Merchant Cash Advances
The MCA application process is designed for speed and ease, making it attractive to businesses that need cash quickly. But that convenience comes with higher costs and potential risks. So it’s important to understand the terms before moving forward.
1. Fill out the Application
Most MCA providers offer a simple online application form. You’ll typically need to provide documentation about your business and financials, including basic business information (name, address, industry, time in business), estimated monthly revenue or sales volume, and the business owner’s personal details including bank statements.
2. Submission of Sales and Bank Statements
To evaluate your eligibility, the MCA provider will request recent credit card processing statements and business bank statements (usually three to six months’ worth).
These documents help the provider assess your average sales volume and cash flow, which are the main factors in determining how much you can borrow.
3. Credit Check
Some MCA providers may run a soft pull on your personal credit report, but many do not rely heavily on credit scores. The emphasis is on your business’s revenue and consistency of sales. Still, you should be prepared for a hard credit pull in some cases.
4. Offer and Agreement
If you qualify, you’ll receive an offer that includes the following details:
- Advance amount
- Factor rate
- Estimated repayment structure (daily/weekly holdback rate)
- Total repayment amount
Read the agreement carefully, as MCAs can include confessions of judgment, personal guarantees, or UCC liens, all of which can complicate things if you fall behind on payments.
5. Approval and Funding
Once you accept the offer and sign the agreement, funds are often deposited within 24 to 48 hours. No collateral is typically required.
Application Process for Business Loans
The application process for a traditional business loan is more detailed and time-consuming than for a merchant cash advance, but it generally offers better terms, lower interest rates, and higher borrowing limits. Here’s what to expect:
1. Choose a Lender and Loan Type
Start by identifying the type of loan you need (term loan, SBA loan, line of credit, etc.) and selecting a lender (bank, credit union, or online lender) that fits your business profile.
2. Complete a Formal Application
Similar to an MCA, you’ll need to provide detailed business and personal information, including:
- Business name, structure, and tax ID
- Owner(s) name, Social Security number, and contact information
- Loan amount requested and intended use of funds
3. Submit Required Documentation
Traditional lenders require documentation to assess your business’s financial health and creditworthiness. You may need to provide:
- Business tax returns (two to three years)
- Personal tax returns (for all owners)
- Profit and loss statements
- Balance sheets
- Cash flow projections
- Business bank statements (typically three to six months)
- Business licenses or articles of incorporation
- Debt schedule (list of existing business debts)
4. Underwriting and Credit Check
The lender will conduct a thorough review of your creditworthiness, including personal and business credit scores, debt-to-income and debt service coverage ratios, time in business and revenue history, and more.
This stage can take anywhere from a few days to several weeks, depending on the lender and loan type.
5. Receive Offer and Close the Loan
If approved, you’ll receive a loan offer outlining the amount, interest rate, term length, repayment schedule, and any collateral requirements. Upon acceptance, you’ll sign a loan agreement, and the funds are typically disbursed within a few days.
Best Practices for Securing Business Financing
Taking time to prepare can mean the difference between getting the funding you need on fair terms or being stuck with costly financing that strains your business.
Here are some best practices to help improve your chances of approval and get the most favorable terms:
- Know how much you need and why: Be specific about how much funding you’re requesting and what it will be used for (e.g., equipment, payroll, inventory, expansion). Lenders are more likely to approve applications with clear, justifiable use cases.
- Maintain strong financial records: Keep up-to-date financial statements, including profit & loss statements, balance sheets, and cash flow reports. Lenders want to see that you’re organized and understand your financial position.
- Improve your credit profile: Check and improve both your personal and business credit scores before applying. Pay down existing debt, avoid late payments, and correct any errors on your credit reports.
- Build relationships with lenders early: Establish business accounts with local banks or credit unions and maintain a good banking history. Building trust over time can help when you need to apply for financing.
- Understand and compare funding options: Evaluate all available options (term loans, SBA loans, lines of credit, equipment financing, MCAs). Compare interest rates, fees, repayment terms, and total cost of borrowing — not just how quickly you can get the money.
- Don’t overborrow: Only borrow what you can realistically repay. Taking on too much debt can hurt your credit and cash flow and put your business at risk.
- Review the fine print: Carefully read loan agreements or MCA contracts. Understand fees, prepayment penalties, personal guarantees, and any legal clauses like confessions of judgment.
- Seek professional advice: A CPA, financial advisor, or small business attorney can help you understand your options and prepare your application to maximize your chances of approval.
How Tayne Law Can Help
Consulting with a trusted legal advisor is essential if you’re considering or struggling with business debt like an MCA. At Tayne Law, we’ve been advising business clients regarding their debts for over two decades. We offer a no-obligation phone consultation to learn how we work and how we might be able to help you. Give us a call at toll-free at (866) 890-7337 or fill out our short contact form.
