What’s The Difference Between a Merchant Cash Advance and Business Loan?

When it comes to securing financing for your business, the options can seem overwhelming. Among the many choices available, Merchant Cash Advances (MCAs) and traditional Business Loans are two popular yet distinct options. While both can provide the capital needed to grow your business, they differ significantly in structure, pricing, and repayment terms. In this blog, we’ll delve into the benefits of each product, the types of businesses that typically use them, the pricing differences, and how the repayment processes compare.

What is a Business Loan?

A business loan is a traditional form of financing in which a lender provides a lump sum of money that the borrower agrees to repay over a fixed term, typically with interest. Depending on whether the borrower offers collateral, business loans can be secured or unsecured.

Key Characteristics of Business Loans:

1. Fixed Repayment Schedule: Business loans generally come with a fixed repayment schedule, which means you’ll make regular payments over the loan term until the debt is fully repaid. The repayment terms can range from a few months to several years, depending on the loan amount and agreement.
2. Interest Rates: The cost of borrowing is primarily determined by the interest rate, which can be fixed or variable. Interest rates on business loans vary depending on the borrower’s creditworthiness, the amount borrowed, and whether the loan is secured or unsecured.
3. Use of Funds: The capital from a business loan can be used for a wide range of purposes, including purchasing equipment, expanding operations, hiring staff, or managing cash flow.
4. Creditworthiness: Approval for a business loan often hinges on the business’s credit history, financial stability, and the ability to provide collateral if required.

What is a Merchant Cash Advance?

A Merchant Cash Advance (MCA) is a type of financing where a lender provides a lump sum of capital in exchange for a percentage of the business’s future sales. MCAs are particularly common among businesses that process a significant volume of credit or debit card transactions.

Key Characteristics of Merchant Cash Advances:

1. Sales-Based Repayment: Unlike a business loan, repayment of an MCA is directly tied to the business’s sales. The lender takes a fixed percentage of daily or weekly sales until the advance, plus a fee, is repaid.
2. Factor Rates: Instead of interest rates, MCAs use a factor rate to determine the cost of borrowing. Factor rates typically range from 1.1 to 1.5, meaning the borrower will repay 1.1 to 1.5 times the amount advanced.
3. Flexibility: Repayment amounts fluctuate with sales volumes, making MCAs more flexible than traditional loans. On slower days, the repayment amount is lower, while on busier days, more of the advance is paid back.
4. Approval Criteria: MCAs are generally easier to obtain than business loans because they rely on the business’s sales performance rather than credit scores. This makes them accessible to businesses with less-than-perfect credit or those that lack significant assets.

What Type of Business Would Typically Use Each Product?

The suitability of an MCA or a business loan depends largely on the business’s needs, cash flow patterns, and financial health.

Businesses That Might Opt for a Business Loan:

1. Established Businesses with Steady Cash Flow: Businesses with predictable revenue streams and solid financial records are well-suited for traditional business loans. These companies can manage fixed monthly payments and may prefer the lower costs associated with loans.
2. Businesses Needing Large Sums for Specific Projects: If a business requires a substantial amount of capital for a defined purpose—such as purchasing equipment, expanding facilities, or funding a large marketing campaign—a business loan is often the best option due to its structured terms and potentially lower cost.
3. Businesses with Strong Credit History: Companies with a good credit score and financial stability will find it easier to qualify for business loans, often securing favourable interest rates and terms.

Businesses That Might Opt for a Merchant Cash Advance:

1. Retailers, Restaurants, and E-commerce Businesses: Businesses that rely heavily on daily card sales, such as retail shops, restaurants, or online stores, often favour MCAs because the repayment structure aligns with their revenue patterns.
2. Seasonal Businesses: Companies with fluctuating sales volumes due to seasonality may benefit from the flexible repayment schedule of an MCA, which adjusts according to their income rather than requiring fixed monthly payments.
3. Businesses with Urgent or Short-Term Capital Needs: MCAs are typically quicker to obtain than traditional loans, making them suitable for businesses that need immediate access to funds, perhaps to cover inventory costs, manage cash flow during a slow period, or capitalise on a timely opportunity.

Pricing Differences

The cost of a business loan is usually determined by the interest rate, which can vary significantly depending on factors like the borrower’s creditworthiness, the loan amount, and the length of the repayment term. Business loans tend to be more affordable than MCAs, especially for borrowers with good credit, as they often come with lower interest rates.

In contrast, MCAs can be more expensive. The factor rates used in MCAs translate to a higher cost of borrowing compared to traditional loans. For example, an MCA with a factor rate of 1.3 means that for every £10,000 borrowed, the business will repay £13,000, irrespective of how quickly the advance is paid off. This makes MCAs a costlier option, particularly if the business has strong, steady cash flow that could support a less expensive loan.

Repayment Processes

The repayment process for a business loan is straightforward. The borrower makes fixed payments—usually monthly—that consist of both principal and interest. This predictability is advantageous for budgeting, as the business knows exactly how much it needs to pay each month, regardless of its revenue.

Repayment for an MCA, however, is more dynamic. The lender automatically deducts a percentage of the business’s daily or weekly credit card sales. This means the repayment amount varies based on sales volume. On days when sales are high, the business pays back more of the advance, while on slower days, it pays less. This flexibility can be beneficial for businesses with fluctuating income who want to protect their cash flow, without saving for a large repayment each month.

Conclusion

Choosing between a Merchant Cash Advance and a Business Loan depends on several factors, including your business’s financial health, cash flow, and the urgency of your funding needs. Business loans are generally more affordable and better suited for businesses with steady cash flow and strong credit. In contrast, Merchant Cash Advances offer flexibility and quick access to funds but come at a higher cost and with more variable repayment terms.

By understanding the differences between these two financial products, you can make a more informed decision that aligns with your business’s needs and goals. Whether you need quick cash to seize an opportunity or are planning for a long-term investment, selecting the right financing option is key to your business’s success, and that’s where we can help.