|
Merchant Cash Advance |
Business Loan |
| Type of financing |
Purchase of future sales |
Loan of funds |
| Approval process |
Faster and less stringent |
More thorough and may require collateral |
| Repayment terms |
Remitted based on daily or weekly sales |
Fixed monthly payments |
| Interest rates |
Flat fee typically higher than traditional loans |
Generally lower than cash advances |
| Eligibility |
Businesses with lower credit scores may qualify |
Requires good credit history and financial standing |
| Ideal for |
Businesses with fluctuating revenue or seasonal sales |
Businesses with predictable cash flow and stable revenue |
| Pros |
Quick access to funds, simple application, no collateral required |
Predictable repayment schedule, lower interest rates |
| Cons |
Higher flat fee, potential for cash flow disruptions |
Requires good credit history, application can be lengthy, collateral may be needed |
This table provides a clear comparison between merchant cash advances and business loans based on various criteria.
What are traditional term loans?
When considering avenues for capital infusion into your business, your initial inclination may naturally gravitate towards securing a bank loan, and for good reason. Traditional banks boast a rich legacy in the realm of lending, spanning centuries. Whether your aspirations entail acquiring land, erecting a property, or launching a business venture, the default recourse for capital procurement is often a bank.
The process typically involves applying for a business loan, furnishing requisite documentation, and upon approval, the bank disburses a lump sum of funds in return for your commitment to make monthly payments over a predetermined period, known as the loan term. These payments encompass both the principal amount borrowed and accrued interest, which may be fixed or variable throughout the loan’s duration. Furthermore, depending on the loan term, it may be further delineated as either a long-term or short-term financing arrangement.
Types of traditional loans
Long term loans
In the UK market, long-term loans are exactly what they sound like – loans with a repayment period extending significantly beyond what’s typical for short-term business loans. These loans often span from five years to a decade or even longer.
Securing approval for long-term loans can be challenging due to the stringent qualifying criteria set by traditional banks. Collateral is usually required, and the bank may impose restrictions on future borrowing by the business. Moreover, your business must demonstrate impeccable financial standing, backed by robust financial statements, while your personal credit score must also meet high standards.
Long-term loans are better suited for established businesses with a solid business credit history, particularly those aiming to expand or acquire other companies. Alongside their extended repayment term, these loans typically involve larger sums (often reaching six figures) and may feature lower interest rates compared to short-term alternatives. The British Business Bank is a valuable resource for accessing low-interest loans with diverse terms, especially for established businesses, as they are partially guaranteed by the government. This means that in case of default, the federal government covers a substantial portion of the outstanding balance.
However, borrowers should exercise caution as the lower interest rates over a prolonged period can result in the total repayment amount exceeding that of a short-term business loan. It’s essential to crunch the numbers and evaluate the overall cost carefully before committing to a long-term loan.
Short-term loans
For small business owners, short-term loans often emerge as the preferred choice, even in the early stages of their venture. These loans are tailored to provide swift access to funds when needed most. Typically, short-term loans involve smaller amounts, carry slightly higher interest rates compared to their long-term counterparts, and are designed for repayment over a shorter duration, spanning from a few months to a few years.
When pursuing short-term loans, personal credit plays a significant role, and traditional financial institutions like banks may necessitate collateral as security. However, there’s a silver lining – the landscape offers a plethora of alternative financing options beyond traditional banks, but we’ll delve into that later. This accessibility makes short-term loans more attainable, even for individuals lacking pristine personal credit scores or collateral to offer against the loan.
The difference between short and long term loans
Short-term loans serve as lifelines for addressing immediate working capital needs, such as procuring inventory, covering marketing expenses, and meeting payroll obligations. The beauty of these loans lies in their direct correlation to revenue generation, allowing for swifter repayment. Essentially, you invest the loan in business initiatives that yield rapid returns, thereby mitigating concerns about the higher interest rate.
Conversely, long-term loans are instrumental in fuelling expansion and fostering growth. Ventures like refurbishments, equipment acquisitions, and buyouts necessitate substantial funding over a prolonged period. Unlike short-term loans, these initiatives aren’t directly tied to immediate revenue generation, hence requiring an extended payback period to cushion the impact of larger fixed monthly payments
Secured and unsecured loans
Secured loans operate on the principle of collateral, serving as a safety net for banks. To secure funding for your business, banks may demand collateral—such as real estate or inventory—as a guarantee of repayment. Should you default on the loan, the bank retains the right to seize these assets to settle the debt. When collateral is pledged against a loan, it’s termed as a secured loan, shielding the bank from potential financial losses.
In contrast, unsecured loans dispense with the need for collateral. These loans heavily hinge on your personal creditworthiness and your relationship history with the lender.
Given the absence of collateral, unsecured loans pose a higher risk to lenders. Naturally, with greater risk comes the allure of higher rewards. Thus, lenders typically levy higher interest rates on unsecured loans, enhancing their potential returns.
Moreover, since no assets are pledged as security, borrowers are often required to sign a personal guarantee (PG). By signing the PG, you assume personal responsibility for loan repayment, irrespective of your business’s performance or other stakeholders’ involvement.
Long-term loans predominantly fall under the secured category, whereas the status of short-term loans depends on factors like your credit score, relationship with the bank, and willingness to provide a personal guarantee. This dichotomy also applies to lines of credit, which may be secured or unsecured based on similar considerations.
Merchant cash advance
So far, we’ve explored various types of business financing, from short and long-term loans to secured and unsecured options, including revolving lines of credit. But remember when we mentioned that there’s a bright side to short-term loans? That’s where alternative financing sources come into play, offering small businesses avenues beyond traditional loans and lines of credit.
Merchant cash advances (MCAs) emerged as a pioneering force in alternative financing back in the 1990s. Unlike conventional business loans, MCAs operate on a unique premise.
Now, you might be wondering, how exactly can a company purchase a chunk of your future revenue from credit card sales or receivables and intercept that money before it reaches you? Here’s where your payment processor, also known as your credit card processor, steps in.
Payment processors forged partnerships with merchant cash advance companies, facilitating seamless and expedited fund transfers for merchants. Leveraging their existing access to merchants’ funding accounts for credit card sales, payment processors became instrumental in streamlining the cash advance process. In some instances, payment processors even began offering the service and funding in-house, complementing their core business offerings. This integration gained traction particularly in the early to mid-2000s, marking a significant shift in the landscape of business financing.
Benefits of an MCA
For small business owners, opting for an MCA over a traditional loan presents numerous advantages.
Easy application process
Due to their independence from credit scores, securing approval for a merchant cash advance is significantly simpler for merchants compared to obtaining a loan. Furthermore, the application process for loans tends to be notably lengthier and more intricate. Unlike traditional loans, MCAs don’t mandate conventional collateral. Additionally, while business loans often necessitate a meticulously crafted business plan outlining fund allocation, MCAs offer greater flexibility – as long as the funds are employed for business purposes, you’re ready to proceed.
Relief for businesses with fluctuating sales
Since a merchant cash advance is fulfilled based on a percentage of your future credit card sales, rather than a fixed amount, the actual amount the provider collects changes from month to month.
This can be very beneficial for a merchant managing their cash flow. If you go through a slow season, the collections made on the cash advance decrease. If sales skyrocket, the collections increase.
The percentage that is collected never changes, keeping your business cash flow stable. With loans, you have a fixed repayment amount, which can put a serious dent in your bank account if you’re going through a sales slump.
Get funds faster
When comparing the timeline to secure funding, obtaining a loan often involves a lengthier process compared to an MCA. Once your initial application for an MCA is greenlit, you can expect the cash advance to be swiftly deposited into your account within a matter of days. Subsequently, you’re free to utilise the advance for any business endeavour or expense you deem fit.
Flat-fee structure
One of the standout benefits of an MCA lies in its straightforward structure, typically featuring a one-time flat fee remitted alongside the advance amount, collectively termed as the “purchase amount.” This simplicity contrasts with loans, where borrowers may encounter variable interest rates or additional fees for late payments.
At PDQ-Funding, we understand the importance of hassle-free financing for businesses. That’s why we’re proud to offer top-rated, lightning-fast, merchant-first financing solutions.
Our merchant cash advance program is designed to provide upfront funding for businesses poised for growth.
With a business model centred on agility, they cater to a diverse clientele, offering trendy apparel at discounted rates. To maintain their competitive edge, they rely on immediate access to cash for inventory procurement, a need seamlessly met through PDQ Funding.
Cash advance or loan? Which is right for my business?
Now that you’re acquainted with the distinctions between a merchant cash advance and a loan, the question arises: which option best suits your business needs? The answer hinges on your unique circumstances. Here are some factors to ponder, guiding you towards the optimal choice:
Creditworthiness
Personal credit plays a pivotal role in establishing business credit. Traditional lenders scrutinize your credit history, making loan approval challenging if your credit is less than stellar. In such cases, a merchant cash advance may offer a more accessible avenue.
Profits and Credit Card Revenues
Banks assess your business’s profitability and longevity, while providers of merchant cash advances prioritise your credit card revenues. If your business boasts robust credit card transactions but limited profits, an MCA could be a viable solution.
Repayment Structure
Traditional loans entail fixed monthly instalments, whereas cash advances are repaid through fluctuating amounts based on your credit card revenue, remitted daily or weekly. Opt for a cash advance if you prefer a flexible repayment structure aligned with your revenue fluctuations. Alternatively, if you prefer a predictable repayment schedule, a loan may be more suitable.
Capital Utilisation
Consider your intended use of the funds. If you require capital for ventures promising swift returns, such as purchasing seasonal inventory or launching a marketing campaign, a cash advance is ideal. Conversely, if you’re embarking on long-term ventures like opening a new store or investing in equipment, a bank loan or line of credit may better align with your needs.
Ultimately, your decision should reflect the unique circumstances and aspirations of your business. Assess these factors carefully to determine the financing option that best propels your business forward.
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When it comes to obtaining financing for small businesses, two common options that often come into consideration are merchant cash advances (MCAs) and business loans.