Despite the current popularity of merchant cash advance (MCA) loans, there remains a great deal of confusion concerning the differences between a merchant cash advance and a traditional loan. The commercial financing world is complex enough as it is.
Understanding the distinction is very important for companies who are seeking a quick source of capital. Traditional loans can take a significant amount of time and/or collateral to underwrite, whereas a merchant cash advance can be underwritten in a comparatively shorter time frame.
The difference in products even includes the manner in which the debt is repaid. An MCA can also offer more flexible repayment options and terms compared to a traditional loan, especially for businesses that may have unique lending situations or are involved in a niche industry.
Here are three key distinctions to remember between the two.
In the case of a merchant cash advance and a loan, semantics matter. Let’s break it down to the lowest common denominator: A merchant cash advance is, by definition, an “advance”, or an upfront lump sum in exchange for a future portion of a business’s credit card remittances. A business may receive an advance in as little as 24 to 48 hours after being underwritten and approved.
In contrast, a loan is a sum of money that a lender extends to a borrower in exchange for monthly payments of principal and interest. The payments are based upon an underwriting standard that is arbitrarily assigned to the business based upon its risk classification. There is no guarantee that the business will be approved for the loan, since underwriting is based upon the borrower’s credit score and even upon personal collateral in certain instances. Even if approved, the loan can take several weeks to a couple months to be approved and funded.
Semantically speaking, for a fast source of capital for a business, a merchant cash advance is better positioned to help a business compared to a traditional loan. Offsetting the expedience of a traditional loan is the fact that MCA’s are often priced much higher than traditional loans. Therefore it is critical to analyze your ability to repay the advance carefully before entering into this type of financing arrangement. A good piece of advice is to start small, establish a rapport with the MCA provider and negotiate better terms on subsequent loans. Done correctly, an MCA provider can be an effective partner in managing cash flow and helping in emergency situations.
Speaking of important semantic details, another important detail to consider is how both merchant cash advances and loans are repaid. The debt service breakdown is EXTREMELY important to a business. Payments made to a lender matter not only in terms of dollar amount, but the frequency in which these payments must be made.
For instance, traditional lenders may require a large sum of money to be paid once a month towards servicing the loan. A borrower may find itself in a tight spot at the end of the month if, for instance, an emergency should suddenly arise. The borrower might even find themselves overwhelmed by the amount of the monthly payment itself should business be slow and insufficient capital exists.
"The debt service breakdown is EXTREMELY important to a business."
Meanwhile, a merchant cash advance program allows a company to have a more flexible repayment schedule. With a factor rate of 1.25, a business can get quick access to $20,000 worth of capital and make payments of $200 a day for 125 days, for a total of $25,000 in cost of capital. If you examine this type of payback on an annualized basis, the rates can seem exorbitant. But for business owners in need of quick cash, emergency funds or a shot in the arm, it can be a life saver.
Best of all, without the sometimes restrictive underwriting requirements of a traditional lender, a merchant cash advance can sometimes be more flexible than a traditional loan. If your business is seasonal, for instance, or if your business is outside the realm of traditional or even certain alternate sources of business capital, a merchant cash advance may be one of the few options of financing available.
Best of all, a lender that understands the quirks and the ebbs and flows of your business will be better suited to helping your business get the capital it needs. For example, a lender who extends a moratorium on interest or even on both interest and payments to a seasonal business for a period of time will see a better risk assessment compared to if the borrower took out a traditional loan.
Make sure that before entering into any type of lending agreement that it makes sense for your business.