If you need funding for your small business, there are a lot of ways to get it. Depending on your situation, needs and goals, you may be considering a merchant cash advance vs. bank loan.
Before signing away for the funds, it’s important to note that the two options couldn’t be more different in many ways. Here are the five biggest differences to keep in mind as you shop around and compare options.
When comparing a merchant cash advance vs. loan, here’s what you need to know about how their features break down.
Whether you’re looking to apply for a merchant cash advance or a bank loan, there are costs associated with accessing funding for your business. But how costs for those funding options are calculated are very different.
With a bank loan, you’ll get a more traditional approach. The lender will assign you an interest rate based on business or possibly personal creditworthiness, and it’ll be represented as an annual rate. The lender uses that rate to amortize your loan, and each payment will include both principal and interest.
If you pay off the loan early, you can typically save on interest because interest accrues as you pay it down.
With a merchant cash advance, the purchaser charges a fixed amount of interest using what’s called a factor rate. If you have a 1.2 factor, for instance, you’ll pay 20% of the advance amount in interest – for a $10,000 advance, you’ll ultimately pay back $12,000.
Remember, though, that the amount of interest is fixed, so if you pay back the funds ahead of schedule, you don’t benefit.
It’s also important to note that merchant cash advances are far more expensive than bank loans. With bank loans, you may be able to secure an interest rate in the single digits, while merchant cash advance factor rates can be much higher.
2. Eligibility Criteria
Bank loans can be difficult to get as a small business owner. Banks tend to have the strictest eligibility requirements because new businesses have a high failure rate . That means you may need to have been in business for two or more years and meet annual revenue requirements.
In addition to your time in business and your revenue, banks will also consider several other factors, such as your:
- Business credit history
- Personal credit history
- Other debts
- Cash flow
- Business plan
With a merchant cash advance, the credit requirements are far less stringent, as are the operating requirements. As a result, newer businesses may qualify if they meet other criteria.
Instead of focusing more on credit history, your cash flow is the most important factor. Merchant cash advance providers will review your credit and debit card sales or your bank statements to determine if you have the cash flow required to make your payments.
3. Repayment Process
With a bank loan, you’ll make monthly payments, with each one paying accrued interest and some of your principal balance. This is similar to other installment loans that you might be familiar with, such as mortgage, auto and personal loans.
With merchant cash advances, your payments couldn’t be any more different. Instead of monthly payments, you may have payments taken from your merchant sales or bank account on a weekly or even daily basis.
Additionally, if your merchant cash advance is based on your debit and credit card sales, you’ll typically have a percentage taken out find here instead of a fixed amount. This can be helpful during times when sales are down, but that also means it’ll take you longer to pay off the debt.