Your business may run well as you have a merchant account, the credit sales keep increasing month on month. Of course, you are growing, but you need financing to invest in your business and continue the business growth.
If new businesses are choosing merchant funding, then it becomes hard to reach the business goals. Yes, merchant advances and merchant loans, both are helpful for business growth. But there is a difference between merchant advances and a bank loan. Which is the right option for you? Choosing one of these options depends on your business nature, industry, and financial history.
In many cases, you may find it hard to decide between the two. To make the right decision, you need to first know the differences between the two or what pros and cons they have. In this article, we will be covering the pros and cons of merchant advances and bank loans.
From here, you may know the pros and cons of the respective options.
1. Eligibility and Process
If you apply for a merchant cash advance, you will have to provide the recent bank statements along with merchant account history. The business cash advance lenders determine the ability to cover cash advances based on your financial history. Many companies with good records are eligible to get the money, or else you may find it difficult to get through.
Even bank lenders follow the same rule of application. They expect the loan applicant to provide bank documents, check the credit ratings, collateral, tax records. Further, the bank takes the application for more documentation. The documentation process may take weeks or more than a week. There are chances of rejecting the loan application if the credit history does not match the eligibility criteria.
2. Collateral Requirement
For merchant cash advance, there is no requirement of collateral. Whereas for bank loans, there is a mandatory need for collateral. Merchant cash advance depends more on future sales. Secured business loans ask for collateral to back the loan against default. The preferred collateral required for bank loans is either business inventory or real estate.
3. Rate of Interests and Repayment Policies
Merchant cash advances are different from bank loans. Here you are not borrowing money but selling a part of future credit sales. Due to this, you will have various ways to repay the merchant cash advances:
- Fixing a percentage on daily basis credit and debit sales withheld
- Remitting fixed daily or weekly ACH (Automated Clearing House) which means auto-debit from a bank account
For bank loans, the bank follows strict laws that limit the charges of the cash advance. Though bank loans are harder to secure, they are affordable in the long term. Again it depends on the interest rates, long term, repayment schedule, and other interlinked factors.
Bank loans have a monthly payment which is per the agreement. It is irrespective of the business performance. You will have to pay $200, $500 or the amount as per the loan agreement between the bank and the company. The monthly payment continues until the repayment to the bank is completed. Whereas, the merchant cash advances are usually cleared based on the future revenues of the business. Let the business be good or bad, you’re compelled to share a certain percentage of credit or debit card of processing sales.
Availability of Funds
During the financial crisis in 2008, banks stopped lending to the business. This led creditworthy borrowers to be unable to access traditional financing. The commercial bank loans to small businesses were declined by $40 billion from the second quarter of 2008 to the second quarter of 2010. The business cash advance lenders were the alternative funding option for many businesses during this tough time.
Credit Score Effect
A cash advance doesn’t directly affect the credit score of a business. However, it can affect indirectly multiple ways. But business cash advance lenders get funds approval with no credit score or poor credit score. This can be an added advantage for businesses. However, you shouldn’t think that the cash advance lenders completely ignore the credit score. A few lenders can do strict credit checks which can deduct your credit score. So you need to be careful.
Businesses with clear eligibility to get bank loans. If there is a poor credit score then banks directly reject the application. Banks must consider the credit score as one of the main eligibility criteria.
The common charges that are levied when borrowing funds are processing charges and prepayment charges. The business cash advance lenders charge the processing fee upfront which ranges between 2% to 3% of the amount. Most of the lenders waive off the prepayment charges for a cash advance.
For bank loans, the processing fee follows with the first repayment schedule. Occasionally, there would be chances of availing the bank loan without the processing fee. It depends on the bank offers. The pre-payment charges for bank loans apply to a certain percentage of the loan amount.
Which is Best for Your Business? Merchant Cash Advance or a Bank Loan?
You must account for your business goals for choosing the best financing option. A few factors that you must be mindful of our- cash flow, revenue, and business risk tolerance. If you can understand the difference between a cash advance and a bank loan, only then you can make the best financing decision.
By now you should know the pros and cons of both loan types. You should make the decision based on the important factors that are discussed above. This will help you make the right decision.