As an SME owner, you know that finding the right financing option can make or break your business. Whether you’re looking to expand, cover operational costs, or tackle unexpected expenses, business financing for SMEs can come in many forms. Two popular choices are business loans and merchant cash advances (MCAs). In this blog, we’ll break down the differences between business loans vs. merchant cash advances, looking at the pros and cons of each for SMEs.
Understanding Business Loans for SMEs
What Are Business Loans?
It is a sum of money provided by a lender that a small business borrows and agrees to repay over time, typically with interest. The loan can be used for a variety of purposes, from purchasing equipment to expanding operations. Business loans are often offered by traditional banks, credit unions, or online lenders.
Key Features of Business Loans
- Fixed or variable interest rates: Business loans typically have set interest rates, either fixed or variable.
- Set repayment terms: These loans come with defined repayment schedules, often spanning months or years.
- Collateral: Many business loans require collateral (assets like property or equipment) to secure the loan.
Pros of Business Loans for SMEs
- Lower interest rates: Since these loans are often secured or come from established lenders, interest rates tend to be lower than other financing options.
- Larger loan amounts: You can often borrow a larger amount of money compared to an MCA, making small business loans ideal for major investments.
- Fixed repayment structure: The predictable payment schedule makes it easier for businesses to plan cash flow and manage finances.
Cons of Business Loans for SMEs
- Strict qualification criteria: Banks and lenders usually require a solid credit history, making it more difficult for businesses with poor credit to qualify.
- Longer approval process: Business loans typically take longer to approve and disburse, which may not suit businesses needing quick cash.
Understanding Merchant Cash Advances
What is a Merchant Cash Advance (MCA)?
An MCA is a type of funding that allows businesses to receive a lump sum upfront in exchange for a percentage of future sales. The repayment is typically made through daily or weekly debits taken directly from the business’s credit card or debit card sales. Unlike traditional loans, there’s no fixed payment schedule; the repayment fluctuates based on sales.
Key Features of Merchant Cash Advances
- Repayment based on sales: The repayment amount is linked to daily or weekly sales, which makes it flexible and adjustable based on the business’s performance.
- No collateral: Most MCAs don’t require any collateral, though the business’s future sales act as the “security.”
- Fast access to funds: The approval and funding process for MCAs is usually quicker than business loans, often within 1-2 days.
Pros of MCAs for SMEs
- Quick access to funds: The fast application and approval process mean you can access funds quickly, often in a matter of days.
- Flexible repayments: Since repayments are based on sales, they adjust depending on how well the business is performing, reducing the pressure in slower months.
- Easier approval: MCAs are often easier to qualify for compared to business loans, especially for businesses with less-than-perfect credit.
Cons of MCAs for SMEs
- Higher cost: The cost of an MCA is often higher than a traditional business loan due to the factor rates.
- Repayments can be unpredictable: While flexibility can be a benefit, repayments can also fluctuate significantly, which might make cash flow management difficult.
- Potential for debt cycle: If sales are slow, businesses may struggle to keep up with repayment, leading to debt.
Comparing Business Loans vs. Merchant Cash Advances
Now, let’s compare the two options across a few key categories to help you decide which is best for your business.
Eligibility Requirements
- Business loans: Typically require a strong credit score, a solid financial history, and sometimes collateral. For an SME looking to secure a loan for small business growth, these factors can make traditional business loans appealing, though qualification criteria are often more stringent than with MCAs.
- MCAs: Easier to qualify for, as lenders focus on daily sales rather than credit scores. This makes it a more accessible option for new businesses or businesses with poor credit.
Repayment Structure
- Business loans: Have a fixed repayment schedule, with set monthly payments. This can make budgeting easier, but may put pressure on cash flow.
- MCAs: Repayments are flexible, based on daily or weekly sales. If business is slow, the repayment amount will be smaller, but it can also be unpredictable.
Cost of Financing
- Business loans: Tend to have lower interest rates, especially for businesses with good credit. Overall, the cost of financing is often more affordable.
- MCAs: Have higher costs due to the risk involved and the speed of access. Factor rates (interest rates) for MCAs can be significantly higher than for business loans.
Best Suited For:
- Business loans: Ideal for SMEs with established credit and steady cash flow that need a larger amount of capital for growth or expansion.
- MCAs: Best for SMEs needing quick access to funds with flexible repayment options, particularly those with inconsistent sales or poor credit scores.
Factors to Consider When Choosing Between a Business Loan and an MCA
- Cash Flow Consistency: If your cash flow is stable, a business loan could be a good choice. If it’s unpredictable, an MCA might be more suitable.
- Credit Score: If your credit score is less than stellar, an MCA might be easier to secure than a traditional business loan.
- Cost Sensitivity: If cost is a concern, a business loan will likely be the more affordable option.
- Urgency: If you need funds urgently, an MCA provides a quicker, more flexible solution.
When comparing business loans and merchant cash advances, both have their pros and cons, and which one is right for your business depends on your specific needs. If you’re looking for a larger, more affordable loan with fixed repayments, a business loan is likely the better choice. However, if you need fast access to funds with flexible repayments, a merchant cash advance could be the right fit.
Looking for the right business financing? Contact Funding Guru today, we can help you find the best funding option to suit your needs and help your business grow.
