When it’s time to seek extra funding for your business’s sake, it’s easy toget caught in between two options: a small business loan and merchant cash advance. While both can serve whatever purpose you like, business owners must learn the difference between these products to make the right choice.
These are loans meant for businesses and not individuals. And just like other loans, they have a set interest rate and fixed term. They are a well-known source of supplementary funding for many good reasons:
• Fixed loan terms: you’re sure exactly when you should make your final repayment– and when you’ll have extra cash
• Low Costs: loans are way cheaper than cash advances, with single-figure interest rate.
• Predictability: with a fixed monthly repayment plan, you can easily budget and plan.
• Flexibility: most allow for early repayment, which saves you from paying hefty interests, though beware of the penalties that come with early payment However, business loans also have some cons. The main one is passing the eligibility test: your company must have a good FICO score to qualify with banks are stricter than modern lenders. Their Fixed repayment plan also has a shortcoming— you have to make them even when you’re experiencing a slow sales season. But generally, business loans are a great way to gain business funding.
A cash advance, on the hand, is a very different financing solution. In essence, the financing company buys a portion of your company’s future credit card sales by offering you money in advance which they later reclaiming as a percentage of your credit card sales. Thus, there are no fixed terms for repaying cash advances: you basically agree on the amount and the percentage to be deducted off your sales upfront. This percentage is taken until you’ve pay back the capital and agreed-upon fee. Therefore, if you get a merchant cash advance, a lower percentage doesn’t mean a lower borrowing cost, and this figure isn’t an equivalent of an interest rate. Pros:
• Digital hassle-free loan application and Acceptance: all businesses are liable even those with poor credit and financial histories.
• Repayment depends on sales: unlike loans where you have to pay monthly. • No fixed repayment schedule: the financing company simply deducts its percentage until you clear your debt. Cons • It’s a very expensive way to seek commercial finance
• Has a sky-high APR.
• Nature of repayments makes budgeting difficult
Now that you can tell the difference between business loans and merchant cash advances, you can choose the commercial finance option that suits you best at that particular time depending on the status of your business.
Acquiring the commercial funding to sustain and grow a business remains a significant challenge among upcoming retailers. And when banks are unforgiving, business owners turn to alternative lenders. Merchant Cash advance is one growing alternative financial remedyfor any business looking to get quick funds. Though it traces its roots to the early 2000s from a firm known as AdvanceMe (present-day Can Capital) it was only until 2008 when credit cards went viral that merchants increasingly adopted the MCA product; and now, every retailer is talking about it. But over the years, have altered the terms and policies of the product, and you must now be cautious when planning to go for these alternative means of funding.
With MCAs, a lender may determine you maximum borrowing cap (or advance amount) by looking at your average sales per month. Every lender charges a factor rate which you multiply by the advance amount to get the total payback (the full cost of the MCA). But because payback is on a day to day basis, you decide with the lender on what portion (holdback percentage) they can remit off your daily credit card transactions. And some lenders may add other fees to MCAs. Here’s what an MCA offer entails:
• Advance amount
• Factor rate
• Holdback percentage
• Total payback
However, note that Merchant Cash Advances are not fixed-term like traditional loans;which means if your sales drop, you pay lesser and may end up paying the advance amount over a more extended period than anticipated. For that reason, MCAs work best for seasonal businesses. You want to use short-term funding selectively because they have annual interest rates that range from 60% to triple digits, to cover for their short-term method of the financing. Merchant Cash Advances, in particular, have “factor rates” ranging from 1.15 to 1.5. In essence, the total cost of an advance is the product of the amount being owed and the factor rate. And depending on the lender you consult, there could be other related fees. Though company owners use MCAs as a substitute solution as they wait for major funding from other sources, sometimes the anticipated funds delay or fail to arrive. Despite all that, one still has to make the repayment, which puts the retailer at the risk of defaulting payment. These risk factors makes it an expensive product than traditional loans. The cost of funding is high if the borrower’s risk profile is high.
Gone are the times when cash advances were the borrowers’ first pick when it came to choosing an alternative lending product. Savvy merchants who keep up with the rapid updates in the world of commercial financing will tell you that like payday loans, these days MCAs come with high fees yet they remain the only option for bad-credit borrowers. According to Andrew Mallinger of PIRS Capital, the MCA industry kicked off as a product for clients that couldn’t obtain cash from banks for one reason or another, i.e., lack of collateral or bad credit. However, the surfacing of alternative lending and the growing popularity of platforms like OnDeck is changing is the public’s opinion on cash advances. “The world of commercial funding has evolved; today, MCAs don’t automatically mean exorbitant interest rates and related fees,” explains Mallinger. There are instances where the MCAs may be the most excellent financial remedy for a firm in a cash flow crisis. For instance, retailers with traditional, SBA or long-term equipment loans, can seek short-term liquidity (in the form of an MCA) without having to worry about collateral, long waiting periods or credit. A 2016 study by Bryant Park Capital and deBanked evaluating the confidence of small retailers were hopeful they would get MCA funding. The researchers also found a compound growth rate of annual 56% and a collective loan origination level of $1.9 billion.
Over the years, the alternative lending platform has become a primary target for venture capitalists. And now, investors are also chipping in to reshape the face of MCAs. Last week, PIRS Capital publicized that it has designed a revolving credit line for retailers. The rapid innovations along with the quick adoption of new technology have contributed to the changes in the face of the merchant cash advance segment. With the help of PIRscore, PIRS Capital’s latest piece of tech, the firm intends to underwrite loans through machine learning based on a collection of data points. According to Mallinger, this unique insights and evaluation of would-be borrowers will allow the firm a competitive edge in such a crowded industry. “This is a game-changer, as it allows us to make decisions based on past data via machine learning,” says Mallinger. “The new tech allows the system to re-teach itself on a day to day basis, noticing any new trends.” Mallinger also said that the company is optimistic its tech will take into consideration broader economic data. And though the rise of privately-owned credit scoring models has offered most industry players a competitive edge, the process of data sharing among financial services providers could better the performance of the alternative lending as well as the credit underwriting space. “While there are specific data points that are unique to us and we’d rather keep confidential, there are other data points that are more helpful if keyed into the national database where all lenders can have access,” noted Mallinger
Data sharing is a trend that’s already in practice, and Mallinger says it could benefit the cash advance market a great deal. A joint database of info among MCA firms and other lenders could raise red flags when “bad players” get into play. Supervisory bodies should also crack down on unfair players to rescue small companies from the pangs of phony merchant loan lenders. Meanwhile, business owners must study terms and fees carefully to avoid falling prey for aggressive MCA lenders.