Business Loan or Merchant Loan? Understanding Loan Options for Your Business
May 11, 2022 | Last Updated on: February 7, 2023
May 11, 2022 | Last Updated on: February 7, 2023
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There are many different financing options available to businesses that need to supplement their cash flow, make a purchase, fulfill their expansion goals, or simply cover this month’s operating expenses. Understanding the difference between different loan options and finding the right lender to work with can be overwhelming to even the most seasoned small business owner.
In this article, we look at two financing options available to help you find the best funding option for your business: Merchant loans and business loans.
Merchant loans, or merchant cash advances (MCA), are a type of short-term financing option available to businesses. In a merchant loan, the lender releases a lump sum of cash to the business, which is backed by future sales. The loan is repaid with regular payments that are calculated by using a percentage of credit card or debit card sales. Merchant cash advances are not formally considered loans by lenders because they describe a commercial agreement where the borrower sells future credit card sales to the funding provider.
Payments are made until the agreed amount is paid in full, so the length, or term of the transaction, depends on sales and the amount of money that was borrowed. Typically, a merchant loan will be repaid in less than one year, but many lenders are willing to offer more flexible terms. Merchant loans can include customized financing structures where there is no fixed repayment term. The advance is repaid with daily, weekly, bi-monthly, or monthly payments. Since the payment amount is set on a percentage of future sales, the amount due is lower when sales are less than expected. In periods where sales exceed expectations, the payments are higher, so the loan is paid off faster.
Merchant advances are secured by future debit or credit card sales of the business so they are lower risk for lenders and a great option for businesses that may have been turned down when applying for other financing options. Lenders that offer merchant cash advances work with businesses that have both good credit and bad credit. Since future sales secure the advance, there is no need to offer collateral or a personal guarantee.
Merchant cash advances are funded fast, sometimes even same day. This can be helpful for small business owners who have immediate working capital needs or operate in an industry with regular cash flow fluctuations. Merchant cash advances are not federally regulated like commercial real estate loans, term loans, or other funding methods, so it is important to speak with your lender and research merchant cash advances before applying. Merchant loans come with higher interest rates than traditional term loans but offer higher approval odds and the kind of convenience that some business owners need.
Business loans provide a lump sum cash payment upfront with pre-set repayment terms. There are many different types of business loans like short-term loans, equipment financing, and business acquisition loans. Some entrepreneurs opt to finance their business with revolving credit, like a business line of credit or a business credit card. Some of the most popular types of financing for small businesses include SBA loans, invoice factoring, and term loans.
The Small Business Administration (SBA) helps small businesses get financing through SBA Loans. The SBA doesn’t lend money directly to businesses, but it works with lenders to guarantee a portion of the loan. Borrowers interested in an SBA loan complete an application and receive funds from a traditional lender or an online lender. Lenders that work with the SBA to finance small business owners can be found using the SBA lender search.
There are several financing programs offered through the SBA. Each of the programs offered through the U.S. Small Business Administration comes with a unique borrowing maximum and repayment terms. Some of the more common SBA loans are:
SBA loans are an ideal option for businesses that can meet the approval requirements and don’t have restraints on the timing of their funds. Since the amount of the loan is backed by the SBA, borrowers pay lower interest rates than traditional loans.
Invoice factoring and invoice financing offer additional financing options for small businesses that are new or have not built up a business credit history. Since traditional financing is approved based on a combination of a personal credit score and a business credit score, financing programs like invoice factoring and invoice financing can help new businesses improve their credit score.
While they are similar programs and the terms are often used interchangeably, invoice factoring and invoice financing are different programs. Invoice factoring is when a small business sells their unpaid invoices to an invoice factoring company for up to 95% of their value. The invoice factoring agent then collects on the invoices and sends the balance to the business, less fees which are calculated at a set factor rate. Invoice financing is when a business takes out a line of credit using unpaid invoices as collateral. The borrowing business remains responsible for collecting on outstanding balances.
Small business term loans are a traditional type of financing where the borrower receives a lump sum payment upfront and repays the loan over a pre-determined amount of time at either a fixed or variable interest rate. Fixed interest rates stay the same throughout the life of the loan, while variable rates change in conjunction with market rates. Short-term and long-term loans can be obtained through a traditional bank or credit union or with an online lender, like Biz2Credit.
Term loans do not have restrictions on the use of funds, so businesses borrow funds for the purpose of purchasing equipment or real estate, increasing working capital, refinancing, debt consolidation, or growth strategies. Depending on the creditworthiness of the business, borrowers may be required to make a down payment, leave a personal guarantee, or secure the loan with collateral.
Business loans, like SBA loans and term loans, can be the source of a large lump sum of funds for qualifying businesses. They are approved for larger loan amounts than some short-term financing options like MCAs, invoice factoring, lines of credit, and other solutions. Business term loans allow borrowers to budget accordingly because the repayment terms are fixed and agreed upon at the beginning of the loan.
Term loans can offer fast funding. Traditional lenders and online lenders issue business term loans. Online lenders allow business owners to apply online, upload required documents, and receive a decision and funding within a few days. Making regular, on-time payments on a term loan can help a business improve its business credit score and become eligible for larger loans and higher credit limits in the future.
Term loans and merchant loans can both provide great financing opportunities for small businesses. Deciding which course of action is best for your business depends on a few factors.
Term loans may be the best option for businesses that:
Merchant cash advances are best suited for businesses that:
If you have decided that the best option for your business is a business loan, merchant loan, or merchant cash advance, finding a lender is the next step.
There are many options when it comes to small business financing, but finding the best place to get a business loan doesn’t have to be stressful. Most business owners can get financing with either a traditional bank or an online lender.
Traditional banks offer many financing options for small business owners. Borrowers can find a traditional bank to work with by reaching out to a local branch or credit union. This is a great choice for businesses that are looking for a bank loan with lower interest rates and fixed repayment terms. However, traditional banks have strict approval requirements so businesses with less than perfect credit or new businesses risk being turned away by big banks. Traditional banks have a formal application process so the time between qualifying and being funded can take up to two months.
Alternative lenders, or online lenders, are a great option for businesses interested in applying for a merchant loan. Online marketplaces allow borrowers to compare and contrast different funding options and can offer a fast funding process for business owners that need financing. With the help of an online lender, funds can be deposited in the business bank account in as little as 2 – 3 business days. Online lenders look beyond credit scores when determining creditworthiness and offer many types of loans depending on business needs. Borrowers seek out online lenders and complete the loan application process without ever having to leave home.
Regardless of what type of lender is the best fit for your business financing needs, we recommend checking reviews and asking some questions before applying. Ask the lender what types of small business loans they offer, about repayment terms, and the application and approval processes. There are some great resources online like FundingHero.com, which names Biz2Credit as the top choice and editor’s pick for merchant cash advances.
Running a business includes monitoring the financial health of the organization and adjusting the business plan whenever necessary. Sometimes adapting means exploring the options of business financing. For Victor Alacazar from Ohio, adapting happened very fast when he was able to secure a $20,000 cash advance after only a four-day application process with Biz2Credit.
There are many ways companies can finance their business goals. The option that is best for your business will depend on multiple factors including time, loan amount, and creditworthiness. If you aren’t sure if a merchant cash advance or a term loan is right for your business, reach out to an expert to discuss the potential benefits of each.