Small businesses are always looking for ways to fund their operation. One of those ways is via a small business loan. The problem with going down this route is that the application and approval process tends to be more strenuous. 

On the contrary, merchant cash advances (MCAs) are more straightforward and are faster to process. Let’s take a look at the main differences between MCAs and business loans. 

How Do MCAs and Business Loans Differ?

To be clear, MCAs are not business loans. When you apply and accept an MCA, you are essentially “selling” your future income earnings in exchange for instant access to working capital. Also, instead of collecting the payments to cover the advance, the MCA company will deduct a percentage of your debit and credit card sales until the advance is fully paid. 

On the contrary, business loans can be paid back by using funds from other accounts, instead of being automatically drafted from your sales. 

MCAs typically carry high percentage rates and higher than average fees, driving up the total cost of the loan. Since the daily repayment schedule can result in cash-flow issues, it can be difficult to repay without refinancing. 

Since MCAs are not traditional loans, these agreements don’t come under the same laws that regulate both lenders and financing companies. The result is that the interest rates can soar to as much as 38%.

Reasons To Use MCAs

Despite the steep costs behind acquiring MCAs, they do offer several benefits. Here are just a few:

  • They are fast

As previously mentioned, getting an MCA is a quick and straightforward process. You can get approved for one within a week with no “heavy documentation.” Providers only look at a business’s daily credit card receipts to assess whether the owner can repay.

  • Physical collateral is unnecessary

Since MCAs are unsecured, they don’t require physical collateral. But the MCA does require a personal guarantee, a written agreement that holds you personally responsible for repaying the advance. That way, the MCA provider can recover any losses if the merchant cannot repay. 

  • If sales drop, so will your payment

The repayment schedule is based on a fixed percentage of your sales, all repayments adjust based on how well your business is doing. 

Know The Risks

Although MCAs offer numerous benefits for your business, be aware that it does have some downsides and therefore, you must proceed with caution.

  • APR could reach triple digits

Depending on the lender, extra fees, the size of the advance, how long it takes for the advance to be fully paid, and the “strength” of the business’s credit cards, the annual percentage rate could range anywhere between 40% to 350%.

  • No federal oversight

Since MCAs are structured as commercial transactions and not loans, the merchant cash advance industry is not subject to federal regulation. They are regulated by the Uniform Commercial Code in each state, instead of the banking laws like the Truth in Lending Act. 

  • Your credit score can be pulled

The MCA provider might check your credit score during the application process. Background credit checks are a typical requirement from MCA providers. However, if the inquiry becomes a hard credit check, it can harm your credit score. 

Is A Merchant Cash Advance A Fit For Your Business?

The biggest benefit for merchants to pursue merchant cash advances is to get the money they need for their business…fast. If there is a significant project or another operation that requires an immediate investment, MCAs are definitely the answer. 

However, take the time to consider the aforementioned downsides to ensure that this will not cause problems in your business. If MCAs turn out not to be a good fit, then it would be wise to seek alternative sources of financing.

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