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Business owners may use financing to help grow their company and manage cash flow. In this article, we’ll compare two common financing options: merchant cash advances and business loans.
Before you figure out how to apply for a business loan, it's important to understand the potential benefits of a business cash advance. This way, you can make an informed choice for your business needs.
For U.S. merchants interested in small business financing, this guide covers the basics of a cash advance versus a business loan, including their similarities, differences, and uses.
A business loan is a type of financing in which a business receives money from a lender and pays back the money in regular installments over time, plus interest.
You’ve likely wondered how to get a small business loan and which option best fits your needs. To start, know that there are many types of small business loans and lenders. Business owners can apply for a business loan from a traditional bank or credit union, online lender, or lending marketplace. The U.S. Small Business Administration (SBA) also offers loan programs for various types of growing businesses.
Each lender typically sets their own specific loan terms that vary depending on the borrower's business and credit history.
Your follow-up question for, “How do I get a small business loan?” might be, “How does a business loan work?”
In general, a business loan allows a small business owner to borrow a lump sum of money from a lender. They then repay the funds, along with interest, in predetermined installments, such as on a monthly basis.
Borrowing money through a business loan can offer many potential benefits for a small business, including:
There are also some potential cons of business loans, such as:
If you’ve explored small business loans, you may have also asked, “What is a merchant cash advance?” A merchant cash advance isn’t a loan, but rather a type of financing that business owners pay back with a percentage of their future sales.
Here's how it can work: A merchant cash advance company provides the business owner with a lump sum of money upfront. The business then repays the company from a percentage of the business's daily or weekly credit and debit card sales.
As with any form of financing, there are pros and cons to merchant cash advances.
The potential pros of merchant cash advances include:
The cons of merchant cash advances include:
It's important to understand the differences between a merchant cash advance and a business loan. Merchant cash advances, for example, may come with lower borrowing amounts and shorter repayment terms than business loans. For this reason, merchant cash advances can be a popular solution for new and growing businesses looking for quick access to funding.
Costs for merchant cash advances and business loans are usually charged differently. Traditional loans typically come with fixed or floating interest rates, which are applied to the remaining loan balance each month. So, if a borrower pays off their loan early, they may minimize the amount of interest paid on the loan. Traditional loans are also commonly repaid in predictable, fixed installment amounts each week or month. In contrast, merchant cash advances are repaid based on a percentage of the business’ sales.
In addition, merchant cash advances often charge a variety of fees and use factor rates, which are applied to the overall funding amount upfront. Factor rates can result in much higher financing costs than traditional loans. Also, repaying early won't reduce the cost of the merchant cash advance because the factor rate is applied to the total payment at the start.
Eligibility requirements may also differ for small business loans compared to merchant cash advances. For instance, business owners may not need a strong credit history to apply for a merchant cash advance. Instead, the lender may consider projected sales and revenue to determine eligibility. However, merchant cash advances aren’t typically regulated by federal and state lending laws, which can leave businesses unprotected and vulnerable to risk.
Ultimately, the choice of merchant cash advance vs. business loan will depend on the needs of your business.
Business loans can complement merchant cash advances. A business owner may use a business loan, for example, to expand their company with new equipment or office space. At the same time, they may use a merchant cash advance to access quick funding for a more immediate need, such as emergency expenses.
Just remember that business loans and merchant cash advances often come with different types of repayment periods and terms. When getting funding from multiple sources, business owners should be sure to stay organized and on top of their payments. You should also consider the short- and long-term impacts of how you use these funding sources. Applying for loans from multiple lenders, for instance, can trigger hard credit inquiries, which can potentially lower your credit score. This can impact future borrowing from a traditional bank or credit union, online lender, or lending marketplace.
Financing can be essential for growing businesses. Small businesses may use financial services to launch new products and services, buy equipment, and hire additional staff. Financing may also help business owners prepare for emergency expenses and manage cash flow during seasonal changes.
Business loans and cash advances are two options for financing a business — but they have key differences that are important to understand.
Business financing comes in many forms — such as traditional loans, lines of credit, and merchant cash advances — and can be used for a variety of reasons during different stages of business growth. A business owner might use business financing to fund their startup idea, cover gaps in cash flow, buy new equipment, expand to new retail locations, or plan for other necessary expenses.
When researching how to get a small business loan, however, you might consider who can ask for business financing. In general, many business owners are able to ask for business financing — you just want to do your research on various lenders to ensure you meet their eligibility requirements.
Some lenders might only offer financing for businesses of certain sizes, business owners with certain credit scores, or businesses that can provide collateral. To be eligible for the SBA-guaranteed loan program, for example, a business must meet specific size standards, be for-profit, operate in the United States, and have sound credit.1 These requirements will vary with traditional banks and credit unions, online lenders, and lending marketplaces.
When applying for business financing, also consider the types of documents and information you may need to submit for approval. For instance, business owners applying for financing may need to provide lenders with any business licenses, financial statements, articles of incorporation, tax returns, and certain personal financial information.
Learn more about how to apply for a small business loan.
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