If you are a small business owner, it is likely that you will have to borrow funds at some point in one form or another. The good news is that there are several options at your disposal when it comes to borrowing funds. Some of these options are loans, merchant cash advance and lines of credit. If you are looking to borrow money, this is the right time to learn what may be best for your small business.
Are you interested in knowing the differences between a business loan, lines of credit, and merchant advances so that you can make the most suitable decision for your business? If you are not sure how to decide between bank loans, lines of credit, and merchant advances, it is best that you first understand how these funding sources are similar and different from each other.
What is a Business Loan?
Did you know that a business loan is also called a commercial loan? You can avail a loan to pay for operational costs, buying inventory, hiring staff, or other capital needs. It is worth noting that business loans come in various forms, such as bank loans and microloans.
In most cases, your business equipment or vehicles secure the loan. Also, keep in mind that your lender can take that collateral if you fail to make payments.
Note that depending on your specific needs, preferences, and business structure, you should research the types of business loans you can receive in order to find out what is most suitable for your business, especially in the long run.
What is a Merchant Cash Advance?
You should know that merchant cash advances are an alternative type of financing. Note that the merchant cash provider will purchase a specific amount of your future sales or revenue, usually at a considerable discount of up to 50%.
If you use this form of financing, you will have to make monthly or weekly payments. These payments are based on a specific percentage of your credit transactions.
What is a Line of Credit?
This is another popular mode of finance. A line of credit allows you to draw money and then spend it up to your limit. Once you repay the money, usually with interest, you can spend the credit again.
As a result, it serves as a revolving account. The best thing about a line of credit is that you get flexible access to cash whenever you need it.
Before applying for the business line of credit, you’ll have to determine the total amount that you require. On approval, you can start drawing money.
Benefits of Business Loans, Merchant Cash Advances, and Lines of Credit
Business Loans
- You can avail several kinds of business loans. Some of them are SBA loans, microloans, and balloon payment loans.
- You will enjoy competitive interest rates. Note that depending on your lender and the size of the loan, your interest rates may be as low as 6 percent.
- With predictable and fixed repayment amounts and terms, you can plan your business’ future.
- You will enjoy flexible repayment options. Note that a wide variety of loan terms can result in more flexible payment options.
Merchant Cash Advances
- You don’t need to provide collateral. Keep in mind that lenders use your business’s credit sales history in order to assess your ability to repay.
- You will benefit from an easy and hassle-free application process. This is because fewer documents are often required to apply. Note that lenders are mainly interested in your financial statements and corporate tax returns.
- If you use a conventional MCA, your repayment amount will decrease when your sales are low.
- You will enjoy quick access to capital. This is because funding is usually available within one week of submission of the application.
Lines of Credit
- One great aspect of negotiating a business line of credit is the fruitful relationship that you develop with your lender. Over time, the relationship can help you when you require additional financing.
- If you use your line of credit deliberately and carefully, you may see your business credit rating increase
- With a line of credit, you only pay interest charges on the amount you use
Drawbacks of Business Loans, Merchant Cash Advances, and Lines of Credit
Business Loans
- The application process is lengthy as the required documentation for a business term loan is extensive. As a result, your application may take several days or even weeks to process.
- It is not the right solution if your business is facing ongoing cash flow issues.
- Collateral is required. Most secured loans require you to identify one or more assets to back the business loan against default, like real estate or business inventory.
Merchant Cash Advances
- Cash advances have expensive rates. For example, factor rates — the interest rate that you pay on the cash advance — can be very expensive.
- Note that as merchant cash advances are not loans, they are not regulated by the strict lending laws that tend to govern business loans. This may lead to predatory or unfair lending practices.
- Sometimes, it can be difficult to understand all of the terms and conditions and compare the options.
- Many merchant cash companies prohibit you from changing your credit card processors once the advance is made.
Lines of Credit
- Lines of credit can result in hefty fees for maintenance and withdrawals.
- To apply for a line of credit, you will have to supply financial statements that detail your business’s revenues and cash flow.
Which Financing Option is Best for me?
Business Loans
- You would like to improve your business’s credit.
- You would like to choose your repayment terms and amount
- You have to finance the purchase of expensive equipment or inventory.
Merchant Cash Advances
- You require access to fast capital.
- You have a poor credit history but usually, process a high volume of credit card transactions.
- You cannot qualify for other types of financing.
- You would like to make the most of a time-sensitive business opportunity, like the purchase of discounted business inventory.
Lines of Credit
- You would like to improve your credit score
- You have to even out your cash flow
- You would like to build a good relationship with a conventional lender
Final Thoughts
Before deciding on a source of funding for your business, you should understand how each of these financing options fit into your business based on their immediate as well as long-term impacts.
