Business owners may use financing to help grow their company and manage cash flow. Merchant cash advances and business loans are two common ways to finance a business.
Before you get started, it's important to understand the potential benefits of each so 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 business loans and merchant cash advances, their similarities and differences, and more.
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.
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.
There are many types of business loans and lenders that could benefit small businesses. 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 growing businesses.
Each lender will typically set their own loan terms that will vary depending on the borrower's business and credit history.
The potential benefits of business loans may include:
Some potential cons of business loans include:
A merchant cash advance is not 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.
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.
Merchant cash advances, on the other hand, 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 an advance early won't reduce the cost of the merchant cash advance because the factor rate is applied to the total payment at the start.
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.
Learn more about how to apply for a small business loan.
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