Both financing options offer much-needed capital to businesses, but each has pros and cons.
The search for business funding can be a complicated process full of fine print and confusing jargon.
Some of this lingo is superfluous and unnecessary. Other terms have very precise meanings that will be crucial for you to grasp as you explore your business's funding options. Two of these very important terms are "term loan" and "merchant cash advance," options that every small business owner should be familiar with. This article defines these terms and walks you through both options so you can decide which option might be better for your business.
Let's dive in.
What is a term loan?
Terms loans are the types of small business loans that banks have offered for years. In fact, when you think of a business loan, you probably envision a term loan.
Term loans offer straightforward, traditional funding to small business owners through a lump sum that's paid off, plus interest, with a predetermined, scheduled monthly payment. Generally speaking, term loans offer exceptional terms – with larger loan amounts, lower APRs, and longer repayment terms, they can be an appealing funding option for small businesses.
That said, the terms are only helpful if your business qualifies for a term loan. And, unfortunately, that is a big if. Term loans are some of the most difficult types of business loans to qualify for. Typically, you need to be in business for at least two years, have a personal credit score of at least 620, and at least $100,000 in annual revenue.
What's a merchant cash advance?
Though they are often considered a type of business loan, merchant cash advances are technically, well advances, not loans.
What does this mean? Financing companies that provide merchant cash advances consider your business's future credit card revenue as assets. As such, they're willing to advance your business cash with the promise of a return in the form of a portion of your business's daily credit card revenues.
Merchant cash advances are repaid through a daily payment that your financing company will intercept before your credit card revenues reach your business's bank account. It is crucial to understand that merchant cash advances ultimately end up being one of the most expensive business funding options.
The rates are expressed through decimals called factor rates that, on the low end, can range from 1.14 to 1.18. To figure out how expensive a merchant cash advance will be, multiply the factor rate by how much money you borrowed. For example, suppose you get a merchant cash advance of $10,000. If you pay a factor rate of 1.25, it will end up costing you $12,500. Even with a factor rate in the lower range, this cash advance costs you an extra $2,500 to borrow $10,000.
Merchant cash advance requirements can be flexible: If you have at least one year in business, a personal credit score of around 500 and bring in $50,000 in annual revenue, then you should fulfill the minimum requirements.
Although merchant cash advances are arguably the most expensive business funding option out there, they offer much-needed capital to businesses that might not be able to access it otherwise.
What are the key differences?
Now that we've covered what each of these business funding options can offer, let's take a step back so we can see what the key differences are between term loans and merchant cash advances.
The two business funding types couldn't be more different. In one corner, you have the extremely affordable yet difficult to qualify for term loan. In the other corner, you have the extremely accessible yet difficult to afford merchant cash advance.
Not to mention, the term loan and the merchant cash advance represent the most traditional and the least traditional business funding options. Term loans have been around for ages, whereas merchant cash advances are new. The term loan is basically the yin to the merchant cash advance's yang.
The verdict: Which option is better for your business?
With all of this information laid out for you, what's the next move?
Well, it's time to decide if either one of these funding options is the right choice for your business. Does the term loan's affordability or the merchant cash advance's accessibility sound like what your business needs?
Some advice? Even if one of these options sounds great, getting a good idea of all of your funding options before you sign on the dotted line is crucial. Plus, because term loans and merchant cash advances represent two poles of the business funding spectrum, you'll want to check out other options that aren't quite as extreme.
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