Merchant Cash Advance vs. Business Line of Credit: Which is Better?

When it comes to financing a small business, owners have a few options to choose from. Two popular choices are merchant cash advances and business lines of credit. But which one is the better option for your company? Here’s an in-depth look at the pros and cons of merchant cash advances versus lines of credit, to help you make the best decision.

What is a Merchant Cash Advance?

A merchant cash advance (MCA) works similarly to a business cash advance. An MCA company provides you with a lump sum of capital upfront. In exchange, you agree to pay back the advance through a percentage of your future credit card and debit card sales.

Here’s a quick rundown of how merchant cash advances work:

• You apply for financing and the MCA company evaluates your eligibility based on your credit card sales history. They don’t look at your business or personal credit scores.
• If approved, the MCA company provides you with a lump sum of capital upfront, usually within a few days. The amount you receive is based on your monthly credit card sales.
• To pay back the advance, the MCA company takes a fixed percentage of your daily or weekly credit card sales. This is done via split payments or ACH withdrawals from your bank account.
• The payback period is relatively short, usually less than 18 months. You pay back the advance faster when sales are up and slower when sales are down.
• There’s no set repayment schedule. You simply repay the advance as a percentage of credit card sales until it’s fully paid off.

Some key benefits of merchant cash advances include fast funding, flexible repayments, and approval based on card sales rather than credit scores. However, MCAs can be quite expensive compared to other financing options.

What is a Business Line of Credit?

A business line of credit works more like a traditional loan. Your lender provides you with a revolving credit line up to a set limit. You can draw down funds as needed up to your credit limit. Interest is charged only on the amount you actually use.

Here are some basics on how business lines of credit work:

• You apply for a line of credit with a bank or online lender. They evaluate your eligibility based on business and personal credit scores, time in business, annual revenue, and other factors.
• If approved, you receive a revolving credit line with a defined limit. For example, you may be approved for a $50,000 credit line.
• You can draw down funds as needed up to your credit limit. Interest is charged only on the amount you borrow.
• You make monthly payments on the outstanding balance. Your minimum payment is usually 1-2% of the balance.
• As you pay down the balance, credit becomes available to borrow again. Lines of credit are designed for ongoing borrowing needs.
• Repayment terms are usually 1-5 years. Some lines allow interest-only payments for a set period before principal paydown begins.

The main benefits of lines of credit are lower costs compared to MCAs and the flexibility to borrow only what you need. However, the application process can be lengthy and you may need strong credit to qualify.

Key Differences Between MCAs and Lines of Credit

Now that you understand the basics of both options, let’s look at some of the main differences between merchant cash advances and lines of credit:

Approval Process

• MCAs base approval primarily on your credit card sales history. They can approve you quickly with minimal documentation. Credit scores and financials usually aren’t factors.
• Lines of credit involve a lengthy underwriting process examining your credit scores, financial statements, business plan, and other documents. Approval can take weeks.

Cost of Financing

• MCAs are more expensive, with an effective APR often exceeding 50%. You pay a factor rate upfront on the full advance amount.
• Lines of credit have lower costs, with APRs starting around 5-10% for those with good credit. You only pay interest on what you borrow.

Qualification Requirements

• MCAs have minimal requirements. You need a business bank account and at least 3 months of credit card processing history. Bad credit is OK.
• Lines of credit require good personal credit (660+ score) and an established business history. Specific requirements vary by lender.

Funding Speed

• MCAs provide funding in as little as 24-48 hours. The application process is fast.
• Lines of credit can take 4-8 weeks for approval and funding. The underwriting process is more extensive.

Repayment Process

• MCAs deduct a fixed percentage of credit card sales daily/weekly via split payments or ACH withdrawals. Repayments adjust based on sales.
• Lines of credit involve set monthly payments like a traditional loan. You pay interest plus a portion of the principal balance.

Borrowing Limits

• MCAs allow borrowing up to 2-2.5 times your monthly credit card volume. Advance amounts are generally under $250,000.
• Lines of credit often go up to $100,000-$500,000+ depending on the lender and your qualifications. Limits can exceed $1 million.

Use of Funds

• MCAs are designed for short-term working capital needs like making payroll, buying inventory, or marketing. The payback period is under 18 months.
• Lines of credit allow longer-term uses like equipment purchases, business expansion, or commercial real estate. Payback can exceed 5 years.

As you can see, there are significant differences between merchant cash advances and lines of credit related to cost, approvals, qualifications, and appropriate uses. Keep these differences in mind as you evaluate which option may be a better fit.

When Might an MCA Make Sense for My Business?

While merchant cash advances are more expensive overall, there are some situations where an MCA could be a reasonable choice:

• You need funding fast – MCAs provide the quickest access to capital.
• You won’t qualify for a line of credit – MCAs are available to newer businesses with minimal documentation.
• You have seasonal revenue – MCA repayments go up and down with your sales, so you pay less in slower months.
• You need a smaller amount – Advance amounts are often under $250,000.
• You have short-term needs – MCA contracts are designed for quick payback in 6-18 months.
• You will repay it quickly – The high cost of MCAs makes fast repayment ideal.

For quick emergency funding or smaller capital needs, a merchant cash advance can sometimes be a business owner’s only option. While more expensive, it can provide short-term working capital when other financing is unavailable.

When Might a Line of Credit Be a Better Option?

While MCAs fill a need, lines of credit tend to be the more affordable financing option for many situations:

• You need a larger amount – Lines of credit allow borrowing limits over $1 million.
• You have long-term needs – Lines allow 1-5+ year payback for larger investments.
• You want lower costs – Interest rates on lines of credit are significantly less than MCAs.
• You can qualify for a line – Good credit and business history help approval odds.
• Your revenue is steady – Set line of credit payments may work better than fluctuating MCA payments.
• You want flexible borrowing – Lines allow you to access only what you need.

For larger borrowing needs, longer repayment terms, or more flexible ongoing capital, a line of credit is generally the most cost-effective option for businesses that can qualify.

What About Other Financing Options?

Merchant cash advances and lines of credit are two common choices – but they aren’t the only ways to fund your business. Here are a few other options to consider:

• Term loans – These provide a lump sum upfront with fixed monthly payments over a set repayment term. Term loans are available from banks and online lenders.
• SBA loans – The Small Business Administration guarantees loans made by lenders to qualifying businesses. SBA loans have attractive low fixed rates.
• Equipment financing – Lenders offer loans specifically for purchasing equipment. Payments are made monthly over the equipment’s useful life.
• Invoice factoring – You can sell outstanding invoices to a factoring company for immediate cash flow. The factor collects payment from your customers.
• 401(k) business financing – Some companies let you invest a portion of your 401(k) into your own business. There are no monthly payments or credit requirements.
• Crowdfunding – Platforms like Kickstarter and Indiegogo let you raise funds by taking pre-orders from customers or offering rewards.
• Angel investors – Wealthy individuals provide capital to startups and small businesses in exchange for equity or convertible debt.
• Venture capital – VC firms invest substantial amounts in high-growth startups. They take an ownership stake and often control financial decisions.

As you can see, business financing is not limited to just merchant cash advances and lines of credit. Depending on your needs, one of these alternative funding sources could be a better fit for your company.

Tips for Comparing MCAs and Lines of Credit

If you’ve narrowed your search to merchant cash advances and lines of credit, here are some tips for comparing options:

• Calculate the true cost of an MCA using an annualized rate calculator. Don’t go just by the factor rate.
• Ask lenders to clearly explain fees, deductions, and payment processing. Read the fine print!
• Crunch the numbers at different sales volumes – this shows the potential repayment burden.
• Review the contract terms. MCAs sometimes include things like personal guarantees, confessions of judgement, and cross-collateralization.
• Ask your lender for references and read online reviews. Make sure they have a solid reputation.
• Consider an MCA line of credit rather than a lump-sum advance. This allows more flexible borrowing as needed.
• Shop around! Each provider offers different rates/terms for both MCAs and lines of credit.

Taking the time to research options, compare true costs, and read the fine print can help you make the most informed financing decision for your business.

The Bottom Line

At the end of the day, choosing between a merchant cash advance and a business line of credit requires looking at the full picture of your business – its financial situation, capital needs, growth plans, and ability to qualify for different financing options.

Here are a few key points to remember:

• MCAs provide fast funding with minimal documentation but are very expensive. They make sense for quick emergency needs.
• Lines of credit have lower costs but require stronger credit and time to get approved. They allow more flexible long-term borrowing.
• Analyze the true cost of any MCA using an annualized rate calculator before committing.
• Make sure you understand the contract terms and have a lawyer review them.
• Explore all your business financing options, not just MCAs and lines of credit.

With the right information and a full understanding of the pros and cons, you can determine if a merchant cash advance, line of credit, or alternative funding solution is the best fit for your capital needs and financial situation. The key is doing thorough research and running the numbers before making any financing decisions.