Running a business comes with a myriad of challenges, and raising capital is a significant hurdle that could make or break your enterprise. When faced with financial constraints, you want to find money as quickly as possible without providing an excessive amount of paperwork. Merchant cash advance (MCA) and business line credit are two of the most popular financing methods businesses can use to keep things running. What is the difference between these two options? In this article, we discuss what MCAs and business line credit are, their pros and cons to help you decide what financing method suits your business.
In its 2015 Small Business Credit Survey, the Federal Reserve Bank of New York surmised that 57% of businesses use loans for financing while another 52% used lines of credit. Merchant cash advances are not as popular, but the study found roughly 7% of micro-enterprises with revenues below $100,000 had used this option. When deliberating on the type of financing option, the purpose of the loan should be the primary consideration then determine how much cash is needed and how much you can afford to borrow.
Once an enterprise is up and running, the proprietors must ensure it fulfills its mandate and remains stable to weather the storms of economic downturns. At the close of 2018, a CNBC/SurveyMonkey Small Business Survey indicated declined optimism in small enterprises as the nation faces financial troubles. The Small Business Confidence index had been falling over the previous quarter, and this freefall carried through in the fourth quarter with a drop from 62 to 59 points.
Trade tensions between the US and China and other countries were a significant contributor to this waning confidence coupled with market fluctuations. The National Small Business Association derived that while small and microenterprises are thriving, the hiring numbers are stalling due to financing problems. If they cannot secure funds, then hiring talent is impossible not to mention other factors like affording insurance plans for staff. If economic woes are looming, small businesses tend to cut back on hiring, expansion, innovation, etc. until they are confident of financial security now and in the future.
Reasons for Seeking Financing
There are many reasons for a small business to require a loan at one point or another, and these reasons are tied to spurring and sustaining growth. You can seek additional funds for the following purposes:
Boost working capital – this means increasing the money needed to run the business on a day-to-day basis, so there are no hiccups that could stall operations. Working capital is vital at every stage and even more so in the early stages of a startup when things are yet to be streamlined, and unforeseen expenses are a near-daily occurrence.
Hire talent – for a business to take off and continue thriving, you have to routinely hire the best talent to fill positions as they become available. SBA Office of Advocacy notes that firms with less than 100 workers take the most significant share of small enterprise workers in the country. However, as mentioned above, a shortage of funds can undermine hiring efforts, which consequently means understaffing until the company can afford to hire additional staff.
Acquiring assets – increasing sales volumes usually means getting new machinery and upgrading the equipment you already have. For instance, you could buy more delivery vans, get a software upgrade so processes can run more efficiently, and so on. Getting asset funding helps you acquire the items you need and spreading these hefty costs over many months or years as the enterprise becomes more profitable.
Restricting debt – if you already have liabilities from various lenders, a business line of credit can help consolidate these outstanding debts so that you can manage finances more aptly. This way, you free up money that can be channeled elsewhere to benefit your small enterprise now and in the long run.
Growth funding - after an unbeaten run with your brainchild, you may feel as if things have slowed down and need a jolt to spur growth in the coming years. You need funds to execute the next stage, such as launching new products, opening a new branch in a high-market area, or implement new ideas that you have been exploring.
What is a Merchant Cash Advance?
Merchant cash advances (MCAs) are funding options that are accessed through companies that provide capital for businesses that may not qualify for bank loans. These merchants don't ask for collateral as you either repay your debt through revenue accrued from credit card transactions at your business, or repay with a small, fixed ACH plan that’s debited from your bank account on a daily/weekly basis. Businesses are looking for a quick influx of cash turn to merchant cash advances as they are much faster to acquire.
You will need to have operated the business for a minimum of six months and deposit at least $10,000 in your bank accounts every month. More so, the credit score requirements stipulate at least 500 points, which is a little much for some enterprises but not impossible. In some cases, files with a credit score lower than 500 points may still be approved if the business has a healthy stream of recurring monthly deposits.
MCAs are not as lucrative as bank loans; you can receive funds from $2,500 to $250,000 depending on how well you meet their screening criteria. Wide Merchant Group calculates the repayment by a predetermined factor rate which is then multiplied by the cash advance they extended to see how much you owe them. To cushion themselves against bad debt, MCA providers usually withhold a certain percentage (5% to 40%) of your total credit card sales, or debit a small fixed ACH amount from your bank account. Once you have paid roughly 50% of your balance, you may be eligible for additional funding, granted your business meets the criteria stipulated by the MCA lender.
What is Business Line of Credit?
This financing option is flexible capital that gives you access to cash, but you can only withdraw money up to a specific limit, just like how a credit card works. Unlike a term loan, the business line of credit allows you to withdraw funds whenever the need arises such as making payroll, buying inventory, and other working capital necessities. You can access money through online banking, check card, paper check, or another suitable method at zero charges when retrieving small amounts.
You can apply for a business line of credit from a bank, but they usually have strict qualification criteria and they asking for specific collateral, thus blocking out many enterprises as they fail to qualify. To start with, the enterprise must be operational for at least six months hauling in at least $50,000 in annual revenue. Even if most banks will not impose a minimum credit score, having a low credit rating translates to higher interest rates.
A business line of credit gives you a cash allowance of $10,000 on the lower end and $1 million on the lower end as per how well you fulfill the bank's requirements. These loans attract an annual interest rate computed as per the prime rate, and then you pay an extra 1% or 3%, which is manageable for many businesses. Nonetheless, these rates vary as the market fluctuates so you can expect to repay at a higher or lower interest rate than what the bank stated initially.
Once you fulfill the bank's lending requirements, you will open an account for a small fee depending on what credit lines they have approved. Enterprises that qualify for credit below $25,000 pay roughly $150 and those who are eligible for higher credit pay approximately $250 to open an account. You need to factor in annual operation fees of $100 to $150, but most banks usually waive the costs for the first year.
When to Use MCAs and Business Line of Credit
As explained above, MCAs are relatively easy to secure as compared to bank financing, but their advances are generally capped at a quarter of a million. To this end, you must determine if your enterprise can benefit from this approach or if a business line of credit is the more feasible option. A business line of credit, on the other hand, extends more capital so you can expand your business and take care of other capital-intensive endeavors.
These financing methods are suitable under the following circumstances:
- Low credit score – if you have a poor credit rating, procuring a standard banking loan is not feasible as banks will hesitate to extend credit to such clients. In such a situation, applying for MCAs or business line of credit are the next best options.
- Speedy access – if your business is in a precarious situation (as most startups are) getting quick funding is vital to making payroll, paying vendors, purchasing inventory, upgrading old equipment, etc. to prevent things from crumbling. When the economy is volatile, being cash trapped even for a week can have dire consequences on the micro business.
- Flexible cash – typical bank loans come with strings attached, which means you have to spend the money as stated. The financial options above don't need a specific reason to qualify, so you are free to allocate the funds freely.
Merchant Cash Advances vs. Business Line of Credit
The above benefits of these working capital loans notwithstanding, you must determine which method is most befitting for your business to realize the goals you are pursuing. Understanding the unique advantages of each option is vital in helping you make an informed decision.
When to Take Merchant Cash Advances
After taking a great look at your enterprise, you can turn to MCAs under these conditions:
Businesses like restaurants in a tourist area could do with MCAs as they can pay more or less depending on the amount of revenue they are racking in per season. Term loans could cripple your business as interest rates keep compounding even when business is not thriving, so it is best to stay away from them.
You can apply for merchant cash advances online have the funds deposited into the business account within a 24-hour timeframe. This fast turnaround means you can solve emergencies within a short time before things escalate and cause more harm.
Credit Card Transactions
If your business gets the majority of revenue from credit card transactions such as online shops selling consumer goods, securing funding from a merchant is the sensible option. You can leverage this revenue source to acquire financing with the understanding that repayment will not present a challenge. If not, your business may still be eligible for an ACH-based type of MCA where the funds are debited on a recurrent basis from your bank account.
Since merchants rarely ask for collateral, you can use this financing method if there is no collateral or you are unwilling to submit one for preservation purposes. For example, you could have company trucks or the premises itself as collateral, but you don't wish to risk losing such assets as they are essential to your business.
Merchant cash advances are not reported to credit agencies, and therefore, they have no impact on your credit report. If you are contemplating getting a separate loan such as a mortgage or a car loan, Wide Merchant Group can help while keeping you from opening a new line of credit. You can preserve your credit for other essential things down the line and solve your current problems through a merchant loan.
When to Take Business Line of Credit
Considering a business line of credit is best done under the following conditions:
Great Credit Score
When your credit score is as high as 640 and above, it is easy to get loan approval from a bank as they generally pay attention to impressive credit scores. Businesses with such high ratings usually don't have tax liens or bankruptcy filings on the credit history. If you filed for bankruptcy at some point, your credit score must have taken a hit, and loan managers are not pleased, which means convincing them to issue a loan product is an uphill battle.
Need Capital and Cash flow
Business loans accord you much more capital to make significant upgrades in your business while ensuring the cash flow remains stable. With a term loan, you get higher funding and extended repayment terms depending on the type of loan get; you can pay back peer-to-peer commercial loans over five years. This duration accords you workable cash flow without pressuring you to pay back money too soon.
Qualifying for a commercial loan is not automatic as the business must be accruing a certain level of revenue per year for it to be considered. If your startup has taken off with a consistent upward trend over three years or so, there is potential to repay the term loan, and you are confident that an influx of cash will be fruitful. You need to take a hard look at the books to see where things stand by the numbers.
Building up Credit
Having a good credit rating is vital on a personal and business level, and borrowing is one sure way of boosting the figures. MCA data is not submitted to credit companies and therefore taking out such financing does nothing for your credit score. If you wish to establish your business as a worthy client for term loans, start with small manageable loans and honor the repayment terms.
Astute businesspersons understand the need for a healthy relationship with bankers all too well. Having an active line of credit with a traditional lender comes in handy as your enterprise grows and you seek better opportunities. Eventually, you will qualify for a long-term loan such as a Small Business Administration (SBA) loan whose repayment time frame can be up to 25 years. More so, business loans have set installments so you can budget accordingly without hurting your enterprise.
Find a Merchant Cash Advance Near Me
As you can see above, MCAs and term loans are both viable options for obtaining working capital, but one has to be careful when deciding upon the best route to take. These methods vary in three ways: the qualifying criteria, how you get the money, and how you remit these loans to their respective lenders. Start by understanding the goals you are pursuing and measure them against the current status of your business and future projections.
This step will help you determine if your aims are reasonable or not and then adjust them accordingly, so the incoming financing is put to good use. This information will paint a clear picture of what is needed for growth, and the best financing option will become more apparent. Contact Wide Merchant Group at 800-630-4214 to get the financial assistance your enterprise needs to reach the next level.