Startups and small businesses in need of working capital have funding options, such as business loans and cash advances. Determining whether a loan or a merchant cash advance best suits your situation is a matter of understanding the difference between these funding products.
A business loan is relatively straightforward: loans are paid back with set terms and payments over a predetermined time period. The lender agrees to provide the business owner capital upfront. In return, the business owner agrees to pay back that amount plus interest over the term of the loan.
Typical business loan terms are 3 to 10 years. Interest rates can range between could be as low as 3 percent or as high as 22 percent, depending on the lender, loan type, and the borrower’s credit rating. The borrower will pay a minimum amount of principal and interest on a monthly basis until the loan is repaid in full. Most business loans allow borrowers to make additional payments to shorter the term of the loan, but there may be a prepayment penalty for doing so.
Types of business loans include:
- Term loans
- Asset-based loans
- Business lines of credit
- Equipment loans
- Invoice factoring
- Invoice financing
- Business credit cards
- SBA loans
To qualify for a loan, the business typically needs to have an operating history of at least two years and a strong credit history.
Merchant Cash Advances
The first thing to know is that a merchant cash advance is not a loan, but rather a purchase and sale agreement. The funder agrees to give the business capital upfront in exchange for a predetermined portion of future credit card sales. Another key difference is that a loan is a demand for payment while a cash advance is tied to future receivables.
In addition, a typical advance includes a reconciliation clause that requires the funder to restructure the payment if the business experiences a downturn. This feature means that a merchant cash advance is not a demand for payment and, therefore, not considered a loan.
Another important difference is that loans are based on an interest rate while merchant cash advances are tied to a factor rate, typically in the range of 1.2 to 1.5. When the factor rate is converted into an annual percentage rate (APR), the figure could rise into the triple digits. Because merchant cash advances are not loans, these alternative funding products are not governed by state usury laws.
What Happens If My Business Defaults on a Merchant Cash Advance?
In the event of default, both your business and personal assets will be at risk. Merchant cash advances usually include onerous terms such as confessions of judgment and personal guarantees that allow the funder to seize your business assets and personal property if you cannot pay back the advance. Whether you are considering a merchant cash advance or you are already at risk of defaulting, talk to the experienced debt relief specialists at ReconcileMyMCA.com.