A business cash advance is an increasingly popular alternative to a small business loan.  It makes working capital available to small businesses that do not qualify for traditional business funding in this economic climate.

At the end of the day, providers of small business loans and business cash advances have the same goal in mind: to give business owners access to the capital they need to support and grow their businesses.  The way they work from beginning to end, however, is very different.  They both have strengths and weaknesses.  The main differences are outlined below.

Application Process

The application process for a business cash advance is substantially easier than that of a traditional small business loan.  Traditional business loans can take weeks or months to process and require mountains of paperwork.  Business cash advance pre-approvals can take just a few hours, and funding can occur within 2 – 5 business days.

Paperwork Required

Most business cash advance providers only need to see a few credit card processing statements and some business bank statements in order to approve an applicant.  They may also verify some trade references and confirm that the applicant is current on his obligations to his landlord or mortgage, but this is usually done quickly and doesn’t interfere with the funding process.  Providers of traditional bank loans, however, are much more demanding.  While it will vary from bank to bank you’ll typically be asked to submit your business plan, a summary of your company’s management structure, year-to-date profit and loss statement and balance sheet, a personal financial statement, at least 2 years of personal and business tax returns and a statement summarizing your intended use for the capital.  Once all the paperwork is submitted, if your business and personal credit is less than perfect, you’ll probably be declined.

Credit Requirements

Business cash advance providers have very lenient credit requirements. While a credit pull will be necessary, it’s not the actual credit score that they are evaluating.  What they’re checking for is to make sure the applicant is not in open bankruptcy and that there aren’t any major liens or judgments that could interfere with their ability to collect.  A credit score below 500 will not necessarily disqualify you from receiving an advance.  Additionally, once you’re approved and funded, you are free to use the funds however you see fit.

Cost

Small business loans carry a certain interest rate that defines how much more the borrower pays back compared to how much they borrowed.  Interest accrues over time, so the longer the loan takes to pay back, the more it costs.  Merchant cash advances, however, are more closely related to invoice factoring, except that instead of factoring sales that have already occurred, cash advance providers factor sales that are projected.  They purchase merchants’ future credit card receivables at a discount, and provide that capital upfront in the form of a cash advance.   The discount rate varies according to a number of variables, but it typically falls between 15% and 30% of the amount purchased.  What this means is that an MCA provider may purchase $100,000 worth of receivables, for example, by advancing a business between $70,000 and $85,000 upfront.  Business cash advances usually take anywhere from 6 to 18 months to pay back in full, but there is never a fixed payment schedule and there are no penalties for taking longer than expected to pay back.

Payback Methods

While there are exceptions, most MCA providers require that merchants convert their merchant account to a credit card processor that is set up to do what is known as “split funding.”  Split funding is the preferred process by which MCA providers get paid back.  The credit card processor takes a percentage of each transaction and forwards it to the MCA provider, who applies that amount to the merchant’s remaining balance.  The rest of each transaction is deposited to the merchant’s bank account like normal.  This percentage is generally small, between 10% and 25%, and is agreed upon prior to the MCA provider funding the advance.  The advantage to this process is that business owners don’t have to worry about or remember to write checks at the end of each month, because payment is rendered automatically through the normal course of business.  Split funding is particularly beneficial for some businesses (especially in certain industries or geographic locations) that experience strong seasonality.  If business slows down in a given month, so does the amount they pay towards their balance.  Traditional banks require business owners to commit to a fixed monthly payment, that is either debited directly from the merchant’s bank account (regardless of the existing balance).  This can cause overdraft fees and other penalties.  Another option is that the business owner submit payment to the bank manually.  While this is more desirable than an automatic payment, it is also possible to forget such a payment which can again, result in substantial penalties.

Events of Default

If you have a run of bad months, banks don’t care; they’re going to get their fixed monthly payment one way or another.  Unfortunately for some business owners, this can mean a number of things, all of which you want to steer clear from.  If you were required to put up collateral or you personally guaranteed repayment of the loan, you’re going to find yourself in a sticky situation in the event you can’t make the payments.  The bank is entitled to take the collateral you put up and liquidate it (below market value if they have to) in order to mitigate their losses.  If you signed personally for the loan, the sky’s the limit for the bank.  They’ll take your house and your car if they have to. This is one of the great things about the business cash advance. There is no collateral and no personal guarantee.  In the event that you have to go out of business, your credit card receivables (which is what the cash advance provider purchased from you in the first place), don’t exist anymore.  It’s tough luck for the cash advance provider.  This doesn’t, however, give business owners a free ticket to take an advance and not repay it just because they don’t want to.  In order to get funded, you’ll be required to agree to certain things in order to protect the cash advance provider’s interest in your future receivables.  The most common clauses require you to process all of your credit card transactions through the agreed upon credit card processor (this is the processor who is set up to “split fund” for the cash advance provider).  There are also clauses to prevent business owners from diverting credit card receivables by refusing to accept payments by credit or debit cards.

These are all great reasons the business cash advance is a desirable alternative for many business owners seeking working capital.  This isn’t to say that if you qualify for a small business loan, you shouldn’t explore the opportunity. To the contrary, we are simply suggesting that you explore the variety of options available in order to make the best decision for your business.