Choosing Between Business Line of Credit and Merchant Cash Advance
Choosing the right form of financing is one of the most important choices a business has to make especially now that there are lots of options available to small business owners. In recent times there has been a proliferation of lending sources, with all of them claiming to be the perfect alternatives to commercial bank loans which are understandably in short supply. It is, therefore, necessary that a business evaluates loan options carefully and objectively before making decisions. Here we are going to compare two very popular sources of financing in order to enable business owners to make the right choice Those to be compared are merchant cash advance and business line of credit. One thing to note is that one of them could be said to represent traditional financing institutions while the other—merchant cash advance—could be rightly said to represent the alternative lending industry.
Read More: Benefits of Small Business Financing by Merchant Cash Advance Providers
Business Line Of Credit
A business line of credit is something similar to a term loan that is offered by commercial banks. There is, however, a major difference between a line of credit and a term loan. Term loans are a one-time lump sum of cash that is issued to businesses by a commercial bank after the business has met all of the stringent requirements for the loan. This is in sharp contrast with a line of credit in which the bank allows the business to continue to borrow funds up to a certain predefined limit. In addition, interest is not charged on the limit but on the actual amount that is borrowed, unlike a term loan in which interest is charged on the total loan amount. So in a business line of credit, the business can keep drawing on cash as long as the limit is not exceeded. Even when the limit has been reached and the business pays back the loan, it then becomes eligible to draw on more cash. And the earlier the business is able to repay the balance in full the lower the interest rate it is charged. Unlike a merchant cash advance where the borrowing limit is a couple million dollars, the limit for a line of credit is somewhere around $150000. The minimum amount that can be issued is also around $5000. Also, in a business line of credit, when the credit limit is small collateral might not be required, but when the limit is large there is always the need for collateral.
Qualifications for a business line of credit
It is more difficult to qualify for a business line of credit as compared to merchant cash advance. In most cases, traditional lenders offering a business line of credit insist that the business must have strong revenue. Although it is also required for a business to have strong revenue before being issued with merchant cash advance, it is in the limit in both cases that the difference lies. In general, the revenue requirement for a line of credit is much higher than that of merchant cash advance. Traditional lenders such as commercial banks also insist that a business must have an operating history of at least two years before it can qualify for a line of credit. In addition, if the business is seeking for a business line of credit with a high limit, then an additional requirement would be for it to be able to produce sufficient collateral. The general rule, of course, remains that the higher the amount that is needed, the higher the value of the collateral that would be required. Once the collateral is provided and the borrower fails to make payments for the cash that has been drawn, at the required time, the collateral is seized by the bank.
So far it might appear that a business line of credit is something that can only be offered by a commercial bank. This is, however, far from the reality. Although it was the commercial banks had begun issuing businesses with lines of credit, there are lots of alternative lenders who now offer that form of credit to small business owners. These alternative lenders have looser qualifications than the traditional financial institutions such as commercial banks. Alternative lenders offering businesses with lines of credit are known to charge much higher interest rates than commercial banks, which even makes them more expensive than merchant cash advance. Online lenders providing lines of credit would normally require a business to have been in operation for at least 6 months. Online lender s might also insist that for a business to be eligible it must have annual revenue of at least $25000, insisting that the business must have a credit score of 500 or more. The requirements for a line of credit are somewhat similar to that of merchant cash advance howbeit more stringent if one considers the issue of collateral and guarantees. Documents that are typically needed for a business line of credit include personal and business tax returns, business financial statements such as profit and loss statements, as well as the balance sheet.
Merchant Cash Advance
Merchant cash advance is totally different from a line of credit because while the latter is essentially a loan on which interest can be charged, the former is not structured as a loan. Because merchant cash advance is not a loan, there are no fixed terms in a merchant advance transaction. Unlike a business line of credit that has fixed terms of payments especially when it is obtained from a commercial bank, a merchant cash advance does not have fixed payment terms. For example, in a line of credit the payment period is fixed and if the business is unable to pay it could lose the collateral. But in a merchant cash advance transaction, there are no such deadlines for payments. In addition, there are no rewards for supposed early payments nor are there punishments for late payment. It has even been shown that a business gains nothing by paying a merchant cash advance in the shortest possible time.
A merchant cash advance unlike a business line of credit is a commercial transaction involving two businesses. One of the parties is the merchant cash advance provider while the other is the business seeking the advance. From this, it is clear that a merchant cash advance transaction is between two businesses and as such laws that govern business to business transactions do not apply. Also, regulations that govern loan transactions have no effect on merchant cash advance. Of course, this does not mean that the merchant cash advance industry is chaotic. The reality is that other relevant laws overseeing the conduct of business such as the uniform commercial code and the fair credit reporting act apply. In addition, leaders in the merchant cash advance industry are also working towards developing somewhat universal conventions for the industry even though individual providers will not be under any obligation to abide by those.
In order to obtain a merchant cash advance, the business has to fill an application along with the required documents. The process is much simpler than that of business line of credit since everything can be sorted out in less than a week. The major issues to be decided on are on the factor rate and the holdback percentage. The factor rate is what determines how much the business gets to pay for the service. Factor rates are often less than 1.5, while holdback percentages representing the portion of the daily credit card sales that are to be remitted to the merchant cash advance provider is typically less than 25 percent. Once an agreement has been reached on these two critical issues as well as other minor ones, both parties proceed to sign the merchant cash advance agreement.
Read More: The Best Unsecured Business Loans of 2018
Final words on a business line of credit and merchant cash advance
So far we have examined in detail what a business line of credit and merchant cash advance are. It is obvious that both sources of business funding differ markedly in certain key respects. For example, while a line of credit providers require business owners to sometimes provide collateral, merchant providers provide totally unsecured loans. This is one area where merchant cash advance emerges superior to a line of credit. This is because most small businesses in dire need of working capital might not be able to produce the required collateral. Also significant is the issue of approval rate. It is fact that merchant cash advance has an approval rate of more than 90 percent while a business line of credit has an approval rate of less than 50 percent especially if the lending institution is a commercial bank. Meanwhile, the speed at which a merchant cash advance can be obtained is almost phenomenal when compared with that of a line of credit. While a merchant cash advance could be delivered within 48 hours if the loan amount is small, it takes several weeks or months for a line of credit to be fully approved. Judging from all of the following, it is quite clear that merchant cash advance is the better option for small business in dire need of cash.
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