Business Growth Funds: The Difference Between a Loan and a Cash Advance

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After the thrill of starting your business, you may have settled into a comfortable day-by-day routine as you established yourself. Now you’ve been up and running for a while and are starting to see opportunities for growth. Whether you want to expand to a new location or offer a new service, you’ll want to create a plan for your business growth. A major part of planning is figuring out how you want to move forward in the next steps of your business with a business growth fund. Two common ways to fund an expanding business are small business loans and merchant cash advances. Even though both provide you with working capital as a business growth fund, they each have different benefits. This guide will help you understand the difference between a small business loan and merchant cash advance as well as who might benefit from each.

How do Small Business Loans and Cash Advances Differ?

Both small business loans and cash advances are types of financing options usually provided by an alternative lender. A small business loan is similar to other loans you may have, such as a car loan or a mortgage. You determine how much you wish to borrow and your lender will provide you with a fixed payment based on your loan term and interest rate. Often offered as a short-term loan, a small business loan has a definitive repayment schedule, so you’ll know from the start when you’ll have the loan paid off.

Unlike a small business loan, a merchant cash advance isn’t technically a loan at all. Instead, it’s an advance on future credit card sales. What does this mean? Your lender will give you a lump sum of cash, similar to funds from a loan, but there is no set repayment period. Instead of monthly payments, your lender receives a small percentage of your business’ credit card sales, known as a holdback.

Benefits and Downfalls of a Small Business Loan

One of the biggest benefits of a small business loan is consistency. You’ll know how much your payment will be and exactly how long it will take you to pay off the loan. This known expense can provide some peace of mind from the unknown risks that come with business growth. A consistent payment requirement also allows you to better plan the goals of your business’ growth.

There are drawbacks to a small business loan as your business growth fund, however. If business slows down, you are still required to make your loan payment. In addition, your interest rate will be dependent on your credit score. This can make a big difference if you’re working to rebuild your credit or are planning to make a major purchase in the near future.

Benefits and Downfalls of a Merchant Cash Advance

Even though small business loan applications from an alternative lender are easier than a traditional bank loan, the process for a merchant cash advance is usually even easier. Most of the time your lender will only need proof of your past credit card sales to verify your business is established enough to qualify. Other benefits of a cash advance include automatic payback. When you record a sale via credit card, you’re automatically paying back the money you owe. Since repayment is a fixed percentage of your sales, you won’t have to come up with cash to cover a loan payment if you have a slow month.

Unfortunately, some of the best parts of using a cash advance as your business growth fund can also be downfalls. By taking a percentage of your credit card sales, you’re only repaying that borrowed cash when you make a sale via credit card. Likewise, because the payment is automatic, you instantly lose that small percentage off of each sale. That small percentage may turn into a larger problem if you’re seeing a dip in sales and need that extra money to pay other costs like rent or covering payroll.

Tips for Choosing Between a Loan and a Cash Advance

Choosing between a small business loan and a merchant cash advance to create a business growth fund can be confusing. You might not know which option will end up most cost-effective for your business. Luckily, there are a few questions you can ask yourself to help you choose which financing option is best for you to expand your business.

When to Choose a Small Business Loan

If you answer “yes” to any of these questions, a small business loan might be a good fit for you.

1. Do you have good credit?

Good credit can have a big impact on your small business loan interest rate. If you have good or great credit, you can usually get a lower interest rate and save on interest costs over the life of the loan.

2. Does your business have a consistent income?

When you have a small business loan, you’re going to make set payments. You want to be sure your business income will be enough to cover this payment and any other expenses you have.

3. Are most of your sales in cash or check format?

Cash advances are only paid back with credit card sales. If your business regularly takes payments in cash or via check, a small business loan is probably a better option.

When to Choose a Cash Advance

Consider these questions to help determine if a merchant cash advance is a good choice for your business.

1. Are most of your sales from credit cards?

Unlike businesses that take a lot of cash payments, businesses that do most of their sale via credit cards could benefit from the convenience of a cash advance. For example, an online retailer who only makes sales through credit cards might be able to repay their cash advance more quickly than a business with a lot of check payments.

2. Do you anticipate a slow period?

Businesses such as landscapers or winter gear retailers understand they will likely see seasonal slow periods. If you choose a cash advance, you won’t have to worry about making loan payments during a dip in sales. On the other hand, when you enter your busy season, you’ll see a faster repayment rate to your cash advance.

Securing Funds for your Growing Business

Watching your business grow and expand is one of the best parts of being a business owner. Take the time to plan ahead for growth. Look at all of your options for a business growth fund, including small business loans and cash advances. Regardless of what type of business growth funding you choose, you should be proud of yourself for taking your business to the next level.

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