What is the difference between a merchant cash advance and a loan?

A Merchant Cash Advance (MCA) and a loan are both forms of financing, but they operate differently in terms of structure, repayment, costs, and how they’re treated legally. Here's a comparison of key differences between an MCA and a loan:

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1. Structure

Merchant Cash Advance (MCA):

An MCA is technically not a loan; it’s an advance on future sales. The MCA provider gives the business a lump sum in exchange for a portion of its future credit card or debit card sales or daily revenues.

The business agrees to repay the MCA as a percentage of daily sales (or via fixed ACH withdrawals in some cases), meaning repayment fluctuates depending on how much the business earns each day.

Loan:

A loan is a more traditional form of debt financing, where a lender provides a lump sum of money that the borrower agrees to repay over time, typically with fixed payments. These payments include both principal and interest, and they are usually made on a monthly basis.

2. Repayment Terms

MCA:

Repayment is typically tied to a percentage of daily credit card sales or daily/weekly bank deposits. If sales are lower, the amount deducted is lower, providing more flexibility in slower business periods.

There’s no set timeline for repayment; the repayment period can fluctuate based on sales performance. However, most MCAs are repaid within 6 to 18 months.

MCAs often include a factor rate, which is a multiple applied to the funding amount, rather than a traditional interest rate. For example, if a business is advanced $50,000 at a 1.3 factor rate, it will repay $65,000 in total, regardless of the time taken.

Loan:

Loans have fixed repayment schedules (monthly payments) over a specified term, such as 12 months, 5 years, or longer, depending on the loan type.

Repayment is in set amounts that don’t fluctuate with business performance, which can be challenging for businesses with seasonal or fluctuating revenue.

Loans have an interest rate (APR), which accrues over time, meaning the cost of borrowing can increase if the loan is not repaid quickly.

3. Cost and Pricing

MCA:

MCAs are typically more expensive than loans. They charge a factor rate, usually between 1.1 and 1.5, meaning businesses repay 10-50% more than the original advance amount. This is not calculated as an interest rate, but the effective cost can translate to very high APRs (often in the range of 40-200% or more, depending on repayment speed).

The quicker the MCA is repaid (due to higher sales), the higher the effective cost because the total repayment amount is fixed, unlike loans where interest accrues over time.

Loan:

Loans generally have lower interest rates than MCAs, especially if they’re secured (backed by collateral) or issued by traditional banks. Interest rates for business loans usually range from 5% to 20% APR, depending on the borrower’s creditworthiness and the type of loan.

The total cost of a loan is spread out over the repayment term, and interest accrues on the outstanding balance.

4. Qualification Requirements

MCA:

MCA providers focus more on a business’s cash flow and credit card sales volume than on credit scores. Businesses with poor credit or those that don’t qualify for traditional loans often turn to MCAs.

Approval for an MCA is based on business performance, specifically the volume of daily or monthly sales. As a result, MCAs are easier to qualify for and require less paperwork than loans.

MCAs typically don’t require collateral, since repayment is directly tied to sales.

Loan:

Traditional loans usually require a strong credit history, a personal or business credit score, and detailed financial documents like tax returns, profit and loss statements, and business plans.

Many business loans, especially those from banks or the SBA (Small Business Administration), may require collateral such as business assets or personal guarantees.

The approval process can take longer, often weeks or months, and it is more stringent compared to MCA approvals, which can take as little as 24-48 hours.

5. Legal and Regulatory Treatment

MCA:

Since MCAs are not considered loans, they are not subject to many of the lending regulations that apply to loans, such as interest rate caps or Truth in Lending Act (TILA) disclosures.

MCAs are structured as a sale of future receivables, which means they operate in a legal gray area with less oversight compared to loans.

This lack of regulation can result in higher costs, more aggressive collection practices, and fewer protections for the borrower.

Loan:

Loans are highly regulated. Consumer protection laws apply to loans, which means lenders must disclose key details, such as APR, fees, and repayment schedules.

Usury laws (laws that limit the amount of interest that can be charged) often apply to loans, especially for small businesses and consumers, providing more protection from predatory lending.

6. Flexibility

MCA:

MCA repayment fluctuates based on daily sales, offering more flexibility for businesses with seasonal or variable revenue. The more a business earns, the faster they repay the MCA; if sales slow down, repayment slows down as well.

However, MCAs generally cannot be restructured or refinanced easily if a business is struggling to meet payment obligations.

Loan:

Loans offer less flexibility in terms of repayment; payments are fixed regardless of revenue fluctuations. However, some loans (such as SBA loans) allow for refinancing or restructuring if needed.

Loans can often be used for a variety of purposes (working capital, equipment purchase, real estate, etc.), while MCAs are typically intended for working capital.

7. Use of Funds

MCA:

The funds from an MCA can be used for a wide range of purposes, such as inventory purchases, payroll, equipment repairs, or other working capital needs.

Loan:

Loans can be tailored for specific purposes (e.g., business expansion, real estate, equipment purchase), and the terms and repayment periods are often customized to the purpose of the loan.

Conclusion:

The main difference is that an MCA is not a loan, but an advance on future sales, offering more flexibility but at a higher cost. Loans, on the other hand, provide lower-cost financing with fixed terms but require stronger qualifications and more regulatory protections. MCAs are typically used by businesses that need quick, short-term funding and have difficulty qualifying for traditional loans.