Business Cash Advance vs Bank Business Loan

Business Cash Advance vs Bank Business Loans business loans vs merchant cash advance

Many business owners today confronted with the need for working capital are unsure of the lending options available to them. The small business loan industry has changed over the last couple of years and banks are no longer the only resource for business funding. Alternative lending companies are slowly becoming a major supplier of funding for small businesses because they provide fast short term business loans with a very flexible approval process. These additional borrowing options have only made selecting the right lender more difficult.

Today small business owners that are searching for a small business loan are overwhelmed with a variety of financial products being offered and very little information to help understand which product is best for their business. The entire process for applying and receiving funding is clouded with thousands of internet pages that never seem to make the available options clearly understood in terms of cost, rates and terms, what is needed to apply, or many other underlying questions associated with the loan process.

The information below provides a detailed comparison between a business loan from a bank and a business cash advance (also known as a merchant cash advance) that is offered in the alternative lending industry. The data for the business loan application and funding process was compiled with details from one of the nation’s largest banks along with supporting data from some leading financial websites. The data for the business cash advance is derived from our company’s in-house operations along with an analysis of an actual funded deal from the company.

business loan process

Application Submission Process: A business cash advance can be applied for online from the comfort of your home, office, or business. There is never a need for a face to face meeting with the lender, and all of the discussions and document transfers can take place via phone, fax, or email.

A traditional business loan application requires you going into a branch and having several face to face meetings with a bank lending officer throughout the process.

business loan process

Application Documents Required: The typical documents required for a business cash advance include a few months of recent bank statements along with a few of your most recent merchant processing statements. Additionally you are required to submit a one page application along with some basic business ownership credentials and personal identification.

Applying for a traditional business loan requires an enormous amount of paperwork and individual banks can request even more documentation if they deem it necessary for a particular situation. Besides a several page application, below is an approximate list of some of the general documents along with their supporting documentation required:

business loan process

Credit Requirements: Alternative lenders offer business cash advances based on the gross revenue of the credit card processing receipts of the business and not credit scores. The more consistent your credit card sales are the more likely you will get approved. There have been many business owners with a credit score in the 500’s that applied for a business cash advance and received money for their business.

The most common question asked when looking for a business loan is what kind of credit score is required. Banks consider your credit score as a major factor in the approval process. If you plan on applying for a business loan at any bank you are going to require a credit score of at least 700, and it most likely should be closer to 800.[1,2]

business loan process

Collateral Requirements: There are no collateral requirements for a receiving a business cash advance. All of the risk involved falls to the lender. This is another major reason why alternative lending has become very popular.

Most banks require collateral worth more than the amount borrowed. According to the bank in our study a traditional business loan has collateral requirements of a blanket lien on assets and you can borrow up to 70 percent of your accounts receivable and 40 percent of your inventory. These percentages represent your loan to value or the ratio between your loan amount and the appraised value of your collateral. There are obvious variations to required collateral depending on credit score, collateral type, whether specialized or common, and many other factors. There is the possibility of borrowing up to a 100% percent of the collateral when it is secured by a certificate of deposit. The point is that a significant amount of collateral is required with any bank option.

business loan process

Personal Guarantees: There are no personal guarantees required for a business cash advance. All of the risk is shifted to the lender.

Traditional business loans almost always require a signed personal guarantee. This can subject the borrower to the forfeiture of any and all of your property to the bank if you default on the loan.

business loan process

Ownership Requirements: Alternative lenders require business owners to have a business operating for at least three months but prefer a business operating for at least 6 to 12 months in order to be eligible for a business cash advance.

A traditional business loan requires that you must be the current owner of the business for at least 2 years or longer.

business loan process
Available Loan Amounts:
Business Cash Advance $2,000-$1 million
Traditional Business Loans $25,000-$2 million

business loan process

Main Approval Factors: Getting approved for a business cash advance is very easy. The main requirement is that you are a legal owner or partner in a business that generates at least $2,000 in monthly credit card revenue for at least 3 months. Approvals do not require great credit, impressive P&L statements and balance sheets, lofty projections, substantial tax returns, or any other convincing data.

It is very difficult to get a business loan even with the necessary collateral. Besides great credit, substantial personal wealth and significant tax returns, it was noted in a leading financial publication[3] that the bank lending environment is looking for borrowers to clearly establish profitability. Now you not only have to demonstrate solid financial data in both your current P&L data and business balance sheets, but you are also required to provide a detailed demonstration of how you will show profit over the coming years.

business loan process

Term or Length of Time to Payback Funding: A business cash advance does not have a set term but actually has an approximation or projected time period of total payback. Alternative lenders determine your average monthly sales revenue and establish a payment based on a percentage rate that is deducted from each sale. Based on the monthly revenue averages and the amount deducted from each sale you generate, an approximation of time that the borrower will take to pay off the advance is established. It could be a shorter or longer amount of time depending on sales volume, but there are no penalties for shorter or longer paybacks. General approximations range from about 6 months up to 2 years depending on the borrower and other underlying factors.

A traditional business loan at our major bank has two options, up to 5 years if the business loan is secured by a certificate of deposit, and up to 3 years when secured with general assets from the business. There is generally no possibility of extending the time for payback and earlier payoffs may feature a pre-payment penalty.

business loan process

Fees: A business cash advance from a reputable lender does not have any application fees or closing costs.

A traditional business loan has a closing fee of a half percent of the total financed as well as the possibility of additional closing costs such as a flood certificate, title and appraisal fees, insurance costs, administrative filing fees, and other potential fees; and the totals vary from bank to bank.

business loan process

Restrictions of Money Uses: A business cash advance does not have any restrictions on how you use the money. You can pay off unwanted debt, purchase inventory, equipment and machinery, construction, advertising, or you can disperse the money any way you see fit.

When applying for a business loan from the bank they require a detailed explanation as to how you plan on utilizing the money and may require supporting documentation. They may go as far as making the payments or write the checks for you. If for any reason your decisions are not in line with their expectations or requirements you will not get the loan.

business loan process

Turnaround Time: The alternative lending industry has progressively grown over the last few years and in the process many of the lenders have streamlined the process it takes to apply and receive funding. Many small business owners that apply for a business cash advance can be approved and receive funding within the same week that they apply, no matter how large the approval.

Applying for a traditional business loan is a long and arduous process. Due to the vast document requirements in place by banks, and the suitability requirements imposed by regulators, applying for a business loan with a bank can take anywhere from 1 to 3 months or more. There are 2 reasons that make this process so long and drawn out. First, the creation or acquisition of the necessary paperwork to submit an application requires a lot of time and effort. There are almost always corrections needed or additional paperwork requested that only add time to the process. Also, once all of the necessary paperwork is in place the bank is required to do a very thorough analysis and verification process of each document supplied.

business loan process

Rates: (What Both Options Will cost You) A business cash advance has varying rates depending on your credit profile and the overall strength of the monthly revenues for a business. A business cash advance is not quoted like a business loan which might be set at say 8%, but rather at a rate of say 1.29. The 1.29 represents the premium or fee paid on top of the borrowed amount.

A business cash advance is not structured like a business loan with a set interest rate, it is actually set up as a purchase and sale of future credit card revenue at a slight discount. There is also no interest rate so there is no accruing debt. The total cost of a business cash advance is the borrowed amount plus the established premium and that amount never changes no matter how long it takes to pay off the advance.

Below you can look at the payment structure of an actual advance that took place having a 1.29 rate with an expected payment term of approximately 12 months. This is an example deal for analytical purposes and the rates and terms can vary depending on both the lender and borrower for a particular advance.  It is also important to note that the estimated length of time to payback the advance is based on the average monthly revenues of the business with an agreed upon percentage to be deducted from credit card sales which was set at 16% in the following case.

Business Average Monthly Revenues: $53,000
Estimated Payback Term: 12 Months
Credit Card Revenue to be Applied towards Payback: 16%
Total Amount Borrowed: $78,270
Total Amount Paid Back: $101,672.73

Traditional business loan rates and terms are based on multiple factors such as product or industry, relationship with the bank, credit of the borrower, current financials, and much more. Based on the economical climate today and several leading financial references there is a very good chance that a prime credit candidate (close to 800 FICO Score) can expect to pay approximately 8% for borrowing with most banks. In the major bank of our study there was a clearly established term of 3 years. Business Loans are generally structured with bulk monthly payments and in the following example we analyze a loan with an 8% interest rate over a 3 year period.

Estimated Payback Term: 36 Months
Monthly Payments: $2,452.70
Monthly Interest: $278.53
Closing Costs: $391.35
Total Amount Borrowed: $78,270
Total Amount Paid Back: $88,688.45+*

*Does not include application fees and possible additional costs such as flood certificate, life insurance, title and appraisal fees, administrative filing fees, and other potential expenses necessary for approval

Deciding which type of loan is right for you and your business should not be a difficult process. This article should give you the necessary insight to make a solid and educated decision as to which lender and financial product you should choose the next time you require working capital for your business.

Additional Sources:

Source 1. http://www.finweb.com/loans/the-credit-requirements-for-a-small-business-loan.html#ixzz2kdtfhq7F

Source 2. http://www.forbes.com/sites/meghancasserly/2013/02/13/credit-scores-cash-flow-and-collateral-upping-the-odds-on-your-businesss-first-bank-loan/

Source 3. http://www.bankrate.com/finance/personal-finance/finding-a-small-business-bank-loan-1.aspx#ixzz2kYodYn4j