Choosing the right financing for your business can often feel like walking a tightrope. Whether it’s managing cash flow, expanding operations, or dealing with unexpected expenses, selecting a reliable funding option is critical for your business. Two popular solutions that often come up in these discussions are a line of credit vs Merchant Cash Advance.
But which one suits your needs? While both options provide access to capital, they operate differently and cater to specific business needs. Let’s find that out in this article.
What is a line of credit?
A line of credit (LOC) is a flexible form of financing that allows businesses to borrow up to a predetermined limit, similar to how a credit card works. Instead of receiving a lump sum upfront, you can access funds as needed and only pay interest on the amount you’ve used. The best part? Once you repay what you’ve borrowed, the credit line becomes available again for the future.
So, when would a line of credit be the best choice? If your business experiences seasonal fluctuations, an LOC is a good option. For instance, a retail shoe shop might use LOC to purchase inventory ahead of the holiday season and repay the balance once sales pick up.
What is a merchant cash advance?
A Merchant Cash Advance (MCA) is a fast and flexible funding option that provides businesses with a lump sum of cash upfront in exchange for a percentage of future sales. The difference between a loan and MCA is that MCA is based on your business’s daily/weekly card sales rather than a fixed monthly payment. How does it work?
Imagine running a restaurant that suddenly needs new equipment. Instead of waiting weeks for loan approval, you could secure an MCA, receive funds within days and start repaying through a portion of your daily sales. The repayment structure is connected with your revenue, so when business is slower, the repayment automatically goes down and vice versa.
Do you need a Merchant Cash Advance?
Line of credit vs Merchant cash advance: The differences
Now that we’ve touched a bit on the definition of both financing methods, let’s look at their differences.
1. Repayment structure
With a line of credit, you have more control over repayment. You only pay interest on what you’ve borrowed, and you can decide when and how to repay, as long as you stick to the minimum payments. On the other hand, an MCA automatically deducts a percentage of your daily sales.
2. Eligibility and approval process
A major difference between a line of credit and an MCA is the approval process. Lines of credit typically require strong credit scores, financial statements and even collateral. Meanwhile, MCAs can be obtained with bad credit as well because they rely on your business’s sales history.
According to a 2021 report by Shopify, merchant cash advances have the highest approval rate of 87% in comparison to line of credit (79%) and business loans (70%).
3. Cost of borrowing
The cost of borrowing is another major difference between a line of credit and Merchant Cash Advance. LOCs generally have lower interest rates, which makes them a more affordable option in the long run. MCAs, on the other hand, use factor rates, which can range between 1.2 and 1.5, often making them more expensive overall.
4. Funding speed
Need cash fast? This is where an MCA shines. You can typically get funds within 24-72 hours (even on the same day as well), whereas an LOC might take longer to get approved, depending on your creditworthiness. If time is of the essence, MCAs can be a lifesaver, even if they come at a higher cost.
5. Flexibility
A LOC gives you flexibility in how you use and repay the funds. It’s revolving credit, which means once you repay, you can borrow again without reapplying. An MCA doesn’t work this way – you get a lump sum and start repaying immediately from your sales, with no flexibility to borrow more without a new agreement.
| Feature | Line of credit | Merchant Cash Advance |
|---|---|---|
|
Repayment structure |
Flexible; you only pay interest on what you borrow, with control over when to repay. |
Automatic deductions from daily sales, based on a percentage. |
|
Eligibility and approval |
Requires strong credit, financial statements, and possibly collateral. |
Easier approval, even with bad credit, based on sales history. |
|
Cost of borrowing |
Generally lower interest rates, making it more affordable long-term. |
Higher cost due to factor rates (1.2-1.5), leading to greater overall expense. |
|
Funding speed |
Approval can take longer depending on credit; slower access to funds. |
Fast approval (24-72 hours); ideal for quick access to cash. |
|
Flexibility |
Revolving credit; can borrow again after repayment without reapplying. |
Lump sum with no flexibility for additional borrowing until a new agreement. |
Pros and cons of a line of credit
When comparing line of credit vs Merchant Cash Advance, it’s important to weigh the pros and cons of each option. Let’s discuss LOC first.
Pros
- Flexibility: You can borrow as much or as little as you need, up to your credit limit, and only pay interest on what you use.
- Lower interest rates: Compared to MCA, lines of credit often come with lower interest rates, making them cost-effective in the long run.
- Build business credit: An LOC can also help improve your business’s credit score. By borrowing responsibly and repaying on time, you build trust with lenders, which leads to better financing options in the future.
Cons
- Difficulty to qualify: Lines of credit typically require strong financials and a good credit score. If your business has a less-than-stellar credit history (i.e. below 650) or is just starting out, you might find it tough to get approved.
- Potential for overborrowing: The flexibility of an LOC can also be a curse. Without careful budgeting, it’s easy to overextend yourself, leading to mounting debt.
Pros and cons of a merchant cash advance
Now, let’s take a closer look at the pros and cons of an MCA.
Pros
- Quick access to cash: Most MCAs are approved within 1-3 days, making it a great option if you need cash fast. Whether you’re dealing with an urgent repair or a sudden inventory shortfall, an MCA can deliver the funds you need without the long wait times of traditional loans.
- Easy approval process: Obtaining an MCA is easy. Unlike a line of credit, MCAs don’t rely heavily on your credit score. The primary factor is your business’s daily sales, specifically through credit card transactions. So if your credit score isn’t the best, but you’ve got steady sales, you’ll likely qualify for an MCA.
- No collateral required: Another plus? You don’t need to offer up collateral. Traditional loans require you to put up assets like equipment or property. But with an MCA, you’re simply repaying through a percentage of your sales. There’s no need for a credit check, in some cases, as well.
- Flexible repayments: When sales are high, you can pay more. When sales are slow, you can pay less. This is quite helpful in keeping your cash flow balanced.
Cons
- Higher cost: While the fast approval and ease of access are great, they come at a price. MCAs typically have higher costs due to factor rates, which can range from 1.2 to 1.5.
- Dent on cash flow: Repaying an MCA daily or weekly can become a burden if your business experiences fluctuating sales. During slower months, the constant repayment deductions could tighten your operational budget, leaving you scrambling to cover other expenses.
LOC vs MCA: Which is better for your business?
When it comes down to the ultimate question: line of credit vs Merchant Cash Advance, the answer depends on your business’s unique needs.
1. What’s your cash flow situation?
Is your business seasonal or does it generate consistent, year-round revenue? If your cash flow fluctuates, an LOC may be a better fit. It gives you the freedom to draw funds when needed and repay when the timing’s right.
2. How quickly do you need funds?
Do you need cash within 1-2 days? If time is important, then an MCA is the way to go. With funds available within 24-72 hours, they are a lifesaver when you’re facing urgent situations like equipment breakdowns.
3. How’s your credit?
The condition of your credit score can be the deciding factor in the line of credit vs MCA debate. LOCs typically require a stronger credit profile, with lenders closely scrutinising your financials. If your credit score is higher than 650, an LOC might be your best bet.
4. Cost considerations.
Let’s face it, no one wants to throw money down the drain. If keeping costs low is your top priority, an LOC usually wins. The lower interest rates make it a more affordable option, especially when you plan to repay the loan over an extended period.
5. How long do you need the funds?
If you’re planning for long-term growth or need capital for ongoing expenses, an LOC provides the kind of revolving credit that’s ideal for long-term use. You can borrow, repay and borrow again without reapplying.
6. What’s your risk appetite?
Do you like to play it safe, or are you comfortable with a little more financial risk? A line of credit offers more predictability, with set interest rates and clear repayment terms. An MCA is less predictable – while repayments fluctuate with your sales, the higher cost and impact on cash flow during slow periods make it riskier.
Want to be linked with reliable MCA providers in the UK? ComparedBusiness can help
If you’ve decided to opt for an MCA, ComparedBusiness can ease the process for you. We help you secure merchant cash advance funding from the top lenders in the UK. Just submit your requirements in less than 2 minutes and we will match you with the financial institutions in the UK. You can pick and choose the best option as per your business requirements.
FAQs
MCAs don’t impact your credit score because they don’t involve credit checks or report to credit bureaus. However, failure to meet repayment terms could lead to legal action, which may indirectly affect your credit.
Yes, you can use both a line of credit and a Merchant Cash Advance simultaneously, as long as you can manage the repayment terms of both. However, be cautious, as taking on multiple forms of debt can strain your cash flow and increase financial risk.
Yes, an MCA is a good option for businesses with bad credit, as approval is based on daily or weekly sales rather than credit history. MCA providers focus more on cash flow and sales volume, making it easier for businesses with poor credit scores to secure fast funding.
