Line of Credit vs. Merchant Cash Advance: Which Is Better for Your Business?

Most businesses will encounter a situation where they’ll need fast access to working capital.

And while there are a variety of options for financing—from long-term and short-term loans to invoice financing—when you need quick access to cash there are two popular options you might want to consider: a business line of credit or a merchant cash advance (commonly referred to as an MCA).

Both have their pros and cons, but one may be better for your business depending on your circumstances.

Fortunately, we’ve broken them down so you can decide what will work best for your business.

What’s a business line of credit?

A business line of credit is flexible “revolving” capital that works almost like a credit card, except you get access to cash and, in some cases, lower APRs.

It’s a flexible financing product that lets you withdraw funds up to a predetermined amount—this means you can withdraw funds as you need it, as opposed to receiving the full sum of the loan at once, unlike a term loan. 

A business line of credit is typically used for short-term working capital needs, such as inventory purchases, future project costs, or company payroll.

How do you get a business line of credit?

Banks can be a good place to look for lines of credit, but a number of online lenders offer quicker, easier application processes or requirements.

Banks have high minimum qualifications and often require specific collateral, while online providers can be far more flexible.

You’ll typically need to have been in business for at least six months and have at least $50k in annual revenue to qualify. Generally, there’s no minimum credit score, but lower credit scores will result in higher interest rates, of course.

What does a business line of credit offer?

Credit lines can range from $10,000 to as high as $1 million, depending on your business needs and qualifications. Terms are usually annual with an interest rate based on the prime rate, plus 1% to 3%.

Interest rates vary as the market changes, of course, but many lenders let you withdraw funds—via paper check, online, check card, or other methods—for no fee or very small fees.

However, you can expect to pay a modest fee to open the account once you’ve been approved. For example, you might be charged $150 for credit lines under $25,000 and $250 for larger credit lines. An annual fee is often waived for the first year, and may run $100-$150 annually thereafter. Payments are interest-only on the amount you borrow.

What is a merchant cash advance?

A merchant cash advance is a lump sum of capital you repay using a portion of your daily credit card transactions. Merchant cash advance is a quick, easy way to get a business cash advance with no need for collateral—even if you don’t have a great credit score.

How do you get a merchant cash advance?

Merchant cash advances are often provided through alternative financing companies.

This means they are very quick to procure and have more lenient qualification requirements. Since you’re paying back through your business’s credit card transactions, MCAs often don’t require collateral to secure financing.

You’ll need to have been in business for at least five months, with a 400+ credit score and at least $75K in annual revenue.

What do merchant cash advances offer?

The maximum advance amount you can receive is between $2,500 and $250,000. To determine exactly how much your business pays back, the MCA provider will assign a “factor rate” to the advance you receive. The amount of the advance is multiplied by this factor rate to determine the total amount that must be paid back. Factor rates can range from 1.14–1.44.

The other important number to consider is the “withholding” amount, which is the percentage of your credit card sales that the MCA provider will keep until the full amount has been repaid. Withholding amounts average around 15%, but can be as low as 5% and as high as 40%. Most advances are paid back in full in six to nine months.

What they’re both good for:

• Poor credit: Both of these financing options are easier to procure if you have poor credit.
• Quick access to cash: Both are fairly fast in terms of getting you the cash you need in a timely fashion.  
• Flexibility in what they can be used for: Neither financing option needs to claim a specific purpose for the cash. Just the simple fact that you need it is enough.
• Acting as a bridge to better financing: If you don’t qualify for long-term loans that have lower interest rates, both of these options can put your business in a better place in the future to secure better or more traditional financing.

So how do you choose?

Now that you understand what this financing options are, how do you choose?

Of course, your qualifications will determine your ability to securing financing, and sometimes the best financing is whatever you can get, depending on your situation.

But if you’re deciding between the two, these are some guiding factors you may want to consider.

When you should use a business line of credit:

• If you want to build up your credit score: While MCAs do give you access to quick capital, they aren’t reported to credit agencies. So if you’re looking to build good credit, this will be the way to go.
• If you want to build a relationship with a traditional lender: Both of these options can be offered through alternative or online lenders, but only lines of credit can be given through banks. Establishing a line of credit through a bank is a great way to build a relationship with that bank and eventually convince them to give you more money, such as a long-term loan.
• If you need to even out cash flow: Business lines of credit won’t reduce your cash flow whatsoever. MCAs are designed to take money out of your cash flow with each transaction, so if you can’t handle having less cash on hand, MCAs are not for you.

When you should use a merchant cash advance:

• If your business generates a lot of revenue from credit cards: MCAs are best suited for businesses that are paid primarily through credit cards, so if your business is heavy on credit card transactions—typical for online businesses—MCAs are a great choice.
• If you don’t want to put up any collateral: MCAs seldom require it, so if your business doesn’t have or doesn’t want to, it won’t have to.
• If you want to pay back very quickly: MCAs are typically paid back in less than a year, whereas a business line of credit could vary greatly in repayment plans and options, with interest rates set at an annual percentage.
• If you run a seasonal business: The amount repaid is less when a business is making less revenue and the repayment amount increases when the business makes more revenue. This is in contrast to lines of credit that accrue interest over time, regardless of the time of year.
• If you don’t want a new line of credit on your credit report: As mentioned, MCAs typically don’t report to credit agencies. There are various reasons to desire this—if you’re in the process of securing other financing, such as a mortgage, or if you’re just worried about offsetting your credit negatively, an MCA may be a good choice for you.

As you can see, both of these options have benefits and detractors. But now that you know what those are, you can make a more informed decision for you business when it needs quick, short-term financing.

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