Often, a business has to choose between two or more sources of credit. The simple reason for this is that not all forms of business funding will be favorable to a business at all times. Being that this is the case, a business has to carefully examine both sources of financing—assuming the options has been narrowed down to just two— to make optimal decisions. An optimal decision is, of course, one that serves the long-term interests of the business.
What is a unsecured business Line of credit and what purpose does it serve?
A line of credit can simply be viewed as funds which are provided to businesses by commercial banks to enable the businesses to meet their short-term liquidity needs. To cater for the long-term investment needs of a business, a term loan is often provided instead of a line of credit. Because an unsecured business line of credit is often confused with a term loan, it is important for us to differentiate between the two before attempting to compare it with merchant cash advance.
In what ways is a Line of Credit Different from a Term loan?
Any distinction between a term loan and a line of credit is usually centered on two aspects of the contracts on which they are based. First, a line of credit is essentially a debt which has a variable rate and in which the business is committed to providing the business with a fixed amount. But for the term loan, there can be a fixed or variable interest rate depending on the nature of the loan. Another difference between a business line of credit and a term loan is that while business has to pay interest on the full amount that is borrowed in the case of a term loan, it is only required to pay interest on the actual amount drawn against the commitment in the case of a line of credit.
It has also been observed that a bank is exposed to both liquidity and credit risks when it issues a line of credit risks, but that in issuing term loans the bank is only exposed to credit risks. And while the liquidity risks refer to the bank’s commitment to continue to provide the business in question with funds through the duration of the contract, credit risk refers to that risk of the borrower defaulting on the loan. Although both dangers are quite interrelated, a business line of credit is more associated with dangers than term loans.
Why do small businesses sometimes prefer a line of credit to a short-term loan?
One reason a business might consider a line of credit ahead of a term loan is that it offers borrowers with financial flexibility, the kind that cannot be obtained with a term loan. A business line of credit also provides businesses with a guarantee of credit, providing them with a mechanism for managing fluctuations in working capital. But in spite of how good a business line of credit sounds, there some limitations which have made businesses look in the direction of alternative lenders, particularly merchant cash advance providers.
What is merchant cash advance and how does it tackle problems associated with an unsecured line of credit?
Merchant cash advance lenders are alternative lenders that provide mainly small businesses with quick and easy funding in exchange for a share of their future credit card receivables. Unlike a line of credit, interest is not charged for a merchant loan as it is often called; instead, a fixed fee in the form of a unique factoring is introduced. A merchant cash advance is often the choice a business that does not wish to be burdened with some of the problems associated with traditional lending sources such as a unsecured line of credit.
First, it is much easier and faster in general for a business to obtain funding through merchant lenders than it is through banks. Also, a business has to have a close working relationship with a bank before it can be considered for a business line of credit. This is in contrast to what obtains with mca providers who provide loans to any business that happens to meet a few minor requirements such as accepting credit card payments and having minimum monthly sales revenue of $5000. Also, the limit for a unsecured line of credit is much lower than that of a merchant cash advance. For a while a business cannot obtain more than 500k dollars through a business line of credit it can obtain as much as 5 million from merchant cash advance providers.
Furthermore, once a business has drawn up to its limits, it cannot make further withdrawals until it pays off the debt already incurred. However, for merchant cash advance, the business can obtain additional advance even if the previous one has not be paid off, depending on the merchant cash advance provider. That is not all. For an unsecured line of credit, it is typically required for a business to provide a guarantee of some sort, usually in the form of collateral. That merchant cash advance does not need any security given that it is a sales transaction is a significant advantage it has over an unsecured line of credit.
Whether it is from the angle of speed or ease, it is quite clear than merchant cash advance stands as the better option when compared with an unsecured line of credit. Small business owners have found that with even poor credit scores they can have access to business funding which can be obtained in the shortest space of time. It is no surprise therefore that merchant funding has become so popular among small business owners.