Merchant Cash Advances and alternative lending programs are fundamentally different than traditional business credit products. With an MCA and most alternative lending, a business is leveraging their future receivables to receive an advance, while a traditional loan is a standard credit agreement. A merchant cash advance is not legally a loan at all. On paper, it's a purchase of a business' future receivables (future expected revenue). The MCA funder isn't lending you money — they are buying a portion of your future sales at a discount, and advancing you the cash now. Alternative financing is available to a larger pool of businesses than traditional loans simply because most businesses can't be approved for traditional financing.
A traditional loan from a bank charges an interest rate that accrues over time on your outstanding balance. Traditional bank lending for small businesses is much cheaper than Merchant Cash Advances because banks are restricted by usury laws related to how much interest they can charge. Since banks are limited by how much they can charge in interest, their underwriting guidelines must be much stricter than alternative finance options. With bank rates for business loans at under 15% APR, there is no room for defaults — hence why banks are extremely selective in issuing business credit.
Besides the drastic difference in the cost of capital, the terms are also drastically different. MCAs are generally paid back within 18 months, while traditional business lines of credit or SBA guaranteed loans are set to be paid back within 5–10 years. The incredibly fast payback of an MCA limits the ability to use the funds to grow the business. With traditional financing, there is ample time to invest working capital into systems, people, and equipment that will generate increased revenues.
Obviously traditional bank financing is far superior in rates and terms than MCA, but most businesses can't qualify for traditional financing. Small businesses are left without options when seeking working capital.
Alternative Lenders (MCA funders) are able to issue funds to less creditworthy businesses because MCA funders aren't restricted by rates. Seemingly risky advances to businesses are normal in the alternative lending space because the high margins on advances outweigh the losses on defaults.
The number one reason most businesses can't obtain a traditional business loan is because the business is not creditworthy enough to qualify for bank-level programs. This is the reason for the massive increase in alternative lending programs for small businesses. MCAs are notorious for high rates and short payback terms, but most businesses can't qualify for anything besides an MCA. There are limited options for traditional financing if a small business is under 2 years in business, is not showing profitability, or if the business/owner lacks sufficient established credit.
For small businesses that aren't qualifiable for bank-level programs, there are definitively limited options. As a result of this Small Business Credit Gap, the small business lending market has exploded in size, creating different programs and opportunities for business owners who can't qualify for traditional bank programs.
These programs often leverage not only the business revenues, but also the personal creditworthiness of the business owner. Even though most businesses can't qualify for bank programs right now doesn't necessarily mean they can't qualify in the near future. This has to do with 3 general factors, 2 of which you can control:
