Merchant cash advance vs. line of credit

A line of credit is cheaper than a merchant cash advance by a wide margin, slower to arrange, and often not open to a business early in its life. An advance is faster, several times dearer, and the one you will be offered first. Every page comparing the two says that much and stops. Here is the same $20,000 put through both shapes over the same months, what leaves the account each month, what each does in the month that goes wrong, why the dearer one is the one on offer, and how to get from it to the other.

The same $20,000 through both

The site's two anchors, from the line-of-credit page and the advance page, on one table. Illustrations, not quotes: the 24% is a rate I picked to show the arithmetic, and the 1.30 is the factor rate the site uses everywhere.

Illustrations, not quotes; real terms come from a funding partner. The line-of-credit figures are the line-of-credit calculator's starting position and the advance figures are the advance calculator's.

Read the outflow row before the cost row, because it is the one that explains why owners confuse the two. Per month, the two are within a few hundred dollars of each other. In total, one costs more than four times the other, and the advance runs two months longer. The monthly figure is what the sales call talks about; the total is what you pay.

What happens in a slow month

Both shapes get taken for the same reason, a week the account cannot carry on its own, so the useful comparison is not the average month. It is the bad one.

On the line, interest runs on the balance and nothing else. In the first month of the illustration that is $400. Many lines let you pay only that in a thin month and leave the balance where it is; the cost of doing so is that the balance does not fall, and a line run interest-only for a year is the expensive way to run a line. But the choice exists, and it is yours that month.

On the advance, the same $3,250 leaves the account in the thin month as in the strong one, because the debit was fixed off your average deposits and does not know what this month did. The only thing that moves it is a reconciliation clause, if the contract has one, which you invoke in writing with statements attached. The advance guide walks through that clause and the thin-week test. Same need, opposite behaviour in the month you took the money for. That is the difference to price, more than the cost row.

Why you're offered the more expensive one first

If the line is cheaper and more forgiving, the question is why anyone takes the advance, and the answer is not stupidity. It is which question a partner can answer yes to.

A line is credit. In my read of how it is underwritten, a partner is deciding whether you will pay it back, and it reads trading history, deposits and their consistency, negative days, and the owner's own credit, and it is commonly backed by a personal guarantee. An advance is a purchase of future receivables. The question is narrower: do the sales exist, read from deposits and card volume. Early in a business's life the second question is easier to answer than the first, because there is less history to read, so the advance is usually the earlier shape and the line the later one. The advance costs more partly because it is answering an easier question about a business that has less to show.

None of that is a threshold I can give you, because no partner has given me one. What I can say is which file each shape reads, and the bank-statements guide goes through that file line by line.

When paying more for speed makes sense

Take the $4,600 difference on the illustration, the $6,000 against the $1,400, and give it a name: the price of now. It is worth paying in exactly one case. The money buys something that earns more than $4,600 between today and the month a line could have been arranged, and the line was not open today. Parts for a job already sold. The repair to the truck that is stopping work. Stock for a season that is booked rather than hoped for.

It is not worth paying when what the money buys could wait for the line, or when it earns nothing at all, which is the case of covering a shortfall. Two lines to write down before you sign either: what this money earns before the line could be open, in dollars; and what the advance costs over the line, in dollars. If the first is not clearly bigger than the second, the answer is the line, or waiting, and not the advance.

When you need money twice in a year

The difference grows over a year, because the two shapes behave differently the second time. Say the same need comes twice, spring and fall, $20,000 each, cleared in three months each time. Illustration, not a quote.

The fall row is where owners get into trouble. A line is built to be drawn twice; an advance is a one-time purchase, and the way a funder offers "another" is a renewal: a new purchase, a new fee, sometimes with the old balance folded in. That is the renewal trap, and it is where an advance stops being a step and becomes a home.

How to move from an advance to a line of credit

The advance guide calls an advance a step rather than a home, and the step has a direction. If an advance is what is open to you now, take it for something that earns, and use the months it runs to build the file a line reads.

1. Everything through the business account. Every card settlement, every check, every transfer, so the deposits are all in one place a partner can read.
2. No negative days and no returned items for the months the advance runs. The debit clearing cleanly every day is itself part of the record.
3. Finish it. A completed advance in the statements reads differently from one still remitting; do not take the renewal.
4. Write the half page. Which deposits are what, which months were not ordinary, the advance named with its dates. The bank-statements guide has the list.
5. Then ask for the line, with the completed advance in the file. Partners underwrite and decide, and I cannot tell you they will say yes; I can tell you that is the file a line is read from.

Try for the line first, whichever way you are reading this. If the answer is no, the form is the same either way: it takes about two minutes, asks for bands rather than figures, and I do not run credit on it. Say what the money is for and when it earns, and the shape follows from that.