KEY POINTS

  • Small businesses are often in need of quick capital that can't be accessed through traditional bank loans or credit cards. The 2008 financial crisis left hundreds of thousands of small businesses with pent-up demand for working capital to grow their businesses. Only 2.4 million traditional loans were originated to businesses with $1 million or less in revenue in 2013, down 54% from 2007.
  • To fill this niche, a handful of start-ups and payments companies are now offering small businesses a financing opportunity that works like an advance on sales. In this report, we focus on two examples: Square Capital and PayPal Working Capital. These programs offer merchants financing in exchange for a fixed fee which is paid back as a percentage of the merchant's daily sales. If merchants have no sales on a particular day they pay nothing.
  • The programs are most competitive with credit cards and banks loans. Though the equivalent annual percentage rate (APR) of these programs is higher, they can save time, the terms are clear, and repayment is automated. Merchants often value these features enough to pay what equates to a premium.
  • Square, PayPal, and others are offering these lending programs because they can meet an existing demand among merchants they have already acquired as clients. Both companies are seeing more pressure on their primary card-processing businesses as new entrants such as Stripe and Amazon gain market share. Capital lending offers a high return without extensive startup costs.
  • Banks should be worried. These programs compete with existing banking products, including credit cards and bank loans. Even though these programs tend to be more expensive than loans and lines of credit, a large group of merchants turn to them because they can gain access to financing more quickly and easily and because the repayment schedule tracks their business performance. In addition, Square and PayPal could adjust their loan terms to make them even more competitive with banks' interest rates.

Small Business Lending VolumeBI Intelligence

Introduction

Small businesses are often cash-starved [...]