Securing bank loans remains a challenge for many small businesses and entrepreneurs. But for those in need of smaller cash infusions, a new financing option with low fees and flexible payback is gaining attention.
The mobile card reader company Square announced last week that it will now offer cash advances to merchants who use Square to process credit card transactions. Square will charge a fee for the service, but says "since Square Capital is not a loan, there is no interest rate." Nor is there the lengthy application process or protracted approval time that banks are known for.
Square Capital will offer customized advances to merchants based on its own data about their revenue activities. Merchants who take advantage of the offer will pay back the advance and fee with their future credit card sales revenues: a percentage of each day's sales will automatically go toward the Square Capital balance.
One advantage is that merchants' repayments scale to their sales success. The company explains, for example, that if a merchant takes a $10,000 cash advance, then: "Square deposits $10,000 in your bank account upon approval. In return, you owe Square $11,000 in future card sales. The amount you owe never changes, regardless of how long it takes to pay Square. Each day, 10% of your card sales go to paying your Square Capital balance of $11,000. Payment is tied directly to your card sales, so you pay more when business is strong and less if things slow down."
Square is not the first non-bank to offer such services to merchants. PayPal's merchant credit program is called Working Capital, and Alibaba has financed hundreds of thousands of Chinese small businesses.
A recent essay in American Banker gives a sense of the threat these services pose to the banking industry. Columnist Greg Weddell writes:
"In order to stay relevant in small-business lending, banks need to learn from these forward-thinking companies by simplifying their own lending process and integrating the process closely with existing financial platforms. Otherwise, these newer, fiercer competitors' convenience and speed could force banks out of the small-business lending for good."
An earlier American Banker report quotes payments consultant Richard Crone: "It should be a wake-up call for banks. They have to get into mobile, and on both sides [consumer and merchant]. What Square is doing is end to end."
Crone tells American Banker that "small-business lending is the mainstay offering of community banks, typically accounting for more than half of the profit for a community or regional bank." It's why Weddell urges them to compete with Square and others by offering automatic repayments and deposits, speeding up the loan review process, and leveraging their "large networks of potential investors through their wealth management and consumer businesses" to "create their own peer-to-peer small-business lending platforms." He says "banks have the platforms, data, and wide reach" to compete with the more nimble tech companies that are offering small businesses access to cash. But, he notes, "learning to use those resources properly will take time. Banks need to get started now."