PayPal, Square and other tech companies are disrupting banks as they move aggressively into small-business lending
A handful of payments companies including Square and PayPal are moving beyond their core market in payments to take advantage of an opportunity to help small businesses grow.
Following the 2008 financial crisis, banks severely restricted access to capital, disproportionately affecting fledgling and medium-sized businesses. Annual loan originations to businesses with $1 million or less in revenue fell dramatically between 2007 and 2013.
For payments companies like Square and PayPal this created an opportunity. They are now offering loans and advances to their small-business clients and charging a fixed fee for the capital advance. It's a way to develop a new revenue stream and help their merchants grow (which in turn, means more money from credit card transaction fees). In a new BI Intelligence report, we explain how these digital-lending programs work, how they stack up to alternatives, and why banks should be worried about these programs taking off.
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Here are some of the key points from the report:
- 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 tends to be higher, they help merchants 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. The payments business depends on the number and value of purchases made at merchants since payments companies typically take a cut of each transaction as revenue. Logically, then, payments companies want to serve merchants with growing businesses. But without access to capital, it's difficult for a business to grow. Both companies are seeing more pressure on their primary card-processing businesses as new entrants such as Stripe 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 full, the report:
- Analyzes the market for small business lending and which business are most likely to use digital lending programs.
- Explains how these new lending programs work using Square and PayPal as case studies.
- Details the advantages that payments companies and other businesses see in small-business lending.
- Investigates why banks should be worried about these new lending initiatives and how they might push back.