Square is taking a step into a new frontier.The company announced on its blog that it is expanding Square Capital beyond cash advances and into flexible loan products. Merchants can apply online for the loans and receive them as soon as the following day.These loans would carry an 18-month term and would charge a 10-16% interest rate, reports the Wall Street Journal.Celtic Bank, a third-party industrial bank, would originate the loans, which institutional investors would then purchase. This process is similar to other setups of companies such as OnDeck and Lending Club.
Square would use data taken from payments made on its readers to determine how credit worthy a borrower is. Furthermore, Square would also purchase a portion of its own loans in order to take on some of the risk, which in turn would project confidence in the product to investors.
Square Capital is one of the company’s fastest-growing product segments. It issued $400 million in advances in 2015, and more than one-third of that total came in the fourth quarter. Merchants have been using those advances to invest in long-term upgrades, which could help Square generate additional revenue in the long run.
The company could also reap the benefits of long-term lending to consumers, as it would earn fee revenue from the loans it offers through Square Capital.
Square said in its 2015 S-1 filing that it was not yet profitable, and it has been trying to diversify its business as a result in order to boost revenue outside of its mobile point-of-sale product. The revenue earned from loans could help in that mission.
The company could also attract borrowers because its new lending product would charge interest rates that are competitive with, and in some cases lower than, APRs charged on business credit cards. Some small businesses could even consider going through Square in this case.
Finally, Square could become more competitive with other online lenders if this strategy pays off. Square can personalize and use lending as just one piece of a full service suite, which would help the company avoid issues facing the online lending landscape, such as shaky global markets and pressure from regulators.
Square would be wise to try to foster this type of relationship with small businesses. 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).
John Heggestuen, managing analyst at BI Intelligence, Business Insider’s premium research service, has compiled a detailed report on small business lending that explains how these digital-lending programs work, how they stack up to alternatives, and why banks should be worried about these programs taking off.
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.
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