Popular payment processors like Square and Stripe offer business capital loans advertising no interest and flexibility in payments. Many business owners take advantage of these seemingly beneficial options, but often find they are more expensive and less flexible than advertised. Before you borrow, read on to understand how these loans work and the pros and cons of this lending structure.
How Payment Platform Capital Loans Work
Payment platform capital loans have four key characteristics.
There is no application process on these capital loans
Instead, Square and Stripe offer these loans to businesses with a history of collecting revenues through their platform. They use data including length of sales history and volume of sales to determine the size of loan to extend to a particular borrower. Square, for example, only extends loans to businesses that bring in $10,000 of annual revenues. Their loans have an 18 month repayment period, but they offer an amount they believe a business can repay in less than a year.
Borrowers pay a flat fee rather than interest
Both Square and Stripe advertise no-interest loans. Rather, they charge a flat fee, typically 10% of the borrowed amount. For example, they charge a flat $1,000 fee on a $10,000 loan. The borrower will pay a total balance of $11,000.
Payments are made daily as a percentage of sales
Rather than a fixed monthly payment, the payment platforms take a fixed percentage of sales off the top and apply it to the loan on a daily basis. Typically, this percentage ranges from 8% to 20% of sales. This means, using the example above, if the fixed rate is 10%, on a day when a business makes $1,000 of sales, the platform takes $100 toward the total outstanding balance. On a day when sales are $3,000, they take $300. This minimizes situations where there is no cash to put towards the loan.
Periodic Minimum Payments are Required
To reduce their risk, the processors do require a minimum payment over set periods of time. For example, Square requires borrowers to repay 1/18 of the initial balance every 60 days. If this minimum isn’t met, the processor will withdraw the difference from the business’s bank account. However, as discussed above, they’ve factored in sales history, so the business should be able to meet the minimums required.
These loans could be useful if a business has no other debt and needs funds for growth projects. In this situation, the business owner should forecast both current and future (post growth) revenues and expenses. Factor in the fixed percentage of sales that will go toward the loan. Then be sure that the remaining cash flow is sufficient to pay expenses and ideally, save for future needs.
Cautions Regarding Payment Processor Capital Loans
Business owners are at most risk when they use this type of capital loan to pay off existing debt. While a “no-interest” loan featuring flexible payments can be tempting to refinance credit card debt, consider two cautions first.
These capital loans actually lack flexibility
These loans obligate a percentage of sales to repayment. For many businesses, obligating 10-15% of their revenues can leave them lacking cash for necessary expenses. Many businesses incur credit card debt because sales are too low to cover regular expenses. Refinancing to a loan that obligates a portion of revenues can actually decrease the amount of cash available for expenses. Often, this results in growing a new credit card balance.
In comparison, a traditional loan requires a fixed monthly payment, but allows the business owner to choose when to make larger payments without obligating them to do so. If you accept a processor loan, be sure to analyze if your company’s cash flow can absorb the required payment percentage.
The cost of borrowing is typically rather high
While processors advertise these loans as no-interest, the 10% fixed fee is a cost of borrowing. If you pay off the loan in less than a year, the equivalent interest rate is actually higher than 10%. Square loans, which have a term of 18 months, are typically repaid in 6-9 months.
Let’s say, rather than accept a Square loan for $10,000, you used a credit card charging 15% interest and paid the balance off after six months. Because interest only accrued for six months on the credit card, you’d pay about $750 in interest. (The annual interest of $10,000 times 15% = $1,500, divided by two because you’re only borrowing for half a year.) Interest of $750 is half of the $1,500 fee Square charges to borrow the same funds for the same period. Rather than take a Square loan, you could keep the balance on the card (or other lower interest-rate debt). If you pay the same percentage of sales to card debt, you effectively pay less to borrow the same funds.
Determine if Capital Loans are Right for You
Loans from processors can be appropriate if the borrower needs the discipline of the steady daily payments toward the balance. They can also fund growth projects that should result in increased revenues.
However, before taking a capital loan like this, be sure that remaining cash flow is sufficient to meet expected expenses. If it isn’t, create a plan to meet or reduce those expenses without using other high-interest debt. As always, analyzing the various options will ensure that you access funds at the least cost and greatest flexibility.