Re: their small business 'loans' -- with the caveat that I am not an expert:
The "loan" distinction is important not for semantic reasons but practical one -- they are offering small businesses cash advances. These are different from loans because they are not secured. There are no assets put up as collateral. However Square believes they can do this better than other services because they can effectively secure the advance by taking a piece of each card swipe at the merchant's point of sale system. But if the business goes under, Square has no claim on any assets.
I don't totally understand why/when merchant cash advances work, but I believe that adequately captures the 'how'.
Square only offers an advance based upon your cash flow history. There is still risk, but they recoup their loan at a pretty good pace which makes the implied interest rate very high. But- it can be a good deal for the vendor anyhow because it is unsecured, and there is guaranteed cash flow with which to repay it. If you don't make any money, you don't pay anything.
But square appears smart enough only to give the money to people who are fairly certain to have stable enough cash flow to make it work.
On the one actual square example I've seen it looks like the repayment is on the order of 6 months, and is a total of roughly half a month's cash flow.
> If you don't make any money, you don't pay anything
With the transactions, and hence Square's information, being several days ahead of the cash settlement, they might have preferential access to cash in order to recoup from a business that is about to fail.
> However Square believes they can do this better than other services because they can effectively secure the advance by taking a piece of each card swipe at the merchant's point of sale system.
Payment processors have been active in the merchant cash advance space for a long time. What you describe (split withholding) is not new, nor is it something that only Square does. Where split withholding isn't available, merchant cash advance providers set up lock box accounts. This is not a complicated process.
Also of note is the fact that according to Square's S-1, it "fund[s] a significant majority of these advances from arrangements with third parties that commit to purchase the future receivables related to these advances."
Seeing a business' cash flow should give you great insight into their ability to repay. Just a few of the things you can calculate that a bank can't: microtrends in income, repeat customers (and trends thereof), changes in transaction size as well as volume, etc. Plus it's easier to collect on that loan.
1. Square provides merchant cash advance. This is not a loan.
2. Payment processors like Square have knowledge of a company's credit card receipts but cannot determine a company's cash flow unless they obtain additional documentation from the merchant. Calculating cash flow requires not just incomings but outgoings of cash. Payment processors obviously don't have the latter.
3. Merchant cash advance is a last-resort financing option for small businesses. Despite your implied suggestion that merchant cash advance providers have underwriting advantages over banks, there's a reason merchant cash advance is frequently the most expensive form of small business financing.
I don't follow why a bank can't see cash flow? I live in Australia, and here almost everyone is using PayPass by MasterCard or PayWave by VISA - both are contactless PINless card payments. All those transactions have to go in to the merchants bank account.
Um, sure -- but they get bulk deposited, not individual transactions. The merchant account is what sees the individual transactions, and that bank generally isn't the one businesses go to for loans afaik.
The "loan" distinction is important not for semantic reasons but practical one -- they are offering small businesses cash advances. These are different from loans because they are not secured. There are no assets put up as collateral. However Square believes they can do this better than other services because they can effectively secure the advance by taking a piece of each card swipe at the merchant's point of sale system. But if the business goes under, Square has no claim on any assets.
I don't totally understand why/when merchant cash advances work, but I believe that adequately captures the 'how'.