Square Capital Revs Up, Funds $189M to Small Biz in Q2
August 4, 2016
Square is proving that the business loan sector is still hot, especially since their payment processing ecosystem requires nearly no marketing budget to advertise Square Capital. With $189 million funded in Q2, a growth of 123% year-over-year, their shift from merchant cash advances to loans seems to have had the desired effect since they have attracted even more investors willing to buy them.
“We sell a majority of our loans to third-party investors for an upfront fee and a small ongoing servicing fee. In addition, we continue to have a strong continued pipeline of interested investors,” the company said in its earnings report.
The average loan size remains small, only $6,000, but ranges from $1,000 to $100,000. Square CFO Sarah Friar, said during the earnings call that their data shows an overall increase in the gross payment volume of merchants who use their loans, which indicates that borrowers are indeed using the funds to grow their businesses.
A typical Square Capital loan is close to 10% of a seller’s annual processing sales and the average repayment term is 9 months. Loss rates remained steady at 4%.
Friar also said that PayPal Working Capital and American Express Working Capital were not really competition since they are working directly with their own existing user base.
The company made about 34,000 loans in Q2.
Square Sets Foot in UK with Squareup Europe
July 20, 2016Square is making a jump across the pond to sell its service in the UK.
The payments company incorporated Squareup Europe Ltd in London early last month.
The six year old company started by Twitter chief Jack Dorsey plans to provide payment services in Britain which it began testing last month, Reuters reported.
With a presence in the US, Canada, Japan and Australia, the company provides payment solutions to merchants through its mobile point of sale device on iPhones and iPads.
In the US, Square made the natural transition to offering loans to its customers. In Q2, Square reported a loss of $97 million but raised projections for 2016 revenues from $600 – $620 million to $615 – $635 million. With low customer acquisition costs, Square is well positioned to become an easy choice for merchants who already use the product. The company made 23,000 advances for $153 million in the first quarter before moving on to ditch the MCA program for business loans.
Square Capital Has No Borrower Acquisition Costs, Hints at Making Loans to Non-Square Users
May 8, 2016
As the marketplace lending industry frets over acquisition costs, one lender is sitting pretty, Square. That’s because they source their borrowers from their existing payment processing ecosystem. Square CFO Sarah Friar said on their earnings call last week that it was one of the big advantages they had with investors looking to buy loans. “We’re not having to go out and it’s not costing us more to do customer acquisition because it doesn’t cost us anything. We’ve already acquired them,” she said. Compare that to OnDeck who spent $16.5 million in Q1 to acquire borrowers through sales and marketing.
Also on the call, Friar did reveal one benefit of having switched from a merchant cash advance product to a loan product that didn’t have anything to do with investors, and that’s being able to handle clients who want to satisfy the balance in full or obtain additional funds. Since no interest accrues with traditional merchant cash advances, there are no presumed discounts if you want to repurchase your sold receivables. Early repayments were apparently the number one request they received from their clients.
It’s not clear exactly what Square did previously when merchants wanted to “repay early,” but there are other merchant cash advance companies that will allow clients to repurchase back their sold receivables at a slightly discounted price if it’s relatively soon after the original transaction occurred. Either way, Friar said that the shift from MCA to loan hadn’t changed the level of demand.
Notably, while not even directly asked, Friar also said that they are also continuing to look into making loans to non-Square users, perhaps through other card processors.
Jim Cramer Unimpressed With Square Capital’s 4% Bad Debt
May 6, 2016
Jim Cramer told TheStreet that he wasn’t impressed by Square Capital’s 4% bad debt because as he put it, the average default rate on credit cards is about 2.67% right now. That comparison belies the fact that Square’s customers make payments daily, the cost of capital is more expensive than a credit card, and that Square did little or no underwriting to achieve these results.
In fact, a study conducted jointly by AltFinanceDaily and Bryant Park Capital last year determined the average industry (SMB Lending & MCA) default rate to be 6.4%. Square if anything, is outperforming some of their successful peers and given some recent structural changes, they probably stand to improve even further.
OnDeck’s default rate is reportedly about 7% and that’s with an underwriting model often touted as revolutionary.
The comparison between credit cards and Square Capital’s daily payment product is interesting but misleading. Nonetheless, Cramer appears to be unimpressed with alternative lending in general. “Is Square going to be like an On Deck and Lending Club? We don’t want that,” he said, referring to their recently depressed stock prices.
Three days ago, Cramer made his views known through a tweet.
I do not like these new kinds of “banks” https://t.co/DO33G0cBCz
— Jim Cramer (@jimcramer) May 3, 2016
You can watch his comments about Square Capital, OnDeck and Lending Club below:
So far his analysis is quite the opposite of what it was imagined to be 18 months ago.
Square Capital’s Default Rate is 4%
May 5, 2016
Square revealed today that its Square Capital division had extended $153 million through more than 23,000 advances and loans in the first quarter. The company is still transitioning from merchant cash advances to loans to appease institutional investors. This was not only said at LendIt by Jackie Reses but also reiterated in their Q1 earnings report. “We believe that the transition to a loan product further increases our ability to attract new Square Capital investors,” it said.
Their default rate continued to hover at 4%.
That number is shockingly low considering that under a pure merchant cash advance model they did not conduct credit checks, nor did even they review bank statements or tax returns. Rather the company relied almost entirely on a merchant’s sales history with Square.
This process may have made funding easy but was potentially a hard sell to regulators. As part of their transition to a lending model, all applicants are now subject to a credit approval and have to supply identifying documents. Square also bought an analytics startup less than two months ago to help them make more informed underwriting decisions. This can only mean that if their default rate was 4% with no underwriting, their prowess as a lender will likely increase considerably.
Square Capital’s Jackie Reses Reveals Why They Really Gave Up Merchant Cash Advances
April 14, 2016
At Lendit, Bloomberg Reporter Emily Chang asked Square Capital head Jacqueline Reses to explain the real reason behind Square’s shift from merchant cash advances to loans.
Reses said that it was not a customer issue, but an investor one. “This industry and this conference more than anyone understands the nuance between MCAs and loans,” she said. “From an investor side, that’s really where the savings are between the form of an MCA and the form of a loan, in that there’s an actual repayment date.”
Reading between the lines, she seemed to be saying that investors like certainty and exact terms whereas the traditional merchant cash advance product was harder to sell off or securitize because they lack a defined element of time.
Fast loan approvals shouldn’t be criminalized
Referring to the criticism that online lenders have been getting recently for their fast approvals, Chang specifically asked if companies like OnDeck were approving loans too quickly.
Reses responded, “I don’t think the ability to execute something quickly, smoothly, transparently, should be criminalized as something that requires oversight, and so I think being good at something should be well regarded.” She later added, “I think the notion that credit decisions being swift is a problem is just misguided.”
Transparency
Reses used the word “transparency” several times but in explaining such did not reference the disclosure of Annual Percentage Rates even once. Instead she mentioned the importance of spelling out the total dollar cost to the merchants, subtly reconfirming the findings that are coming from many other alternative lenders.
Was the move from MCA just about investors though?
Read our initial assessment and expanded theory.
Watch the full “fireside chat” video below:
Square Baits New Merchants with Payments
March 30, 2016
Jack Dorsey wants Square to be a one stop shop and is baiting merchants with its new payment integration tool.
Square launched new API tools on Wednesday (March 30) for online and retail stores who “with few lines of codes can seamlessly integrate Square into the checkout process.” The company is going after payment giants like PayPal, Braintree and Stripe alluring merchants with an easier-to-use payment tool and is priced similarly at 2.9 percent and 30 cents per transaction.
For its erstwhile customers, picking Square over rivals makes sense given the integration between online and offline sales and for the businesses that do not use Square, the company wants to handcuff them.
At the time of founding, Square’s primary business model was a merchant-first approach. It went after 27 million micro merchants who hitherto were invisible to incumbent players in the space. It took in these small heterogenous group of merchants and equipped and trained them with a dongle to accept card payments for a flat fee.
And now its plan to consolidate a fragmented customer base seems to be working thus far. It recently swapped out its merchant cash advances for bank loans again, similar to PayPal’s loan products.
But why launch a payment tool now? Almost 46 percent of shopping cart abandonment happens at the payment stage frustrating buyers with a lengthy checkout form. And this new API allows online stores to integrate a simple checkout form for card details unlike Stripe which requires an e-wallet sign up. It also launched an API for inventory, payroll management and for registers which can integrate Square’s payment tool with custom point of sale software.
Square is hoping that merchants come for payments and stay for more. “Sellers, even if they don’t have an offline presence today, will have ambitions for where their business wants to go and will choose a provider that, regardless of how their business grows, will be there with them,” Square’s head of engineering Alyssa Henry told Forbes.
What’s next for Square’s gung ho growth?
Why Square Ditched Their Merchant Cash Advance Program
March 27, 2016
Square did $400 million in merchant cash advances last year. Now they are no longer even offering them. To fill the void, they’ve partnered up with Celtic Bank to issue a unique kind of merchant loan, one in which borrowers have a fixed term to repay but make their payments daily by diverting a percentage of every transaction they process to Square.
But why make this change? After all, Square reported that its merchant cash advances typically tended to cycle through to completion in approximately nine months despite there being no fixed term. Their loans will have terms of 18 months, almost ensuring that money will turn over slower, not faster.
Todd Baker, the managing principal of Broadmoor Consulting LLC, says it’s a P/E play. That’s because as part of the change, Square will not be keeping the bulk of the loans on their balance sheet. Instead, they’ll be bundled together and sold to institutional investors. That positions them to be an originator or marketplace dependent on fee income instead of a lender. “Banks and lenders trade at 12x-15x p/e while tech trades at infinity,” Baker said.
Square likely encountered trouble trying to bundle up merchant cash advances because their legal standing across states is not as defined. Celtic Bank-issued-loans however are considered to be rather protected under federal preemption laws established under the Federal Deposit Insurance Act.
But that’s not the whole story either
Online lenders were widely criticized in the wake of the San Bernardino attacks after it was learned the terrorists obtained a loan from Prosper. “The issue may end up being whether marketplace lenders are too easy of a source of cash to finance terrorist attacks,” said Guggenheim Partners analyst Jaret Seiberg in a research letter back in December.
Square’s merchant cash advance program had very little underwriting. The focus was almost entirely on a merchant’s historical sales activity. No credit check was required, nor did applicants have to supply a photo ID or financial statements. This one-click process may have played a major role in originating $400 million in merchant cash advances in 2015, but it probably raised red flags with regulators.
Notably, the new Square Capital application page makes light of this issue. “To help the government fight the funding of terrorism and money laundering activities, Federal law requires all financial institutions to obtain verify and record information that identifies each person who opens an account,” it says. “What this means for you: When you open an account, we will ask for your name, address, date of birth, and other information that will allow us to identify you. We may also ask to see your driver’s license and other identifying documents.”
There’s easy and then there’s too easy. For Square, $400 million a year in merchant cash advances may have been proof of concept for demand but also proof that it was time to slow it down just one notch and make sure they aren’t being reckless.
Few would be impressed by one-click no-underwriting funding if it meant money flowed into the coffers of terrorists even once. Similarly, institutional investors would not be too happy if it was deemed that all of the California merchant cash advances in a bundle they bought were subject to a class action lawsuit. Square can now focus on what they are known for, technology, and perhaps improve their market cap.
By moving away from merchant cash advances, Square has killed at least three birds with one stone. Long live the bank charter model.
