Having long-established relationships with small businesses pays off when it comes to offering them financing.
That’s clear for traditional banks, which remain the primary go-to financing source for small-business owners, according to a new survey by Morning Consult and Protocol. And it’s also true for major payments companies like PayPal, Square and Shopify.
The survey of more than 700 U.S. businesses with revenues of $1 million to $10 million underlines how banks remain entrenched in the small-business market. It also shows how some major tech companies with access to proprietary cash-flow data have been able to expand steadily into financing.
Most small-business owners in the survey – 94% – have bank accounts. These business owners rely on banks for a range of services, including lending and financing. Most of those surveyed, more than 90%, said they were “very satisfied” or “somewhat satisfied” with their bank.
But major tech companies that began by offering small businesses tools for processing payments or setting up online stores have also emerged as a financing option, particularly for short-term needs.
The most prominent is PayPal, whose online checkout and payments processing tools have been widely used in the small-business market for more than two decades. PayPal began offering financing to its clients about a decade ago, and now offers three types of financing, including PayPal Working Capital, which it launched in 2013 and is geared to short-term business needs.
Nearly three-fourths, or 72%, of business owners who used PayPal’s payments services also secured short-term financing from the company. PayPal financing is offered mainly to users of its tools, although it has a separate loan product, LoanBuilder, which is available to non-Paypal clients.
Square, whose parent company recently changed its name to Block, first gained fame for the ubiquitous payments dongle used at coffee shops and farmers’ markets. But it’s grown far beyond those card swipers. It began offering small-business financing in 2014, and roughly a third of businesses that use Square, 36%, said they also used its financing.
Shopify, which began by helping small businesses set up online stores and expanded into other services like payments processing, began offering financing in 2020. More than a third of small-business owners who use Shopify products also use its financing.
Their sizable customer bases allowed PayPal, Square and Shopify to expand into financing much more easily than alternative small-business lenders, such as Funding Circle and OnDeck. Only 12% of surveyed businesses that used short-term financing used OnDeck, and only 10% used Funding Circle.
Access to proprietary customer data allows companies like PayPal and Block to quickly make risk evaluations or pricing decisions, said Alex Johnson, fintech research director at Cornerstone Advisors. “It often acts as a ‘trigger’ allowing those platforms to proactively identify merchants that may need liquidity and offer it to them before they start shopping around,” he told Protocol.
This makes it convenient and easier for small-business owners to secure financing “because the platforms already know them.” he said. But there’s a downside for small businesses. “It basically short circuits the shopping process and discourages price comparisons,” Johnson said.
PayPal, Square and Shopify offer financing that’s repaid by small-business owners based on a preset percentage of their daily sales, also referred to as sales-based financing. It is similar to the system used by merchant cash advance companies, which are used by 40% of businesses who seek short-term financing in the Morning Consult/Protocol survey.
Small-business advocates have criticized merchant cash advances and other sales-based financing, arguing that companies do not provide adequate disclosures on the total cost of the loans, where APRs can sometimes soar into the triple digits. Some charge a loan fee which isn’t prorated for early repayment: Ironically, the more successful a business is and the faster it pays back a loan, the higher its effective cost of borrowing might be. Lenders argue that a flat fee is easier for businesses to understand and budget around.
Last month, Rep. Nydia Velazquez and Sen. Robert Menendez introduced a bill that would require more-detailed disclosures from small-business financing companies, including APR and total finance charges. Similar proposals have also been presented in New York and California.
Proposed new regulations would enable small-business owners to “make better decisions up front,” Johnson said. “Consequently, it will likely make it harder for online lenders as they will have to compete more clearly on price, not just convenience.”