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With Square Capital, Square Begins Offering Controversial Merchant Cash Advances

Jack Dorsey's company launches a pilot for offering what are essentially unregulated loans.

Franz Pfluegl/Shutterstock
Jason Del Rey has been a business journalist for 15 years and has covered Amazon, Walmart, and the e-commerce industry for the last decade. He was a senior correspondent at Vox.

Square’s search for new revenue streams is pushing it toward a controversial industry: Merchant cash advances.

The financial product, which operates outside of the regulation of loans, is often a last resort for financing for business owners who either have bad credit, can’t get a bank loan, or can’t get a bank loan fast enough. So the business owner agrees to pay a “lender” a cut of future sales, plus a fixed cost on top, to get a lump sum of money up front.

On Wednesday, The Information reported that Square was experimenting with extending capital to some of its customers, but few other details were available. Since then, Re/code has viewed two emails sent to business owners that describe the product: Square Capital.

The pilot test for Square Capital comes as Jack Dorsey’s company is looking for new areas of growth and new products to offer small business owners as it decides whether to raise another round of funding or pursue an IPO.

This is how Square Capital works. In one of the emails, Square offers to provide the business owner with a lump sum payment of $7,300. In return, Square charges the owner $1,022, which works out to 14 percent of additional cost. As a result, the business owner will end up having to pay Square back $8,322 in total.

Square tells the business owner he or she has as long as needed to pay Square back. “Your $7,300 in Square Capital will only cost $1,022 regardless of how long it takes to pay back,” the email reads.

But this is one way cash advances differ from loans — the business owner doesn’t decide when to repay Square. Instead, Square takes the payment in the form of a 10 percent cut of the business owner’s credit- and debit-card sales every day until the debt is paid. So the business will be done repaying Square the total of $8,322 once it has reached $83,220 in sales made with credit or debit cards.

The amount owed to Square — in this case $8,322 — does not change no matter how long it takes to hit that number, but the quicker a business pays off the cash advance, the more expensive it is. You can see this by comparing them based on a standard metric of borrowing, the annual percentage rate of interest.

If the business has moderate sales and takes a year to reach the $83,220 required to fully pay off the cash advance, the APR on the above example remains at 14 percent. If it only takes six months, however, the APR rises to 28 percent. And if the business has a fabulous first month after the advance in which it pays Square back completely, the APR jumps up to at least 165 percent.

Square is already handling payments for these businesses, so it likely has a very good idea of how long it will take a given business owner to pay it back. But it’s not clear how good or bad of a deal these cash advances are for business owners without knowing what the duration of the payback period is. The two business owners that received the Square Capital emails that Re/code viewed did not respond to my request for information on how quickly they would generate the sales needed to repay Square.

There are certainly use cases in which a cash advance could make sense for a business owner. If a business has a one-time unexpected expense come up, for example, and can’t get a loan or can’t get one quickly enough, a cash advance could be helpful.

The biggest criticism of these types of financial products is that the lender is cutting into a business’ daily cash flow to repay the advance, often during a period when a business can least afford it. On the other hand, if a business makes nothing, they pay nothing to Square, unlike with some other cash advance programs where payment is still required.

Square spokesman Aaron Zamost declined to comment.

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