One of my eyebrows has been arched a bit higher than usual ever since I read a story in the Wall Street Journal about a week ago. The piece reported that payments firm Square has partnered with a bank in Utah to offer loans to small businesses. The plan seems to be that businesses will repay the loan over 18 months by sharing a higher percentage of their transaction revenues with Square.
A few days’ perspective have persuaded me to give that eyebrow a day off to relax. For one thing, more choice for borrowers is a good thing in general. And I like how Square is taking elegant advantage of its market position and customers’ behavior. Traditional lenders – yes, I mean you, banks – could learn a lot from this move even if they probably won’t emulate it. Five things in Square’s program point to the future of business lending.
1) Businesses want funds they can obtain quickly and repay easily. (I know, banks – not your forte.)
2) If you trust the source, you are more likely to borrow when the need arises. Square is a transaction platform. If you use it at all, you probably use it often. Merchants used to being paid via Square will probably be comfortable borrowing there too – why wouldn’t they? It’s fast, easy, and repayment sounds like it will be almost automatic.
3) If you are buying money, or anything else, convenience, speed and trust command a premium. If the Wall Street Journal is to be believed, a steep premium – 10% of the amount borrowed.
4) Lending will always be about risk, but how we measure and manage that risk is evolving. Square’s merchant network data and direct access to the borrower’s receivables flow amount to an organic and accurate source of information with a built-in collection mechanism. What lender wouldn’t want that?
5) Think about how that high rate gets borrowers to self-select. If a Square merchant is willing to pay 10% for money (when the Fed is charging banks just 50 basis points) either conventional lenders won’t touch her, or she has found a high return investment in a market she clearly knows better than anyone else.
So… immediacy, network-based cross-sell, behavioral pricing and innovative risk modeling… it sure sounds like internet disruption. Even so, there are still challenges to overcome.
Square’s main market – micro businesses – are more like consumers than corporations. Firms who sell to large corporations and governments are different. They finance their businesses with few working capital options other than their own balance sheets. These firms want the convenience, but need it at much lower fees. They also have to comply with the complicated purchasing and accounting standards of larger corporate supply chains.
Tungsten believes that the models that will succeed in this segment must be able to adapt continually, on both ends of the supply chain. Responding to changes in corporate strategy, investment returns and business conditions, they will recombine funding sources, pricing offers, tenors and risk levels into lending products that come into being to serve a single buyer and seller at a particular moment in time.