Is Paypal your Pal?

Fancy new financing

Anjali Oberoi | If you’ve ever had to fundraise for a startup, you know that fundraising is more of a second job than a side job. In fact, the bottlenecks to fundraising efficiently are more often than not internal to startups, with entrepreneurs struggling to allocate sufficient time and resources to it. Even when they manage to do so, fundraising is typically a tedious months-long process, nicely summarized here by Alejandro Cremades.

One thing that Cremades mentions is the greater level of difficulty in accessing funds for first-time entrepreneurs. If you have more than one successful venture under your belt, you can leverage your contacts and reputation to fasttrack the process. On the other hand, if you’re a first-timer, you might get caught in a vicious cycle - you need funds to make a good product, but you also need to prove that your product is good in order to get funded.

Enter new solutions! PayPal and Square have taken note of this situation and the opportunity that it presents for them. Both payment system leaders recently launched brand new divisions that offer quick-lending solutions to their clients. PayPal Working Capital proposes loans as small as $1,000 and as high as 35% of the lendee’s annual revenue. Square Capital’s loans range from $2,000 to $50,000.

Both services boast three unconventional features in the lending space: Firstly, the funds are transferred to you within 24 hours of your application (provided, of course, you’re approved). Secondly, the cost of the loan is a transparent flat fee. In other words, none of these seemingly endless compounded interest payments and incomprehensible late fees. Finally, the loan is repaid with a percentage of every sale you make, withdrawn automatically by the payment system until the full amount is reached. In other words, a few clicks is literally all the effort needed to obtain and maintain a PayPal or Square loan. Think how convenient this could be if your small business faced a sudden cash crunch or a critical equipment failure that would call for immediate replacement. In such moments, the last thing you would want to be doing is running after loan officers and filling loan applications.

It’s about how quickly you need the money

But what about non-emergency situations? On its website, PayPal Working Capital promotes itself as a service to help you “build” and “grow” your business. It features several success stories where PayPal loans were clearly not used to address emergencies. Square Capital uses similar language, and mentions expanding business, purchasing equipment, and recruiting staff as some of the reasons to take a Square loan. Are they really?

Whenever you find yourself swept off your feet by a financial product, remember the old adage: everything comes at a price. In the case of these sexy PayPal and Square loans, the price of convenience may not leap to the eye, but it sure is there, hiking up the total price of the loan, i.e. basically the difference between the money you’ve received and the one you’ll pay back. Can that price hike be measured exactly? While it may seem that assessing fixed-fee loans against standard compounded interest loans is like comparing apples and oranges, there are mathematical ways to do so. For example, you can calculate the APR (Annual Percentage Rate) that a fixed-fee loan would have if it were repackaged as a compounded interest loan.

It is precisely to help you do this that we have built the tool to the right. We spent some time plugging sample combinations of annual revenues, desired loan amounts, and repayment levels into PayPal’s Fee Calculator. Each time, we used the fixed fee generated to estimate the loan’s equivalent APR*, and record it in a database connected to this tool.

Check it out for yourself, using the drop-down menus. See for example what happens if you have a business with $500K annual revenue and request a $100K loan that you’ll repay with 20% of your sales. The equivalent APR is around 26.5%. This is probably way higher than the interest you would pay on an ordinary business loan from your bank, or than the APR of a credit line you might already have.

Even if your business makes $1MM in annual revenue and you need a loan of only $25K, the minimum equivalent APR that you’d get with PayPal is about 14%. This is hardly exceptional in the current lending market. Unless again, you need that $25K in cash right now and no one else will lend it to you that fast. Then, a PayPal loan might be exactly what you need.

In conclusion, to the question “is PayPal your pal?” (and “is Square fair?”), there is no simple answer that applies in every situation. The takeaway of this piece is best broken down into three points:

1. The fixed-fee feature might give the illusion that PayPal and Square loans are cheap. That is not true. They’re just more convenient, and you’ll pay extra for the convenience.

2. If you have the choice between a Paypal or Square loan and a more classic bank loan, the latter is likely cheaper.

3. Sometimes you do not have the luxury of choice, and taking a PayPal or Square loan could save your business.

* Illustration by Dannae Alvarez