Introduction to Square Capital

Square Capital is a financing tool designed to assist small businesses with growth and cash flow management, offering a distinctive alternative to traditional payday loans. While often mistaken for payday loans, Square Capital aims to cater specifically to the needs of merchants who use Square's payment processing services.

Differences Between Square Capital and Payday Loans

Purpose: Square Capital is focused on small businesses looking to fund growth, manage cash flow, or purchase inventory, whereas payday loans are typically used by individuals to cover immediate personal expenses until their next paycheck. Repayment: Square Capital loans are repaid through a percentage of the business's daily card sales, which can be more manageable during slower sales periods. In contrast, payday loans usually require a lump-sum repayment by the next payday. Interest Rates: Payday loans often come with very high-interest rates, whereas Square Capital's fees and terms are generally more transparent and favorable for businesses.

Micromerchants and Square Payment Processing

For Square micromerchants, payment card processing can serve as their paycheck. This is why Square introduces a loan on this ‘paycheck’. The majority of mayors in 2008, particularly in the 76th annual U.S. Conference of Mayors, voted to outlaw merchant cash advances, equating them to payday loans due to their exploitative nature.

Background and Resolution on Merchant Cash Advances

In 2008, during a hot and humid day in Miami, the U.S. Conference of Mayors voted in a public resolution to protect small business owners from predatory lenders. They addressed significant issues in how finances are provided to small businesses, often leading to financial strain and sometimes bankruptcy.

Key points from the resolution include:

The U.S. Conference of Mayors met to address challenges faced by mayors across the US and to protect the general health and viability of small business communities. Eight million small businesses pursue financing annually, and 35% of them rely on home-equity loans, often at a significant cost. Banks tightening their lending criteria led to a shortage of credit opportunities for small business owners. Merchant cash advances, often at exorbitant interest rates, emerged to fill the lending vacuum, but they are not subject to traditional lending regulations. Mayors advocated for education on the dangers of merchant cash advances and for promoting alternative, more affordable funding sources.

Square’s Strategic Missteps and the Introduction of Square Capital

Despite these warning signs, Square's introduction of Square Capital in 2014 faced criticism. The company acknowledged cherry-picking micro-merchants and faced scrutiny over marketing practices that simplified repayment structures, leading to potentially misleading interest rates and payment structures.

Jason Del Rey, a journalist at Re/Code, highlighted the issue, emphasizing that the fixed repayment structure, where Square takes a 10% cut of daily credit or debit card sales, varies greatly based on sales performance. Del Rey noted:

“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.”

This structure can lead to significantly higher effective annual percentage rates depending on sales performance, making it a contentious financing option.

Conclusion

While Square Capital provides a much-needed financial solution for many small businesses, its high APR and repayment structure can be misleading. Understanding the true cost of financing and the impact on business cash flow is crucial for entrepreneurs considering these options.