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PayPal's Small Business Lending 'Accelerating' On The Way To $1 Billion

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PayPal got into small-business lending almost two years ago as an add-on for its merchants, and in May the company said its total loans had surpassed $500 million, and that it was lending out $2 million a day in the U.S. alone. But with alternative financing expanding rapidly, and PayPal having an advantage with its captive audience of retailers, I wondered just how fast PayPal's small-business lending was growing now.

In a recent telephone interview with Darrell Esch, PayPal's vice president and general manager of SMB lending, I posed that question, and he told me that the amount of daily lending has been "accelerating" since then. "Where we were doing $2 million before,” he says, “we have moved beyond that point.” While Esch – who joined PayPal from Bank of America – won’t say where its total loan volume is today, if you do a little math it looks like PayPal is on track to reach the billion-dollar mark in the winter.

That fast growth shouldn’t come as a surprise. For alternative lenders in the small-business space, the big question has been how to find enough good borrowers quickly. PayPal, along with American Express and Square, has a built-in base of retail customers, a major advantage in an increasingly crowded market. PayPal built its small-business lending operation off its relationship with merchants on eBay, the online auction house that had owned it for more than a decade until this summer’s spinoff, and eBay’s discussion boards are filled with comments about the program.

With PayPal now on its own, what does the small-business lending program look like? Here are a few key takeaways from my conversation with Esch:

PayPal is attracting larger merchants – including those that have access to traditional banks. The company increased its borrowing limits in the spring, to $85,000 from $65,000, and simultaneously upped the amount a borrower could take on to 15% of sales from 8%. The result: Larger merchants have been taking the bite, including some that have access to traditional bank loans that may be available at lower cost but require more paperwork. “I think we always have had customers who have access to banks,” Esch says. “As we move up [in our borrowing limits], more and more of them have access to traditional products. They choose our products over traditional ones, even when a traditional loan is available, because of the speed they can take possession of the funds and because of the way the repayment is tied to their sales.”

For the small-business lending program, it’s business as usual since the spinoff. “We’re not noticing any customer changes directly related to the spinoff,” Esch says. Even for the eBay merchants, PayPal had been reaching them through their existing PayPal accounts, with banner ads promoting the lending program when they log on and targeted emails. And many customers use the loans as a constant source of working capital: Roughly 90% of those who borrow funds from PayPal apply again once they pay off their loans, Esch says. “You can think of this,” he says, “as shoveling coal into an engine.”

The good news about getting your working capital from PayPal: Its fees are clear upfront, and there aren’t any late fees. When a merchant applies for capital, PayPal tells the would-be borrower the maximum they can have. Then the customer chooses any amount up to that limit and picks the amount of daily sales that will go toward repayment – a structure that from PayPal’s perspective takes a lot of the risk out of the financing. “They’ll see a fixed fee in hard dollar costs,” Esch says. “There’s no interest rate associated with it. There’s no late fees, no other hidden fees. It’s a fixed fee.”

The bad news is that borrowers can’t easily compare the costs of PayPal’s working capital with other financing options they may have. Because of how PayPal’s financing is structured – with repayment done as a percentage of the borrower’s fluctuating sales – neither lender or borrower knows exactly what the effective interest rate will be until the funds are repaid.  “We don’t know how long the customer will take to repay. And even if we knew how long it would take to repay, because it is an unstructured payment, we don’t know when those dollars will come in. Some days we get paid nothing. Some weeks we get paid nothing. Because of that volatility, we don’t know,” Esch says. “You could, at the end, go back and calculate it. This is a topic that people are really interested in, and we do want to find a way to do an apples-to-apples comparison.” For most customers, Esch says, if you translated PayPal’s fees into an APR, the effective rates would be in the mid-teens or low-20s, compared with some alternative lenders’ rates in the 40s, 50s or, even, 60s. “We built it to be favorable to business credit cards, which business customers use a lot to finance their businesses,” Esch says. “Some customers could find a term loan at lower prices, but would trade off the speed of financing and the flexibility.”

Regulation is likely – and PayPal is fine with that. Treasury put out a request for comment on alternative financing earlier this summer, and has extended the time period for anyone who wants to respond through September 30. “I have made some trips to Capitol Hill,” Esch says. “I suspect more regulation will come to the space, and I think that will suit us well. When more regulation in this sector happens, the goods and the bads will be sorted out in the process. We feel very confident in how we are running this program.”