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PayPal has been an online payment processor for some time. A couple of years ago, it decided to get into alternative business funding. It makes sense for PayPal, it sees how much sales revenue passes through its system each month.

But is PayPal’s Working Capital (PPWC) program a good choice for small businesses?There are a number of drawbacks to PayPal Working Capital that any small business owner should understand when looking at funding options for working capital.

First, it’s important to understand how the PPWC works. It exists in its own space, somewhere between a merchant cash advance(MCA) and working capital loan, but not entirely like either one.

PAYPAL WORKING CAPITAL PROGRAM – THE BASICS

PayPal will advance a business with a business or premier account up to 18% of its annual sales revenue that run through PayPal, up to a maximum of $97,000. One way this advance is similar to an MCA in that the borrower pays a fixed fee based on the amount advanced, instead of interest.

The other MCA similarity is that repayment is made by PayPal automatically taking out a certain percentage of daily sales from the borrower’s PayPal account. So in theory, the borrower never has to repay more in a given day than that percentage. If there are no sales one day, no repayment is made that day. Unfortunately, the repayment terms on a PPWC are a bit more complicated than that, which I’ll explain more after we get through the basics.

The higher repayment percentage a business owner is willing to accept, the lower the origination fee. The repayment rate for a PPWC advance varies wildly, from half a percent up to 35%. Keep in mind the repayment percentage is taken off the net amount of your sales after PayPal has taken normal its transaction fee out. Borrowers can select the daily repayment rate they want on their advance, but beware: Repayment in full must be made within 18 months, regardless of the daily repayment rate selected (this is one of the complications I mentioned earlier).

Having a fixed payment period is one way a PPWC advance works more like a small business loan.

LET’S GET TO THE BIGGEST COMPLICATIONS

This fixed payment period, no longer than 18 months, is the reason for a number of other PPWC terms that aren’t so great for the business owner. I’ll explain.

PayPal will take out its daily amount owed the day after the sales are made. So it’s imperative that the borrower keep enough money in their PayPal account to cover the amount owed based on yesterday’s sales. If you’re used to moving money quickly out of your PayPal account, this may be an issue for you. If you use PayPal’s autosweep function to send money out automatically, you’ll have to turn that off.

If you don’t have enough to cover the amount owed on yesterday’s sales, PayPal will take “catch-up payments” from your account until your current. The result of this approach is that your actual PPWC repayment amounts don’t necessarily rise and fall in tandem with your sales revenue like an MCA does. PayPal won’t take catch-up repayments that put your balance in the negative. But If your daily sales fall drop so low that you’re behind more than 50% of your total amount owed, PayPal may consider your account in default.

Now PayPal isn’t going to let you stick to a low daily repayment in hopes of a balloon payment in the 18th month. A second consequence of having to repay the entire amount within 18 months is that PayPal requires you to repay 10% of the full amount, including origination fee, every 90 days. If you can’t meet this repayment schedule, then your PPWC loan goes into default. PayPal can now put restrictions on your PayPal account or even call in the entire amount.

Let’s break this down. These terms mean even if you meet your daily repayment rate every day, if that total amount doesn’t equal at least 10% of what’s owed every 90 days, you’ll be in default anyway. That makes one of the chief drawbacks of the PPWC loan is the false sense of security: A false sense that you’ll never have to pay more than your PayPal cash flow can handle; and a false sense that all your repayments are handled automatically. You risk default every 90 days if you don’t track how much you may need to repay to top-off what your daily sales covered.

WHAT MAKES YOU ELIGIBLE – WHY YOU CAN BE DENIED

If you’re interested in a PPWC loan, you must have at least $15,000 in sales run through your PayPal account each month. Not overall – but through PayPal. You’ll also need to have your PayPal business or premier account for at least three months.

PayPal will calculate your origination fee based on these variables, as well as what daily repayment percentage you select. The higher percentage you select, the lower the origination fee. The fee can range anywhere from three to 20%, based on PayPal’s underwriting algorithm. You won’t see what your fee will be until you finish the application process, but you will see it before you accept the terms. PayPal’s application process is entirely automated with no human contact, which means you can’t negotiate terms.

There have been complaints that this entirely automated process doesn’t always run smoothly. Whether you’re applying or need service on an existing PPWC loan, you’ll have to deal with PayPal’s inconsistent customer service.

PayPal may deny a PPWC application is you show volatile sales fluctuation, which makes this a non-option for seasonal businesses. If your account has a regular and high volume of chargebacks, your application will likely be denied as well.

THERE ARE OTHER OPTIONS

The greatest risks on a PPWC advance are all the different ways you can trigger a default. Any business owner who wants to keep repayments level to actual sales is probably better served with a merchant cash advance. If you have good credit, both a business loan and a line of business credit will likely be less expensive than a PPWC advance.

PayPal’s Working Capital program is a natural extension of their business model and makes good sense for them. Unfortunately, it makes less sense for the borrowers.

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