“Free POS” Is A Loan. Make Sure You’re Not Being Loansharked

“Free POS” is an overplayed marketing tactic used by payments companies who own or have strong affiliations with POS systems. If you honestly believe anything in life is free you’ve got bigger problems than “Free POS” and you can stop reading right now because this is going to be beyond your intellectual abilities.

But if you’re wondering what’s really happening, read on.

Free POS is nothing more than a bit of financial engineering. In essence smaller merchants who might otherwise use a cash register, or even manual pen-and-paper, can’t afford the upfront costs associated with a POS system. A larger company – typically a payments entity – uses their balance sheet to loan a POS system to the merchant. In exchange for covering the upfront cost of the POS system the payments company charges interest (did you think payments companies were UNICEF?).

How much interest? Well, that’s what we need to discuss.

In principle Free POS is not actually a bad thing: we believe Free POS offers smaller merchants an opportunity to access a POS asset which, if used properly, will make their business much more successful than a cash register ever can. So we do think it’s a positive that larger companies are extending such an opportunity to merchants who might not have the financial means otherwise.

Obviously though, there are some lingering concerns.

Our first concern is how the POS is peddled by the payments company. Most payments companies don’t care to understand what POS solution a merchant really needs, nor are they making sure the merchant is properly using their POS to extract positive ROI. Effectively the payments company is jamming a POS down a merchant’s throat even though the POS will never prove more valuable than a cash register or pen-and-paper alternative. Too many payments providers act this way because they’re more interested in placing a sticky POS solution with exorbitant cancellation fees (commonly called Early Termination Fees, or ETFs) than they are in ensuring the success of their merchant.

Our second concern, related to the first, is that payments entities exhibit this apathetic behavior because they’re making so much money on the interest (which can be separate from the ETF) that they don’t bother to structure a fair deal. How much interest is too much?

If you were to get a small business loan your interest rate would be about 10%. But you’d need two years of profitable business operating history, which is likely not the case for merchants in the Free POS market. Other financing options are those run through companies like OnDeck or Square Capital. Under these programs you’re usually paying an APR of 20% or so, but the upfront requirements are less stringent.

So if these are market rates (20% interest, usually due within 12 months) what should payments providers be charging?

Let’s talk about the price of a POS system.

We’re going to assume 2.5 terminals at a unit price of $1,000. That’s certainly more than an iPad and stand costs, but it’s not far off from traditional registers. Add another $1,000 for the cash drawer and some printers and a further $1,000 for a KDS system. That’s $4,500 for all new hardware.

Then there’s the software. Let’s assume $80/mo per terminal, so we’re looking at $200 per month for the software, or if we annualize it another $2,400.

Now we’re at $7,000. We should add $1,500 for installation and another two years of software (since terms are usually 3 years) and we get to $13,300. 20% interest on top of this would be an additional $2,660 for a total of $15,960.

Does a merchant end up paying much more than this interest through the “Free POS” offering?

Assume this merchant does $650K in annual card processing and pays $0 upfront for the POS. Interchange is 1.8%. What effective rate would this merchant need to pay over that three-year term to breakeven with a traditional loan at 20%?

Well, if we annualize this it comes to $5,320 – that’s net after interchange of 1.8%. Thus $5,320 is 0.818% of our annual $650K in card revenue, so we should add this to our interchange of 1.8%. This get us a total effective rate of 2.618%.

But we also know that some POS/payments companies have shown even higher effective rates on this whole deal. If you place an effective rate of 3%, the POS or payments company will earn an additional $2,483 per year, or $7,449 over that three-year term.

Our recommendation? Do your homework. Find out what a traditional SMB loan would cost and compare that to the effective rate marketed by the POS/payments company.

And remember: just because the effective rate looks low at first doesn’t mean it stays that way. As an example, Toast has contract language that gives them unilateral rights to increase your rates at their leisure:

If Toast’s processing costs exceed the revenue associated with the foregoing processing rates for any Merchant location, Toast shall, upon notice to Merchant, be entitled to adjust such processing rates upward so that Toast’s revenue from Merchant… matches Toast’s cost of processing; the rate of such upward adjustment to be made in Toast’s reasonable judgement.

So while the math looks good if you take the first rate offered by a company like Toast, know that they can and will increase rates when they have to. Everyone is in business to make money: just make sure they’re not doing it on your back.