Reforming Retail

Deconstructing Toast POS’s New Loan Program

Like many other payments and POS companies, Toast has launched a merchant lending program. The reasons for doing so are fairly straightfoward:

  • If you have a merchant relationship you may as well try to cross-sell them everything you can. This is why many POS companies are buying solutions to verticalize their stack and effectively monopolize bolt-ons
  • Toast, being a payments processor, can pull the principal and interest of loans directly out of the payments stream, ensuring that they’re paid first. This materially decreases payback risk and it’s something Square pioneered with its lending program
  • Lastly, like merchants that use Square’s full POS product, Toast sees all the transaction data from a merchant, not just the payments data. The difference is not trivial: many quick service restaurants still process 40% of their transactions in cash. The result is that Toast would have a much better handle for how the merchant is performing, and thus should be able to underwrite loans that have a much lower rate of failure.

But getting into the loan business is not exactly the highest margin nor growth business out there. That’s why we suspect Toast only tested the idea before punting responsibility to a partner instead. While Toast likely has $120MM or so left on their balance sheet that capital is much more appropriately used to grow their core business. Think of it this way.

Toast will earn a higher return on their money by growing Toast. Currently they’re shooting to double their end of 2020 to revenues to > $400M (though they’d double their burn from $100M to $200M by then as insiders tell us). Considering small business loans average an APR of 15%, Toast would more than 6x this just by directing capital towards their core business.

Or would they?

We’ve already demonstrated that Toast’s “free POS” loan program can generate APRs of 65% or higher. These returns are way above state definitions for usury. Is that why Toast chose a loan partner in Utah, where there are no limits for usury definitions? From Bostonmix article,

Barash said Toast Capital loans will be short-term, typically repaid in nine months. He declined to say what the interest rates will be. (Emphasis ours)

Mary Zeven, director of the graduate program in banking and financial law at Boston University School of Law, said “partnering with a Utah bank, where Utah has loose restrictions on usury, will allow higher interest rates than a Massachusetts bank.”

Howell Jackson, a Harvard Law School professor who specializes in financial regulation and consumer protection, added that it is “common practice” for companies running lending programs to partner with Utah banks for this reason.

It’s likely the same reason Square chose to establish its loan practice with a Utah-based bank.

The silver lining in all this? Toast sought a partner instead of trying to do it all in-house. We believe that means the product will be superior to any loan offering Toast might have created internally, and the user experience will likely much better too. Toast probably would have tried to build this inside its walled gardens if not for a finance exec telling product managers that their balance sheet was better used on other growth initiatives. It still wouldn’t surprise us if Toast brings this loan business back in-house eventually given their publicly stated desire to own the entire stack.

Our advice? Seeing as how Toast has had no problems charging merchants extremely high effective APRs on their “free POS” gimmicks before, be very, very careful of the terms in any loan agreement coming from Toast or affiliated Toast partners.

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