How lending startups like Afterpay make their money
It’s called “factoring” of accounts receivables. This is when a company sells its accounts receivables (money owed for a good or service that has already been delivered) to a lender, typically at a discount.
Typically, factoring arrangements are between a business and a lender, with the customer being oblivious to the arrangement. Afterpay’s innovation was to turn this centuries-old, back-office financial arrangement into something customer-facing.
In 2016-17, Afterpay generated about $23 million in fees from retailers and another $6.1 million in late fees. It wrote off only $3.3 million in bad debt.
An example of traditional factoring would be a company selling $100 in accounts receivables to a lender for $95. The company gets $95 cash up front (to spend on wages or ingredients) and eliminates the risk of not being paid. The lender makes a $5 profit once the $100 has been collected.
Similarly, if you make a $100 purchase using Afterpay, the merchant immediately receives $96. Afterpay then collects four instalments of $25 from the customer, making a $4 profit.
The $4 difference is essentially the interest that Afterpay charges (equivalent to 4.17%). The unusual nature of the transaction is that Afterpay lends to the business and the customer repays Afterpay. Read more
Saurav Dutta - Smart Company - 11 Dec 2017