Editor’s note: Joshira Maduro is a research analyst at Charlotte-based LendingTree.

CHARLOTTE – Modern-day layaway is having a moment. Companies that allow shoppers to buy items online on installment plans — known as “buy now, pay later” — are among the hottest firms in the tech world, and small businesses are taking note.

In August, small business payment processor Square announced it would buy one of the biggest buy now, pay later firms, Afterpay, for $29 billion. That deal came just a few weeks before payments company PayPal bought Japan-based Paidy for $2.7 billion. 

These eye-popping price tags are the result of a booming business. Shoppers had an outstanding balance of more than $100 billion through buy now, pay later companies in 2020, according to data from consulting firm McKinsey. This figure is expected to grow by as much as 20% annually over the next few years — surpassing private label credit cards and soon rivaling the personal loan market. More than half the country has now tried out one of these services.

Corporate giants like Macy’s, Bed Bath & Beyond and Amazon have already partnered with buy now, pay later companies to offer these unsecured loans to their customers. Small businesses are beginning to do the same. Affirm has partnered with Shopify, a popular online store platform for small businesses, and Square’s acquisition of Afterpay means that even one-person businesses may soon have access to these services. 

But doing so would not be without risk. Buy now, pay later firms make money on transaction fees that could put a major dent in a small business’s profit. They also add to their customers’ consumer debt, potentially damaging their financial health in the long term. If you’re counting on their repeat business, that can be a concern.

“It’s really about meeting the consumer need of the younger generation, which is cash flow,” said Tariq Bokhari, executive director of the Carolina Fintech Hub in Charlotte, N.C. “If it’s done properly, the pros outweigh the cons.”

How buy now, pay later works

If you shop online, you’ve likely already come across buy now, pay later plans. If online retailers have partnered with one of these companies, you’ll likely see an offer to split your payment when you get to the cart or checkout screen.

These services can be used on purchases as small as $100 or as large as several thousand dollars. If you’re approved, you may be able to split the total cost into four payments or pay monthly for three to 12 months, depending on the service. The service functions as a short-term loan, and it’s an especially attractive offer for customers with high credit utilization or low credit scores who can’t qualify for credit cards.

Some of the biggest buy now, pay later companies include Affirm, Afterpay, Klarna and Zip (formerly known as QuadPay). All have slightly different offerings, but the main business model is the same: 

Businesses sign up with one of the services, and the buy now, pay later software integrates with the retailer’s online checkout system. If a customer chooses to use the service, the buy now, pay later company handles the financing. Business owners get paid the full price right away, while their customers are able to pay over time.

Shoppers may not need to pay interest or fees if payments are made on time. Instead, retailers pay fees to offer the service. Retailers typically pay a transaction fee of about $0.30 plus 5.99% of the purchase price. 

Should small businesses try it? 

Buy now, pay later companies tout the benefits they offer to businesses. The firms say they increase the conversion rate of people who go through with their purchases, significantly increase repeat purchases and lead to a higher average amount spent per order. Affirm Holdings even says purchases are 85% larger on average. 

But industry observers warn that there are downsides, as well. For one, the transaction and processing fees charged can eat into a small business’s already slim profit margins. Retailers may also be concerned about their customer experience if a purchase needs to be exchanged. A buy now, pay later plan can be a headache if products need to be returned. These companies don’t offer the same protections as traditional credit cards, according to the Consumer Financial Protection Bureau. Policies for disputing charges and returning items can vary. 

But the true concern with buy now, pay later is that this type of easy credit can also increase customers’ financial woes. Research already shows that some 17% of Americans have $10,000 or more in credit card debt. But because many buy now, pay later companies don’t run a hard credit check on their customers, people who wouldn’t be approved for more traditional credit may be able to sign up for one of these installment plans.

That means people who have maxed out credit cards may turn to buy now, pay later companies to continue their purchases, sinking further into debt rather than improving their credit scores. About 57% of people who have used these services report making a purchase they regret because it was too expensive, according to CR Research. About the same percentage have fallen behind on their payments, putting them at risk of late fees and dings on their credit scores.

“The concern is predatory lending and whether customers have enough financial literacy to understand what they’re signing up for,” Bokhari said, adding that retailers should be sure that their customers are educated about the financing and installment plans offered. “Everyone who touches this has a responsibility for it.”

Instead of offering buy now, pay later services, small businesses have other options to build customer loyalty. They may choose to create a rewards program for loyal customers that will keep them coming back into the new year. They might also choose to use discounts — which could mean their customers don’t need to put things on layaway at all.