Square and Stripe have recently emerged as two popular payment processing services for small and growing businesses. As the services have grown in popularity, their simple fixed-rate payment processing fees have drawn in big-name supporters, such as Starbucks (SBUX), to use and promote their systems. For investors and business owners, it’s important to understand how these companies operate to make smart financial decisions in the rapidly shifting payment processing industry.

How Square Works

Co-founded by Jack Dorsey, a founder of Twitter (TWTR), in 2010, Square began as a mobile payment processor for small businesses that operate on the go. The company initially targeted service-based businesses such as plumbers, food trucks, and pedicabs, offering its service as a way to safely, quickly and inexpensively accept credit and debit cards. Square became popular thanks to its free and convenient adapters that operate through a phone’s headphone jack, a flat-rate 2.75 percent processing fee, and no monthly recurring service fee.

The service has been widely adopted by mobile and brick-and-mortar businesses alike. To further extend its reach among the latter, Square released a physical Square Stand in May 2013 that transforms iPads into traditional cash registers. The company has also built out its software suite to better handle diverse product sales from a predefined menu or inventory. Later product additions include inventory management, appointment management, analytics, invoicing, online ordering, gift cards and capital management tools. Then, in October 2013, Square launched Square Cash as a person-to-person mobile payment platform. The company has received multiple funding rounds and was most recently valued at $5 billion.

How Stripe Works

What Square is to mobile payment processing, Stripe is to Internet payment processing. Stripe charges 2.9 percent + .30 cents per transaction with discounts available for high volume clients. Like Square, Stripe doesn’t have any monthly service fees and only charges business owners when a payment is processed. The service, which was designed with online developers in mind, makes it easy to integrate a variety of online payment processing tools and plugins through its application programming interface (API). Sites on common platforms like Wordpress, Drupal, and Joomla can use Stripe for invoice payments, ticket sales and physical goods sales, among other applications.

Stripe isn’t intended for in-person payments and is purely focused on online transactions. These payments have a higher probability of fraud than in-person methods, which explains Stripe’s higher cost per transaction. Based on its most recent funding round, Stripe is valued at $3.5 billion.

Similarities and Differences

The major difference between the two payment processors is how the payment information is acquired. Square is primarily used for in-person payments where the card is present and can be physically swiped through a card reader. The company has announced plans to offer an EMV chip reader in the coming months as well. Stripe is primarily used for Internet transactions where the card isn’t physically present.

Both companies target similarly sized businesses that do not want to pay a monthly transaction fee and do not want to be burdened with expensive payment processing equipment or complex contracts. Both companies offer similar, automated direct deposits within a few days of processing each transaction, so clients will have fast access to cash after each payment takes place.

The Bottom Line

Square and Stripe are major disruptors in traditional payment processing, a space long dominated by large banks. Overturning the traditional monthly merchant account fees and transaction fees allows many more businesses to access credit and debit customers, further shifting the competitive landscape from traditional businesses to startups and growing small to medium sized companies. As these companies continue to innovate, consumers and business owners can expect further changes to make payment processing easier and more accessible. As cash becomes less prevalent and consumers continue to shift towards plastic en masse, these electronic payment processing companies can be expected to grow and more competitors are likely to enter the space.

If you’re excited to invest in one of these companies, keep your eyes on IPO news. These hot companies are in demand, and while they are still privately held today, recent big IPOs will not leave companies like Square or Stripe sitting on the sidelines for long.