B2B Marketplaces → Financial Operating System (Fintech January Newsletter)

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TABLE OF CONTENTS

    B2B marketplaces as a gateway to financial operating systems

    B2B marketplaces, notably fast-moving consumer goods (FMCG) marketplaces, are gaining steam in the Global South, which includes Latin America, Africa, Asia and ¾ of the world population. Informal commerce is central to these economies, driven by small mom and pop shops and kiosks across major cities and even rural areas. There are 6M of such retailers in India, 7M in China, 2M in Brazil, and 2M in Pakistan, and they carry everything from toiletries to medicine to electronics.

    These retailers are critical to the lifeblood of commerce in these regions, and B2B marketplaces that provide constituents with credit to expand their businesses, guarantee payments and delivery, and software to order and promote products are gaining adoption. The software and financial products built into these marketplaces are extremely sticky, and can be a trojan horse for financial operating systems for retailers, distributors, wholesalers, and manufacturers. In some cases, these marketplaces can even be distribution points for consumer financial services.

    We’ve seen many iterations of this model from Colombia to Indonesia (see below for a non-exhaustive map), and we believe there are two product primitives these marketplaces need to include:

    • “come for the tool, stay for the network” software for marketplace participants to enable digital transactions and financial management
    • embedded lending and payments to create liquidity in the marketplaces and to monetize a generally thin margin industry

    While certain marketplaces have centralized logistics to deliver maximum value to retailers (i.e., by replacing the tedious cash and carry routine), others are taking a less capital intensive approach by driving more efficiency to existing distribution networks in the targeted region).

    – Sumeet Singh, a16z fintech deal partner, and David Haber, a16z fintech general partner

    Credit reporting for Buy Now, Pay Later (BNPL)

    Shortly after the CFPB launched a market-monitoring inquiry into five BNPL lenders, Equifax, Experian, and TransUnion announced that they would begin including BNPL data into their credit reporting. BNPL lenders have historically required minimal data from consumers when underwriting them (as compared, for example, to what credit card lenders ask for in an application), which has made BNPL a rare and important form of credit access for the 60 million thin- and no-file consumers in the U.S.

    If credit bureaus start furnishing BNPL performance data to their lender clients, it could help the credit invisible population bolster their credit profiles for much larger purchases. Equifax internal research (done in conjunction with FICO) found that on-time payments for BNPL could increase credit scores by 13-21 points. We suspect even more consumers will take out BNPL products in the coming years, as it becomes more seamless with checkout – Verifone just announced that BNPL will be a payment option on millions of its payment devices and online checkout systems across the country.

    While this all sounds promising, how the bureaus choose to categorize and report BNPL loans matters. If, for instance, they treat it as a new, standalone category, it may be ignored entirely by downstream lenders, whose systems still rely heavily on FICO, which employs a fairly rigid framework to generate a score (and one that likely won’t incorporate a brand new category any time soon). With this in mind, our suggestion would be to classify BNPL in the same category as an unsecured personal loan – while it may not be interest-bearing, lenders have no recourse to repossess goods sold through BNPL.

    As the credit bureaus continue to work out the specifics, meaningful change will also still be needed on the lender side. Lenders should work proactively to incorporate bureau-reported BNPL performance into their risk models. Each BNPL player has a different product strategy (e.g. those who underwrite more significantly vs. those who allow anyone to pay in installments) which can translate into different loss rates over the course of a given credit cycle. Already we’ve seen with rent repayment – another new form of data now incorporated into credit scores – lenders are still using older credit scores or using these new credit scores just for pre-qualification. Inertia can be a powerful force here, as many risk teams are hesitant to shake things up for fear of taking on higher losses.

    – Marc Andrusko, a16z fintech deal partner, and Seema Amble, a16z fintech partner

    Regulatory changes (and opportunity) for payment apps

    As of January 1st this year, the IRS rolled out a new reporting requirement for payment apps (e.g., Venmo, Cash App, and Zelle), as well as storefront providers (e.g., eBay, Etsy, Cashdrop). Any transactions for goods and services – not peer to peer personal payments – totaling more than $600 now need to be reported to the IRS. Previously, these platforms were only required to report transactions if a user made more than $20,000 in payments and 200 transactions. To be clear, this isn’t a change in the tax code, but rather in the reporting rules. Nevertheless, it could have some interesting implications for many of the micro and small businesses that rely on payment apps and online storefronts to operate.

    Over the last few years, especially during the pandemic, payments apps and storefronts have seen a significant surge of activity from solo entrepreneurs and side hustlers. These apps were already familiar to these entrepreneurs, given that many of them already used them personally as consumers, and were an easy tool for them to take payments. Practically speaking, many entrepreneurs probably didn’t pay tax on dollars coming through these payment apps. This new requirement changes that, making these apps potentially less attractive to use.

    While the new reporting requirement may make them less appealing for small business payments, it also presents an interesting opportunity for payment apps to create a software connectivity layer with the government. More importantly, this new reporting requirement could catalyze these platforms to move from being purely transactional to being more of a control hub or operating system for the entrepreneur. We’ve seen that tax tracking is a huge pain point for small and solo entrepreneurs. Imagine if they could see more than just their earnings, and could in their payment app track tax requirements, pay out employees, and see a better snapshot of overall cash flow, or even access offers for working capital loans. When a software provider is wedged into the “checkout” experience for small business, it enables the software to be the central source of truth for those businesses, eventually powering every other financial transaction the business makes.

    Bottom line: while in the short-term this might seem like an additional administrative burden, it might be one of the examples where regulatory change catalyzes a new business model.

    – Seema Amble, a16z fintech partner

    Bancorp for insurtech

    Starting any company can be daunting, and insurance startups are among the most difficult to get off the ground. High capital requirements, state by state regulation, finding capacity partners are all factors that can force founding teams to work for 12-24 months before having a product in market. This intense company creation period is even more arduous if a startup wants to control more of the customer journey. To do that, startups typically create an MGA, or a Managing General Agent.

    As a quick primer, an MGA is a hybrid operating structure, where a startup has more control over the customer journey and has been granted underwriting authority by the insurance carriers and reinsurers it works with. This model was historically developed to deal with risks that were better understood by the distributor. These MGAs also might have shared responsibilities for claims, policy servicing, and payments, in turn effectively controlling the entire customer journey.

    During the recent renaissance the insurance industry has undergone, startups have utilized a variation of the MGA model: instead of working with traditional insurance carriers, they have leveraged a “fronting carrier.” These fronting carriers generally take little to no risk, but rather cede (or give away) the risk to a reinsurance carrier. Unlike well known names – State Farm, Progressive, Travelers – fronting carriers are generally brandless, and instead of building massive balance sheets to generate value for shareholders, they earn a percentage of premium for services offered. In a way, a fronting carrier is to insurtech startups as Bancorp is Chime – the licensed entity that enables the experience to happen.

    In enabling the experience to happen a business can expect some take rate, and in a dramatically growing industry such as neobanking (or insurtech in the case of fronting carriers) the ability to grow with your customer can create a very valuable place to operate.

    The fronting carrier ecosystem is one that has generally focused on P&C (property and casualty) or life insurance – those familiar with the space might know State National in P&C, or Fidelity Security Life in life insurance. But what might exist if there were a fronting carrier tailormade for insurtech businesses? Ten years ago it was hard to consider all of the use cases Plaid might enable, but given the amount still to be built across insurance, we wonder if a different sandbox might spur further and faster innovation.

    – Joe Schmidt, a16z fintech deal partner

    Is now a bad time to raise capital?

    Most of the fintech IPOs that happened in 2021 are down significantly from their offering price. As market volatility continues to percolate in the background, how do you know if now is the right time to raise capital? Is it better to wait until public equities are in the green? Are we heading into a cold winter where the bears are here to stay, or will the bulls rear their heads in a few weeks when omicron runs its course? If we go out now, will we get the valuation we want or will investors look at public comps that are down, in some cases as much as 70%, from their highs?

    Several factors contribute to whether now is the right time for companies to raise – What momentum do you currently have? What are your public comps trading at? And how much runway do you have left? Not all companies have the luxury of waiting a quarter, as their runway shrinks and monthly burn is rising with anticipated growth. Ideally, you should build in a 6-12 months buffer to fundraise, in case it takes longer than expected.

    An alternative to fundraising is to manage debt expense (or start speaking to lenders as a lower cost of capital option).

    If you do speak to investors, sell the bigger vision and focus on the building blocks for the next 10-20 years, not short-term market conditions, continue to create a product that customers can’t live without, and optimize by creating multiple paths so you have the ability to choose whether raising now is the best outcome.

    – Melissa Wasser, a16z fintech capital network

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    The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; a16z has not reviewed such advertisements and does not endorse any advertising content contained therein.

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