By James Green, Investor
On the eve of NuBank’s IPO, we have been thinking about the rise of neobanks throughout the world. We’ve seen Monzo ($4.1B) in the UK, Chime (~$35B) in the US, N26 ($9B) in broader Europe. This list goes on. Our guess is that by the end of 2021, we’ll have >$150B of global enterprise value created from consumer neobanks. Given the rise of NuBank etc, it’s very possible this could be an underestimate.
We believe that the rise of these neobanks are a result of the fact that global banks treat customers as commodities. Clearly, inferior products, experience and user experience (UX) are no longer accepted at the business level.
This terrible bank to customer relationship creates remarkable financial profiles. JPMorgan regularly produces over 50% EBITDA (profit) margins. Furthermore, Itau in Brazil continues to produce strong profit margins of ~35% and this is something repeated at banks around the world. Given these profit margins, it’s likely that there are opportunities to address some of their legacy product lines.
To date, most of neobank’s innovation addresses the consumer product lines of legacy banks and thus the majority of the power has accrued to consumer neobanks over the past five years. On the business side, we have seen small business banks and lenders emerge with folks like Kabbage and BlueVine, but for the most part these are horizontal business solutions without specific understanding of a particular niche.
Clearly, consumer banking lines are being addressed ad nauseam by a number of players and we at CRV believe that business banking will follow this same trend. Unlike in consumer banking, however, we believe that vertical business banking solutions will accrue much of the value over the next five years and create foundational companies.
Here’s why we think a vertical approach is the way to create an enduring business neobank:
Talent: Startups can attract better talent than typical banks and thus produce better technology. Legacy banks have a hard time rearchitecting and new players will be built from the ground up.
Vertical Customer Acquisition: Vertical specialization is how lenders have typically scaled customer acquisition (think USAA) and there is no reason to think that shouldn’t happen in the business market to create multiple financial products for the same type of customer.
Better Underwriting: The unit economics of these banks should be better if you’re lending, managing, underwriting, giving credit to the same type of customers instead of taking a truly horizontal approach.
- Clearly, the needs of an ecommerce business are much different to that of a startup, a typical home builder, your local doctor, etc. A bank, much like vertical SaaS, should be specific to the industry that one operates in.
- We believe that the lifetime value (LTV) of customers should be large and long if you start with a sticky checking account, then layer on adjacent financial products.
Technology is Available Now: Banking-As-A-Service players are only now becoming commonplace (Unit, Synapse etc) and the underlying stack to build a neo-bank is now available off the shelf.
- A secondary option is to go straight to Evolve or Cross River and build from their infrastructure, but this takes much more compliance and management from day one.
We don’t believe all industries will need a vertical banking solution, but many are ripe for an offering. So what characteristics do we believe need to be reflected in for vertical banking solutions?
High Growth and High Demand Industries (Startups, Healthcare with telemedicine, E-commerce)
- In this case, the underlying business is growing so fast leading to material increases in deposits for the checking accounts and likely spending via debit and credit cards.
High Cash Flow, but With High Complexity (Rental Properties)
- Key value drivers include low risk with large checking balances plus payments that go from a core bank account to renters with the associated paperwork
Industries with Lots of Paperwork and Process (Homebuilders, Accounting, Legal, Insurance Brokers)
- Where there are lots of compliance, checkpoints, document management — a financial product should sit alongside these needs.
Low Access to Capital (International Markets)
- Clearly in international markets the access to capital is less well defined than in the US. Jeeves currently solves this for the international startup, but your every day business in the international markets are still starved of appropriate financial resources.
We’re already seeing this thesis play out in the US startup space with our investment in Mercury where our partner Saar Gur led the A and doubled down on their most recent B round. More and more startups want software and financial products tailored to their needs which Mercury does in a best in class fashion. No longer is it satisfactory to just have an okay experience with your banking product — the consumer neobanks have made sure of that — so why would it be ok when you’re starting a company?
Here at CRV, we invest in foundational companies at the earliest stages and our fintech portfolio is flourishing. Companies like Mercury, Jeeves, Karat Financial and many more are paving the way in financial innovation and we’re eager to collaborate with more entrepreneurs who are disrupting this space. If you’re building something in the financial services space, we want to speak with you, so swing by, get to know our team and let’s chat!
