FTT+ Issue 3: Finix, Sequoia, and the Future of Payments — The Economy’s Impact on Fintech

Hi everyone! Ian here. Hope everyone’s doing well.

Things with FTT have been…hectic to say the least. We’ve started to hire pretty aggressively, and we’re relaunching the FTT+ tier later this month (more details on that soon) so expect a lot more details on what we’ve been up to soon. We won’t be raising rates for early members, so if you think a friend or colleague would be interested in Fintech Today+, put us in an email to ian@fintechtoday.co and I’ll get them in at the current rate.

I’ll just dive right in, since I spent most of the day unpacking two unusual stories in unusual times.

Finix, Sequoia, and Stripe: Are Payments Really a Winner Take All Market?

Well this is...one of the more bizarre things I’ve come across in my time in tech. For Sequoia to do this is a bit unprecedented, and the story seems quite deep, based on how many calls I had on this topic this afternoon. Essentially, Sequoia is removing itself from involvement in Finix, and is citing “competitive reasons” because they also invested in Stripe.

(Editor’s Note: I have friends at both Finix and Stripe, and am writing this as an impartial third party. Love my friends who work at the two firms, but don’t have any involvement or stake in either company.)

All in all, this doesn’t really change the trajectory for Finix at all—they got $21 million in an equity-free investment from Sequoia, who has recused themselves from any involvement in Finix.

The reason Sequoia walked away *has* to be a bit deeper than they’re letting on though—it’s pretty widely known that Sequoia is on the board of Stripe and is the biggest outside investor in the company, so this coming up *after the fact* doesn’t make much sense to me. If this wasn’t an issue before, why is it an issue now?

But from what I hear from both sides, this isn’t anyone’s particular fault. From what I heard through the grapevine, Stripe didn’t pressure Sequoia to do *this* (whatever *this* is), mainly because Finix is competitive with a piece of Stripe, and Stripe is a $35 billion company. And Finix repeatedly asked Sequoia about conflicts of interest on the deal and both sides agreed to move forward.

The Finix deal was extremely competitive from what I understand—by the time Finix had met Sequoia, they already had 2 term sheets in hand. And given how competitive hot deals are in Silicon Valley, especially in fintech nowadays, there seemed to be some urgency on the investor’s side to get the deal done quickly. 

But Sequoia removing themselves from involvement in Finix over competitive reasons also lets us talk about Lightspeed, a POS terminal maker from Canada that works with restaurants and hospitality companies. The day after the Finix deal was announced, Stripe and Lightspeed announced a partnerships around payments.

For many on Twitter (and in my network), this was a “big deal,” since Stripe doesn’t really make a big deal about its partnerships (the last time I think was Amazon?) But to me, it showed that big companies like Lightspeeed POS can use Stripe and Finix in tandem, and that the two aren’t as competitive as the media makes them out to be. (From what I’ve heard, Lightspeed is using Stripe in Canada and for a tipping function that Finix doesn’t have the capability to support yet. Finix says Lightspeed is still a Finix customer.)

Payments isn’t the winner take all market that everyone makes it out to be; in fact, traditional retailers have multiple payment processors for different use cases. If you want to start taking payments in a different region, or for local currencies, you may need a different processor. If you want to get into the weed business, your current processor may not allow it. 

Some payments folks I’ve spoken to today even say that there’s a world where Stripe and Finix can partner up: in theory, Stripe can be a channel partner and funnel merchants who want more customization in their payment stack and different economics to Finix, and Finix can compensate Stripe accordingly. 

Payment is a big world (some estimates put the entire market at around $3 trillion) and some of the biggest tech companies already work with multiple processors. It’s a lot like how the biggest tech companies don’t just work with one cloud provider: they have a certain percentage across Google Cloud and AWS. I fully expect the same thing to happen in payments, whether that’s now, or in a few years. 

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The Fed Funds Rate and the Economy’s Effect on Fintech Startups

So CoronaVirus huh? Weird shit—I only started taking it seriously when I read Sequoia Capital’s “Black Swan of 2020” memo, which everyone immediately likened to “RIP Good Times,” a memo written in 2008 amidst the financial crisis on how to weather the upcoming difficult macroeconomic environment. 

Lots of folks in and outside of fintech said that Sequoia’s memo was the 2020 version of this. As far as economic cycles go, we’re somewhat overdue for a downturn, and it seems like the combination of Coronavirus and the oil price war, which has tanked oil prices, might be a catalyst that triggers it. I certainly hope not (you shouldn’t really *hope* for a downturn) but I will say that I’ve been expecting a downturn since about the summer. Just didn’t know it’d be a health pandemic that would be the thing to freak out the markets. 

In any case, Sequoia’s given founders great advice already. The advice I keep telling founders is to raise your rounds quickly, or at least get a term sheet from someone soon. If things keep getting worse, then its fair to assume VC funding into Series A and B startups are the first thing that’s going to dry up. Early stage (preseed and seed) seems to be stable for now; haven’t heard much from investors or founders on that end. But still, things get weird when capital dries up. 

As for how the economy ties into fintech companies, the relationship between the two is actually more deep than people realize. The biggest effect the macroeconomy can have on fintech companies seems to revolve around the Fed Funds rate. Last week, the Federal Reserve slashed the rate by 50 basis points out of nowhere—something that hasn’t happened since the last financial crisis—and Reuters reports that its expected that cut another 25 basis points later this month. 

Here are some ways the Fed Funds rate can affect fintech startups:

Companies Generating Revenue from Interest Margin

A lot of companies that collect deposits from customers have a way to generate revenue: they make money off of the interest that they collect off those deposits. To my knowledge, most fintech neobanks and others that collect deposits collect revenue from interest margin to some degree, though some might pass that revenue along to consumers (more on that later.) This is still a small amount of revenue for neobanks, that also make money off interchange, but as rates continue to decline, this revenue stream may go to 0, and startups might be pressed to find other sources of revenue, and fast. 

Companies Tapping into the Debt Markets

Interesting, rates getting slashed has the opposite effect on companies that are reliant on the debt markets. Because interest rates keep declining, companies that have tapped into the debt markets might be finding much more attractive terms for borrowing capital from the debt markets than just 2 months before. Given the amount of interested in both consumer and business credit cards (particularly business credit cards) I wonder if a savvy fintech company with strong underlying financials will take the opportunity to raise a massive debt round while all this is going on. 

Companies that have high yield savings accounts 

I’ve written about high yield savings accounts for FTT before—long story short, some of the biggest companies like Intuit’s Credit Karma, Betterment, and Wealthfront all have high yield savings products (for a clear overview of how they work, check out Wealthfront’s post here) I always thought it was an odd race for startups to engage in—at one point, the economics on raising your yield becomes flat out untenable. There are startups that are marketing 5-7% returns on a savings accounts—how does that scale if they start attracting users that want to put in $100,000 bucks? Or if they get a ton of users? It all seemed like a marketing ploy that was bound to catch up with them, and I think this might be the issue. You can see that Credit Karma and others have already dropped their rates. I fully expect others to follow suit, especially if the Fed decides to drop rates yet again. 

The issue here is that these massive savings rates were a way to grab deposits from competitors, like big banks, that offer minuscule basis points for deposits to the average consumer. Instead of collecting that revenue, they passed it along to the consumers, as I mentioned before. But if the interest rates drop, that margin drops too, and that leaves companies with two options: drop rates or sustain rates and pay off their balance sheets (which is insane...don’t do this.) 

If high yield savings rates continue to drop, where does it stop? Does it become a value-add product if you’re offering customers 0.75% interest on their checking account?

What About Negative Interest Rates?

Another big question is: what if the US actually starts implementing negative interest rates, and rates go below 0? Yes I used to think this was crazy talk. But its something that a lot of economists are thinking about too. And if that happens, I’m not sure what will happen with fintech companies.

There’s some precedent here too: Germany currently has negative interest rates, but that hasn’t slowed down N26, it seems (though N26 has a charter, which would allow them to lend off their deposits).

In theory, you’d diversity away from holding your funds in a bank account and start investing them in low risk/high yield asset classes like treasury bonds. Which is the whole point of negative interest rates—its designed to entice investors to put money into the market. For fintech startups, it turns them into a broker/dealer of sorts, which operationally sounds like a nightmare scenario to me.