Starting in the early 2000s, I worked for my family’s tea business taking phone orders at our shop. As customers placed wholesale orders, I’d manually enter their credit card information into Paypal or pray they would mail us a check within 30 days as they’d promised. At the time, I thought it was normal. But looking back, I realize how inefficient it all was and that businesses still face this in 2020.
I dealt with inefficient payment solutions, merchant tools, and internal business software on a daily basis that were all impediments to running a business. Twenty years later, I’m now an investor at Lightspeed with a front-row seat at the cusp of change.
We’re seeing vertical software companies and marketplaces becoming FinTech companies because they facilitate transactions. To keep up with constantly evolving regulations and compliance standards, companies will need more modern payments infrastructure. Software developers will need the right tools to manage all their financial data or potentially bring payments in-house.
Lightspeed recently announced the closing of over $4 Billion across three new funds to invest in early, growth, and later-stage startups earlier this month. With that said, I’m personally excited to invest in more B2B FinTech startups that will enable businesses to scale and be more productive. I want to help fix the inefficiencies of payments and financial software that I experienced firsthand.
Within B2B FinTech, here are a few specific themes I’m most passionate about investing in right now:
- Payments Infrastructure and Embedded Financial Services
- Better Financial Data Platforms for KYC and AML
- Automating Financial Operations
Below I go into detail on observed pain paints, market trends, and the opportunity for each category.
1. Payments Infrastructure and Embedded Financial Services
In the early 2000s, merchants had to work directly with banks, checkout providers, domain names, and design consultants. Now in 2020, there are thousands of independent software vendors (ISVs) that businesses can leverage to easily create a storefront. For example, Shopify provides a variety of value-added services through its app ecosystem. Shopify enables financial services within their e-commerce platform, making it possible for them to collect payments revenue while helping merchants to get up and running quickly.
Despite all that, businesses in the U.S. are owed over $3 trillion in accounts receivable on any given day. Most homegrown websites and ISVs face a confusing world of payment providers, while merchants choose from a plethora of platforms that are difficult to differentiate from one another. Like my family’s small business, many others aren’t getting paid on time and are faced with fraud risk. ISVs and merchants tend to choose the tools that are easiest to implement, and as a result, they choose simplicity over profits and speed.
As companies scale to larger processing volumes, typically of at least $100 million, they are incentivized to bring payments in-house. For integrating payments, Stripe is an easy-to-use, but expensive, tool for an ISV at scale. Stripe offers a developer-friendly API and platform rich with data but at a higher cost-per-transaction. But companies with over $100 million in GMV are leaving profit on the table by using Stripe or another payment service provider (PSP). By using a PSP, the merchant loses profit because each entity in the payment process charges basis points in fees.
Companies that have acquired networks of merchants and end customers have more leverage to create an optimal payments infrastructure stack. As ISVs and online businesses grow in scale, they are incentivized to process payments faster, move funds with greater certainty, and offer competitive payment terms to their merchants. Payment facilitation and push payments are some methods that companies can use to do that.
A payment facilitator or PayFac (think: Stripe, Square, Shopify) allows an ISV to capture additional profit on each transaction by becoming the merchant of record. Depending on what processor they switch from, PayFacs can get an additional 80bps on each transaction. And in return, the PayFac underwrites merchant risk and assumes fraud liability on behalf of their sub-merchants. A few software companies that are helping ISVs become payment facilitators are Amaryllis, Finix, Infinicept, and Payrix.
Push payments allow merchants to get paid faster and eliminate chargebacks. In this case, transactions are denied immediately if a customer doesn’t have the funds. Because push payments are instantaneous, a slight error can result in lost funds. New methods such as push-to-card give merchants certainty and defer payments by offering consumers virtual, cash-like payment cards.
The number of ISVs that now process over $100 million in transaction volume is astounding, and it continues to grow at a rapid pace. Companies with over $1 billion in transaction volume generate an increasing portion of their revenue from payments despite starting out as pure software companies.
Of Shopify’s $1.6 billion of Revenue in 2019, $940 million came from Merchant Solutions. Shopify states in their Annual Report they “principally generate Merchant Solutions revenues from payment processing fees from Shopify Payments.” In other words, over 50% of Shopify’s revenue last year came from payments.
As a merchant, my family’s tea business had to jump through several hoops to receive payment from the customer. Net 30 terms were common, which resulted in slow payments from our customers. Our inventory would take at least a month to arrive at our warehouse because many of our products were imported. It was a constant working capital exercise.
That’s why I’m keen to meet companies building better payments infrastructure to help businesses capture more profit and get paid faster. (Coming soon: A post to discuss the landscape of companies tackling this opportunity.)
2. Better Financial Data Platforms for KYC and AML
Every company that sells products and services digitally factors in assumed losses due to fraud. Albeit a small percentage of revenue, fraud can add up to millions of dollars over time. It will continue to rise due to fraudsters getting more sophisticated and the patched-up nature of banking infrastructure. I’m excited by the large opportunity to invest in better financial data platforms with know-your-customer (KYC) and anti-money laundering (AML) technology, which are still in early innings.
If deploying anti-fraud technology is the defensive, then building better financial data platforms is the offensive. Anti-fraud solutions catch fraudsters in the act and block fraudulent transactions. So then, how are better financial data platforms the offensive strategy? Building platforms with better KYC capabilities verifies users and funds upfront, while AML solutions create better processes to swiftly investigate or prevent money laundering. The goal of “offensive strategies” is to prevent fraudsters from entering your ecosystem in the first place.
But why now? The rise of FinTech replacing traditional financial services has heightened the need for better technology to manage risk. Banking, insurance, and lending are a few financial services that are now being served digitally thanks to Neobanks, Insurtech, and other FinTech startups. This has caused an increased amount of transactional and PII data generated, and therefore, increased risk.
Banks and enterprises often have insufficient or messy customer data that make it difficult to deal with fraud, compliance, and underwriting. Several startups are taking the approach of integrating with banks to get access to data on transactions, customers, and businesses. They can resell their data platform to FinTechs or ISVs that need to verify customer or account information.
For AML, predictive models to demystify money-laundering are still nascent. Financial crimes are complex and need to be investigated. Signals that may have led to previous money-laundering schemes may not be able to pinpoint future criminal activity. Hindsight is 20/20.
Due to stricter compliance regulations globally, data privacy solutions are expected to be a large and rapidly growing market. New regulations have emerged such as GDPR, which took into effect in May 2018. The AML & KYC solution market size alone is projected to grow from $1.5 billion in 2019 to $3.6 Billion by 2024 at a CAGR of 19.5%, according to ResearchandMarkets.
I look forward to partnering with entrepreneurs building better KYC and AML solutions as offensive strategies to fight fraud.
3. Automating Financial Operations
In grade school, I spent every weekend and holiday break using Quickbooks. Every year around tax season, I remember spending Spring Break doing reconciliation and retroactively sorting orders into the right accounts. While it felt like a relief from spreadsheets initially, I came to realize I was doing the same repeatable tasks. Millions of other businesses face the same inefficiencies in keeping track of their finances.
In the last decade, dozens of software companies have emerged that offer cloud-based solutions to augment the FP&A department. Many of them are systems of record, which still require manual entry. Some software vendors can integrate with other applications to extract data then apply predefined rules to partially automate tedious tasks. Public financial SaaS companies in this space have created over $280 billion in market cap. And yet, there is a wide-open opportunity to further automate financial operations with an intelligent layer of software that can integrate with these applications.
While there are software vendors that claim to offer a full suite of financial SaaS applications, FP&A teams prefer to use a collection of best-of-breed solutions. They often are willing to connect pieces of a puzzle after choosing the best pieces. Some SaaS companies offer an open platform for developers to build connectors, such as Concur. There are also ISVs that build integrations between applications. Today, this is often not done perfectly as large finance teams still exist to clean up after less-than-perfect data mapping between applications.
There’s an opportunity for startups that can take financial operations automation to the next level. Businesses still require large finance teams when they could be using more intelligent software that can save analysts from performing tedious tasks. This may appear in the form of better data pipelines, financial data mapping, or something else entirely.
Let’s enable businesses together
As evidenced above in the graph of FinTech companies in Lightspeed’s portfolio, this is a space we care deeply about. Looking ahead, we’ll continue to back outlier companies in the FinTech sector and invest in founders with a vision to transform the way people do business. If you have started a company in the space, we would love to hear from you. You can reach me at natalie@lsvp.com.
Many thanks to my colleagues and friends who reviewed drafts of this post.
