On Sunday Square announced it was gobbling up Afterpay in a deal worth $29 billion at the time of announcement. Alex followed up yesterday with more details on why the deal made sense for Square and Afterpay over here, but we wanted to ask some notable VCs what it means for the startup market.
For context, the Square deal follows a ton of money and interest flowing into the BNPL market. Just this year, VCs have invested in companies like Alma ($59.4 million, January 2021), Scalapay ($48 million, January 2021), Wisetack ($19 million, February 2021), Zilch ($80 million, April 2021) and Dividio ($30 million, June 2021).
Most of the investors we reached out to were generally bullish on the Square and Afterpay integration, but they were less excited about opportunities for other consumer BNPL businesses to emerge.
Then there’s Klarna, which raised $639 million at a post-money valuation of $45.6 billion in June, after raising $1 billion in March at a post-money valuation of $31 billion.
There’s also interest from some major public companies. After a slow start, PayPal is aggressively pushing BNPL services with merchants that offer it as a payment option. And there are reports that Apple is building its own BNPL offering through Apple Pay.
We reached out to Commerce Ventures founder and GP Dan Rosen, Better Tomorrow Ventures founding partner Jake Gibson, Fika Ventures partner TX Zhuo, and Matthew Harris of Bain Capital Ventures to see what they thought of the deal, as well as what it might mean for the opportunity for other BNPL companies and startups.
The main takeaways? “Buy now, pay later” may be effective at driving retail conversion, but scale matters and long-term margins look slim for BNPL startups.
Now, let’s hear from the venture community.
The venture view
Why is the BNPL market so hot?
From a macro perspective, the growth of the BNPL market — at least in the U.S. — is driven by a confluence of factors, according to Dan Rosen, founder and GP at Commerce Ventures. He cites a low penetration of credit cards among younger consumers, which was an artifact of the CARD Act preventing credit card issuance to consumers younger than 21 and marketing on college campuses; ongoing federal monetary intervention that resulted in historically low interest rates; and increasing purchasing power amongst millennials, as well as a desire to spend disproportionately on e-commerce platforms as all reasons for BNPL adoption.
In general, younger consumers have been more wary of taking on credit card debt and actually reduced their card utilization rate during the pandemic. That’s opened the door for alternative financing solutions that are more predictable, according to fintech investor and Better Tomorrow Ventures founding partner Jake Gibson.
“Generally I also think it’s intuitive that consumers would prefer turning their purchases into something they understand and can manage — basically converting to subscription payments – versus the uncertainty around credit card balances and compounding interest,” Gibson wrote.
At the same time, BNPL increases retail conversion rates and “allows retailers to build relationships with customers through interactions that extend beyond a single transaction,” according to Fika Ventures partner TX Zhuo. For most retailers, even modest increases to their conversion rates could help them drastically boost profitability.
For startups and other fintech companies, BNPL offerings enable them to integrate into existing e-commerce businesses, according to Matthew Harris of Bain Capital Ventures. He emphasized that “deep and lucrative connections to e-commerce merchants are valuable.” However, he added that outside of payments companies or shopping cart companies, there aren’t many avenues for businesses to strike those merchant relationships.
Most of the investors we reached out to were generally bullish on the Square and Afterpay integration, but they were less excited about opportunities for other consumer BNPL businesses to emerge.
“I don’t see a lot of headroom/new angles in the consumer BNPL space … scale matters and it will be hard for new entrants to achieve escape velocity,” Harris wrote.
They also warned that existing BNPL companies would likely need to find other products or lines of business to create sustainable, long-term value. “Over the long term the pricing/margins in this industry will head toward zero (or no more than interchange at the most) because it’s a commodity capital business,” Commerce Ventures’ Rosen wrote.
Harris added that “the pressure is on for Affirm and Klarna to build out their ‘cardholder’ bases, through organic or inorganic means,” and he suspects that “one or both of those companies will look to buy neobanks in the near future.”
While they see limited opportunity in the consumer BNPL market, some investors believed the model could be applied to more verticalized forms of financing.
“There is a real opportunity in the B2B space,” Harris wrote. “As it goes more digital … [this] creates an opportunity for BNPL models to replace/enhance traditional invoice financing and trade credit.”
Gibson believes there’s an opportunity for “POS-based lending for any sort of high-dollar discretionary transactions not covered by insurance” and thinks we’ll see a lot more verticalized point of sale-based BNPL. Already, he’s seen a few pitches for things like dental work and veterinarians, and says he’s sure BNPL offerings for cosmetic surgery or dermatology probably exist.
All in all, the opportunity to build a huge consumer business off the BNPL model may have already passed. Furthermore, given the mixed financial results from even the biggest players, the BNPL market seems like a race to the bottom of a commodity lending business unless they diversify their product lines or, like Afterpay, they combine with another fintech company.