At Core Innovation Capital, we focus on aligning profit margins with customer impact as we believe the largest businesses ultimately do right by its stakeholders, particularly its customers. En route to maximizing impact, we have supported many outstanding founders building innovative direct-to-consumer (D2C) fintech startups, from Nerdwallet, which shepards people into the right financial products, to Opportun, which lends to underserved communities, to Trim, which automatically cancels your unwanted subscriptions. While D2C fintech remains a core piece of the puzzle, we believe the next wave of category-defining fintech startups will come to you, perhaps counter-intuitively, not through a traditional financial services application, but through B2B software products.
In an attempt to build a viable business model with compelling unit economics, we are increasingly seeing a strategy in which financial technology supplements SaaS offerings, ultimately delivering financial services in a sustainable, and impactful, way. A successful SaaS business typically finds a wedge into the operational workflow of its customer by creating a must-have product. The business then opportunistically layers on fintech products, ultimately making financial services a core driver of its business model. The opportunity to build a full-scale financial stack is made possible by the stickiness built from its core wedge and the trust earned by working with the customer over time. This trust is placed upon the highest pedestal for all fintech companies.
Two wildly successful case studies come to mind, Toast and Shopify. Toast, which focuses on restaurants, found a value proposition that resonated — faster table turns that increases revenue opportunities combined with back-office automation that improves efficiency and lowers costs. First and foremost, Toast was a SaaS business for automating restaurant administrative work. These digital services have proven mission critical in a post COVID world. And for a restaurant industry that sees low single digit profit margins, increased costs and efficiencies are the difference between open for business or closed for good. Yet, the low-margin nature of restaurants made it hard for Toast to extract profits out of just its SaaS product. What makes Toast an exceptional, and sustainable, company, is its ability to blend financial services revenue with subscription revenue. Financial services, including integrated payments processing and other fintech products, currently account for 83% of Toast’s revenue, adding tens of billions to the addressable market that a SaaS-only business could pursue. While payments is an obviously large portion of the financial tool set that Toast provides, Toast Capital creates high margin lending revenue by providing working capital loans of as little as $5k or up to $250k. Cash is the oxygen of a small business, so for small restaurant owners that may struggle to find affordable funding through traditional means, these loans make a substantial difference. Furthermore, the Toast Restaurant Card is a debit card that provides restaurants access to funds and gives rewards for restaurant-specific partners. Taken together, this initially sticky SaaS business upsells financial products that both increase gross profits and customer impact.
Shopify also started with a SaaS product prior to ultimately building more and more complimentary fintech products to assist an underserved segment of customers. Its core ecommerce software product has always been built to serve the pain points of SMB merchants, not major enterprises. It saw the potential impact of helping SMBs expand online sales channels, and built a low-priced product to wedge into a market segment that typically is difficult to acquire. To this day the large majority of users are on a plan for less than $50/month. It proved much more viable to acquire these customers by promising to expand their digital capabilities, a must-have in the 21st century, than by pitching a new payments product. In addition, Shopify’s ecommerce store-in-a-box provided an attractive alternative to competing on Amazon. And from the start, Shopify has always built its business with financial services as an integral part of its long term strategy. At its IPO in 2015, subscription revenue accounted for 63.5% of revenue. Currently, subscription revenue accounts for only 27.5% of revenue, while fintech services account for 72.5% of revenue. Put simply — Shopify is primarily a fintech company. These fintech solutions help merchants (1) accept payments across multiple platforms, (2) secure financing at a fixed percentage of future daily sales through Shopify Capital, (3) sell goods to buyers on a buy now pay later plan through Shop Pay Installments, (4) manage excess cash through Shopify Balance, and much more. Just like Toast, adding a suite of fintech products increased Shopify’s total addressable market by tens of billions of dollars. For merchants, using Shopify streamlines business processes, makes it feasible to run an ecommerce business without the reliance on Amazon, and allows merchants to turn all focus towards the customer. Once again, higher impact came with higher profits.
My takeaway is that the next generation of great fintech companies may not initially position themselves in classic financial services. Several private companies have taken note of this successful business model and have begun to blend SaaS products with fintech products to create powerful, and venture-backable, businesses. For example, Rippling took a unique approach trying to build it all at once, in what Parker Conrad calls a compound startup, where a startup tackles many point solutions simultaneously to solve its customers’ biggest problems. Rippling’s SaaS platform automates cumbersome HR tasks, while complementing products simplify the finance tasks that the same back-office teams deal with (e.g.,expense management, payroll, corporate cards, and bill pay). As a fintech focused investor, writing off Rippling as a SaaS business and not a fintech company would have been a mistake.
And while Rippling serves many different industries, we’re also seeing successful vertical approaches that target pain points for specific industries. For instance, CloudTrucks built software to manage trucking businesses, including the ability to lease trucks and connect with the best loads. It layers on the fintech products that these trucking carriers (many of which are small business owners with less than ten trucks) need such as invoice factoring, fleet card for spend management, and insurance. Most industries involved in supply chain must natively interact with payments, making SaaS plus fintech a very viable business model. ChannelMeter created a SaaS product for brands that work with creators to optimize the day-to-day complexities of managing many freelance businesses at once. Now, ChannelMeter is in the perfect position to offer debt financing and other fintech tools to creators that struggle monitoring and optimizing working capital. Forward, a Core portfolio company, created a workflow product for local governments to manage disbursement of government aid to communities in need. The company is in an exciting position to ultimately bring safer financial products to these underbanked communities. FarmRaise helps farmers track expenses and build sustainable farming practices into their daily routines, all while simultaneously helping them access cheaper loans.
At the end of 2022, investors had all but shunned consumer fintech due to scary business models and struggling unit economics. But that does not mean we are going back to incumbent banking with miscellaneous fees, arduous operational processes, and limited personalization. 2023 will see finance solutions coming to customers in more convenient, affordable, and relatable ways, whether you are a trucker, creator, farmer, or any underserved community in between!
Comments, feedback, questions always welcome! Twitter: @roosontheloos
Author: David Roos
