Lending Briefing: The SMB Brexit, and digital lending VC funding
- Given the recent announcement from expense management platform Brex to stop serving SMBs, how are its competitors looking to address the market?
- We also take a look at the first quarter VC funding in fintech, and how lending compares to other verticals in the space.
With Brex out, how do its competitors plan to serve SMBs?
Brex took over the headlines these past few days after its announcement that it will stop serving traditional small businesses, focusing only on tech startups with capital backing.
This news triggered many conversations and opinions in the industry, giving us all a break from talking about crypto and layoffs – the spotlight is now on corporate expense fintechs, which were industry darlings not too long ago.
Long story short – the fintech realized SMBs were more complicated than anticipated. It was spreading itself too thin, according to founder and co-CEO Pedro Franceschi, and it couldn’t serve either small businesses or startups well.
“Over time, we realized that our startup customers – the very customers we started with – were growing very fast, and needed Brex to scale with them. Scale AI went from 5 people when we started serving them, to almost 1,000. Brex didn’t work as well for larger companies,” the executive explained in a Twitter thread.
Brex started out around five years ago as an expense management solution for startups and SMBs, expanding in the latter segment in 2020. Revenues mostly came from interchange fees, as the main product was corporate cards.
Meanwhile, competitor Ramp also started with offering free services and corporate cards, but its approach is now centered around building software designed to help SMBs save money. Most corporate card companies were incentivizing spending, offering lots of rewards schemes, as this fuels interchange revenues. But small businesses actually want savings, according to Colin Kennedy, chief business officer at Ramp.
“The focus seems to remain very much on gamification of spending, not in investing in a software layer. We're just taking a different approach – we think we can continue to incentivize savings while delivering a world class software solution,” Kennedy told Tearsheet.
Ramp launched right before the pandemic started, a stressful and critical time when travel and expense management were taking the backseat. This fueled the rationale to help small businesses save money and continue to grow, giving clients better visibility into data around how the businesses were performing.
“Your product gets tested by very demanding users - one of the massive benefits of servicing middle-market, small to medium sized businesses and additional larger clients is that you get extremely good feedback and your product is really pressure tested by SMBs,” Kennedy said.
There was definitely some pressure testing happening at Brex as well, and the results were not that pretty. But Ramp seemed confident in its expense-saving approach despite the competition. The company’s CEO Eric Glyman pointed to American Express, a big player in this market, saying that one in three Ramp clients switch over from AmEx – of those, 90% leave their traditional expense management providers like Concur and Expensify.
And the fintech says its software solution was built to scale – companies that started small can grow to thousands of employees on Ramp. This is going to be a key variable, considering that Brex pivoted from corporate cards towards focusing on its software offering to make sure startups would scale with it. Turns out not all of them could.
But this was a last-minute realization that running a business on interchange fees is “a race to the bottom”, according to Thejo Kote, founder of Airbase, a rival spending management platform for SMBs.
“This is hopefully the beginning of the end of the crazy VC-fueled delusional business models which assume you could build a profitable software business on the back of low-margin interchange revenue,” he said in a post.
Kote believed that the transition from corporate cards to a spending management system was a type of bait and switch strategy, keeping services free until there’s a product to charge for.
Meaningful recurring revenue comes through subscription fees, he said, which is what Airbase does, as it takes time to build a comprehensive platform that can be useful for the different needs of SMBs.
“The real reason this is happening is that VCs were happy to pour billions into companies at 100X multiples of their 20% gross margin interchange revenues. Those days are done and everyone needs to show an actual business model and revenue that justifies the crazy valuations,” Kote argued.
To put things in context, Brex was valued at $12.3 billion in January this year, following a $300 million raise. Ramp recently doubled its valuation from $3.9 billion in August 2021 to $8.1 billion in March 2022.
We all knew this was going to be a tough year for fintechs, and this latest move by Brex signals a maturing point for the industry. You try things and sometimes it doesn’t work – time will tell if others actually figured out how to do it.
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