Lending Briefing: The SMB Brexit, and digital lending VC funding

“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. 

Chart of the week

Digital lending continues to lag behind investments, payments, and banking technology sectors when it comes to venture capital. With investors increasingly more selective, fintechs will have to demonstrate profitability if they’re looking for fresh funds – and being profitable in lending is difficult…

Quote of the week

Plaid CEO Zach Perret asked a pertinent question on Twitter:

What we’re reading 

Fannie Mae and Freddie Mac are letting borrowers use cash flow data to lower their mortgage rates 

Alex Johnson’s State of the Union report where he delves into the three credit bureaus that dominate the US market 

A group of Democratic senators believe banks should have to disclose how their lending and investment activities impact pollution

Bloomberg’s Matt Levine on crypto lending and debt in a market downturn – risky business 

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