Square's Afterpay Acquisition: What It Means for Startups

Square’s Acquisition of Afterpay: VC Perspectives

On Sunday, Square revealed its acquisition of Afterpay in a transaction valued at $29 billion upon initial announcement. Further analysis regarding the strategic rationale behind the deal for both Square and Afterpay was provided by Alex yesterday; that information can be found here.

However, we sought insights from prominent venture capitalists to understand the implications of this acquisition for the broader startup landscape.

BNPL Market Investment Surge

This acquisition occurs amidst substantial investment and growing interest in the “Buy Now, Pay Later” (BNPL) market. Throughout this year alone, venture capital firms have directed funding towards companies such as Alma ($59.4 million, January 2021), Scalapay ($48 million, January 2021), and Wisetack ($19 million, February 2021).

Additional investments include $80 million for Zilch (April 2021) and $30 million for Dividio (June 2021).

Significant Funding Rounds for Key Players

Klarna, a major player in the BNPL space, secured $639 million in June, resulting in a post-money valuation of $45.6 billion. This followed a $1 billion raise in March, which established a post-money valuation of $31 billion.

Interest from Established Companies

Major public companies are also demonstrating increased interest in the BNPL sector. PayPal, after a relatively slow start, is now actively promoting BNPL services to its merchant network.

Reports also suggest that Apple is developing its own BNPL solution integrated within Apple Pay.

Expert Opinions from Venture Capitalists

We consulted with Dan Rosen, founder and General Partner at Commerce Ventures, Jake Gibson, founding partner at Better Tomorrow Ventures, TX Zhuo, partner at Fika Ventures, and Matthew Harris from Bain Capital Ventures. Their perspectives were sought regarding the Square-Afterpay deal and its potential impact on other BNPL companies and startups.

Key Takeaways: Scale and Margins

A central conclusion from these discussions is that while “Buy Now, Pay Later” services can effectively boost retail conversion rates, achieving significant scale is crucial.

Furthermore, long-term profitability margins appear to be limited for BNPL startups.

Venture Community Insights

Let’s now examine the detailed viewpoints offered by members of the venture capital community.

A Look at the BNPL Landscape

What factors are contributing to the rapid growth observed in the Buy Now, Pay Later (BNPL) market?

According to Dan Rosen, founder and General Partner at Commerce Ventures, the expansion of the BNPL market – particularly within the United States – stems from a combination of influential elements. These include limited credit card access among younger demographics, a consequence of the CARD Act restricting issuance to those under 21 and limiting campus marketing; sustained federal monetary policies leading to historically low interest rates; and the increasing financial capacity of millennials, coupled with a preference for spending on e-commerce platforms.

Generally, a greater reluctance towards accumulating credit card debt has been noted among younger consumers, with a demonstrable decrease in card utilization rates during the pandemic period. This has created an opening for alternative financing options offering greater predictability, as noted by Jake Gibson, founding partner at Better Tomorrow Ventures and a fintech investor.

Gibson further explained, “It’s intuitively appealing to consumers to transform purchases into manageable, understood installments – essentially converting them to subscription-like payments – rather than facing the uncertainties of credit card balances and compounding interest.”

Simultaneously, BNPL solutions demonstrably improve retail conversion rates and “facilitate retailers in fostering customer relationships through interactions extending beyond a single purchase,” as highlighted by TX Zhuo, a partner at Fika Ventures. Even small improvements in conversion rates can significantly enhance profitability for retailers.

For fintech companies and startups, BNPL integrations provide a pathway to connect with established e-commerce businesses, according to Matthew Harris of Bain Capital Ventures. He underscored the value of “establishing strong and profitable connections with e-commerce merchants.” He also pointed out that, outside of payment processors or shopping cart platforms, opportunities to forge such merchant relationships are scarce.

The investors consulted generally expressed optimism regarding the integration of Square and Afterpay. However, they displayed less enthusiasm for the emergence of new consumer BNPL businesses.

Harris stated, “I don’t foresee substantial opportunities or novel approaches within the consumer BNPL sector… achieving significant scale is crucial, and it will be challenging for new entrants to gain sufficient momentum.”

A cautionary note was also raised regarding the need for existing BNPL companies to diversify their offerings to ensure long-term sustainability and value creation. Rosen of Commerce Ventures wrote, “In the long run, pricing and margins in this industry will likely converge towards zero, or at best, interchange rates, as it’s fundamentally a commodity capital business.”

Harris added that “Affirm and Klarna are under pressure to expand their ‘cardholder’ bases, whether organically or through acquisitions,” and he anticipates that “one or both of these companies may consider acquiring neobanks in the coming future.”

Despite limited prospects in the consumer BNPL market, some investors believe the model holds potential when applied to more specialized financing areas.

Harris wrote, “A genuine opportunity exists within the B2B space.” He continued, “As more business processes become digital… this creates a chance for BNPL models to replace or improve traditional invoice financing and trade credit.”

Gibson suggests a potential for “point-of-sale lending for significant, discretionary expenses not covered by insurance” and predicts an increase in verticalized, point-of-sale BNPL solutions. He has already encountered proposals for services like dental care and veterinary services, and believes BNPL options for cosmetic surgery or dermatology likely already exist.

In conclusion, the window of opportunity to build a substantial consumer business solely on the BNPL model may have already closed. Given the mixed financial performance of leading companies, the BNPL market appears to be heading towards a race to the bottom in commodity lending, unless businesses diversify their product lines or, like Afterpay, merge with other fintech entities.