Fintech Acquisitions: Why Are They Buying Legacy Firms?

A Shift in Fintech Acquisitions

The dynamics within the financial technology (fintech) sector are undergoing a notable transformation.

Previously, it was commonly anticipated that established financial institutions would acquire emerging, digitally focused fintech companies.

The Rise of Fintech Acquirers

Currently, however, a reversal is occurring, with fintech startups increasingly taking on the role of acquirers.

Recent activity demonstrates this trend, with several significant acquisitions completed or announced within the past year.

Consider these examples:

• In February 2020, LendingClub revealed its intention to purchase Radius Bank through a combination of cash and stock, with a total valuation of $185 million.
• The acquisition finalized in February 2021, resulting in an unexpectedly rapid and substantial profit during the second quarter.
• SoFi reached an agreement in March of this year to acquire Golden Pacific Bancorp (GBP) for approximately $22.3 million.
• This strategic move was intended to expedite SoFi’s process of obtaining a national bank charter.
• Figure Technologies, a lender utilizing blockchain technology, announced a merger earlier this month with Homebridge Financial Services.
• Homebridge Financial Services operates 180 retail locations and facilitated over $25 billion in mortgage loans during 2020.
• Last autumn, Jiko, a fintech startup and challenger bank, finalized the acquisition of Mid-Central National Bank, located in Wadena, Minnesota.
• This deal, which involved extensive due diligence, had a sales price comparable to a Series A funding round, as stated by the company’s founder.

Understanding the Change

This shift raises a key question: what factors are driving fintech companies to acquire traditional financial services businesses, rather than the other way around?

The reasons behind this evolving landscape are complex and multifaceted.

Strategic advantages, such as access to banking charters and established infrastructure, are likely playing a significant role.

Acquiring a Business: A Strategic Move

Certain organizations view acquisitions as a method to accelerate growth and secure necessary licenses, circumventing the complexities of establishing a financial institution within a heavily regulated sector.

SoFi, an online lending platform, has persistently sought entry into the banking industry. Following several attempts, the company appears poised to introduce checking and savings accounts to its existing 2.6 million users, who currently utilize its lending and investment services.

Although SoFi had previously obtained preliminary approval for a new bank charter, the purchase of GPB is anticipated to expedite the process compared to a ground-up build. The completion of this acquisition is projected before the year's end.

For SoFi, which generated over $230 million in revenue last quarter, the $22 million expenditure represents a worthwhile investment. This is due to the accelerated market entry and minimized regulatory challenges it provides.

Benefits of Acquisition for SoFi

The acquisition strategy allows SoFi to bypass a lengthy and complex establishment process. Building a bank from the ground up requires significant time and resources, particularly given the stringent regulatory environment.

By acquiring an existing entity, SoFi gains immediate access to established infrastructure and operational capabilities. This translates to a faster rollout of banking products and services to its substantial member base.

Reduced Regulatory Burden

Navigating the regulatory landscape for financial institutions is notoriously difficult. An acquisition can streamline this process, as the target company may already possess certain approvals and licenses.

This reduction in regulatory hurdles allows SoFi to focus its resources on innovation and customer acquisition, rather than solely on compliance matters.

Financial Implications

The $22 million acquisition cost is relatively modest for SoFi, considering its recent revenue performance. This suggests the company views the long-term benefits as outweighing the initial investment.

The improved time to market and reduced regulatory burden are expected to contribute to increased revenue and profitability for SoFi in the coming years.

Strategic Implications

This acquisition signals SoFi’s commitment to becoming a comprehensive financial services provider. Offering a full suite of banking products alongside its existing offerings enhances its value proposition to customers.

The move also positions SoFi to compete more effectively with traditional banks and other fintech companies in the rapidly evolving financial landscape.

Technical Adaptability

Conversely, Jiko represents a fintech company established in 2016, dedicating several years to securing the acquisition of a banking institution. The acquisition of Mid-Central National Bank by Jiko wasn't driven by expediency, but rather by the opportunity to fundamentally redesign a bank's architecture.

This level of reconstruction is beyond the reach of most fintech companies. Many new challenger banks and neobanks operate as rebranded applications built upon existing financial institutions, which manage deposits and supply the essential infrastructure and licenses for service delivery.

As a newcomer to the financial sector, Jiko faced considerable challenges. However, securing regulatory endorsement from the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Bank of San Francisco granted the company significant technical adaptability.

Stephane Lintner, Jiko’s founder and CEO, detailed the company’s objectives in a statement to TechCrunch: “Jiko aims to establish a secure and streamlined financial landscape, evolving into the leading platform for straightforward and effortless money management.” He further explained, “A commitment to consistent engagement with regulatory authorities is essential to credibly offer safe storage and access. An OCC charter, coupled with federal oversight, was the sole pathway for Jiko to realize this vision.”

The acquisition of Mid-Central Bank provided Jiko with direct access to the Federal Reserve and the capacity to independently process debit card transactions, eliminating the need for intermediaries. Consequently, Jiko functions as a fully autonomous bank holding company, positioned for substantial growth and competition.

“From a technological perspective, Jiko is no longer reliant on partner banks or external entities. We maintain complete ownership of our systems, from the user interface to the backend infrastructure, a fundamental requirement for achieving our core mission,” Lintner stated.

Enhanced Financial Performance

The acquisition of a bank by LendingClub yielded several advantages. Specifically, it enabled the reduction of expenses linked to loan warehousing, boosted interest revenue through balance sheet loan holdings, and fostered greater investor trust by demonstrating a commitment to its own products.

Scott Sanborn, CEO of LendingClub, detailed the transformative impact of the Radius Bank acquisition on the company’s financial standing in a discussion with Protocol.

He explained that, previously, the marketplace segment of their operation—funded by investors—required loan warehousing. “Prior to the pandemic, we had approximately $1 billion in warehoused loans, incurring a funding cost of 330 basis points,” Sanborn stated.

“This cost is eliminated by transitioning to deposits, which currently stand at 30 basis points. This represents a significant expense reduction.” He further elaborated, “Furthermore, a new revenue stream, interest income, was introduced. We previously divested all loans we originated. Now, we retain between 15% and 25% of originated loans, generating an interest income stream that is both novel and independent of origination volume.”

“Our interest income experienced a substantial increase, rising from $19 million in the first quarter to $46 million in the second. By simply retaining a portion of these loans on our balance sheet, we are projected to earn three times more revenue compared to the loans we sell. This activity incurs minimal additional costs, resulting in a considerable margin improvement.”

Although the initial investment of $185 million was substantial, the acquisition immediately improved LendingClub’s financial results. The company has yet to fully leverage the opportunity to deepen customer engagement or introduce new services to its existing customer base of 3.5 million.

Valuation Arbitrage in Fintech Mergers

A strategic approach involves uniting a well-established, potentially undervalued business with a rapidly growing entity benefiting from tech-focused valuations. The merger between Figure and Homebridge exemplifies this, as an innovative blockchain firm integrated with a traditional mortgage provider.

Logan Allin, Managing Partner at Fin VC, emphasizes the significance of fintech companies acquiring established financial services businesses, predicting an increase in such activity.

He describes this as an “economic arbitrage,” where fintech firms—valued using tech multiples—acquire companies assessed on tangible book value or a fraction thereof. This is particularly notable in the case of Figure, a portfolio company of his, and its combination with Homebridge.

The acquisition provides access to substantial revenue and profitability, valued not on revenue multiples but on the acquired company’s balance sheet strength.

Allin highlights that Homebridge, as a mortgage lender, possesses extensive consumer data—surpassing that of most organizations. This presents significant opportunities for cross-selling Figure’s products and services.

Transforming this established business into a technology-driven entity could potentially increase its valuation by a factor of five to ten, altering the calculation of its enterprise value. Allin anticipates further instances of this trend, benefiting venture capital investors, consumers, and commercial clients alike.

As fintech companies achieve increasingly higher valuations in both private and public markets, anticipate greater acquisition of traditional banks and lenders by newer companies.

These acquisitions may be driven by the desire for licenses, strong balance sheets, or simply the potential to be valued as “tech-enabled businesses.”

Key Benefits of this Trend

• Enhanced valuation potential for legacy businesses.
• Access to valuable consumer data.
• Opportunities for product cross-selling.
• Increased profitability through technological integration.

Ultimately, this trend represents a shift in how financial services companies are valued, favoring those that can leverage technology to unlock new growth opportunities.