Build, Buy, or Partner: The Fintech Tradeoffs for a VSV

It’s well known that fintech is a common expansion direction for a Vertical SaaS Vendor (VSV). However, fintech products are incredibly challenging to build and typically take a long time to execute. There are regulatory hurdles and legal risks galore. To bring clarity to the challenge of building fintech products, we facilitated a conversation between a small group of Vertical SaaS CEOs and operators with Samantha Ku, COO of Square Financial Services.

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Here are some key takeaways from this VSaaS Collective session on fintech with Samantha Ku:

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Partnering can be a fast way to get off the ground with fintech

If you want to get off the ground fast with fintech, Samantha recommends partnering with an embedded fintech vendor.

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“To build fintech infrastructure for the first time, you have three options. You can build, you can partner, or you can buy. Build and buy are going to be the most expensive and the most time-consuming. For most non-financial companies, the fastest and easiest way will be to partner with fintechs, who have already done the legwork with banks and created the APIs to help companies quickly add on these services. And then on top of all that, I think the most paramount thing is the compliance and legal aspect, which cannot be stressed enough. These partnerships really have all of those pieces in place for your business to start selling to customers.” 

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Becoming a bank

At a certain scale, you may want to start figuring out how to build capabilities in-house. Square walked the hardest road and went through a six-year process to become a bank. Understanding why and how they did it is valuable.

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“We actually started as a merchant cash advance (MCA) product and then moved to working with a bank partner. Eventually, to expand our scalability within the regulatory environment, we decided to become a bank. Working with bank partners in the beginning was definitely the fastest way to start, but the regulatory environment was very, very limited for us, specifically in loan servicing and origination. We had to maintain state by state licensing. It was very expensive. There were certain states we just couldn't operate in altogether, and for the long-term scalability of our financial services… we decided to build a bank. The application took three years, and upon approval, we were actually subject to a three-year de novo period, which includes an extensive regulatory environment, very intensive regulatory exams, and a much tighter risk sandbox. Meaning, every new product that was not approved in our original charter, we couldn't quickly add to our product suite. So upon passing this de novo period, we now have the ability to expand our financial service offerings faster and with better economics.” 

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How to decide what product to go after

As we’ve discussed in previous Collective sessions, one of the biggest challenges for a VSV is knowing what product to launch next. The same holds true in fintech. A key variable to think about is where you have a competitive advantage.

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“It's important to start where you have a competitive advantage. For us, we had so much data with Square Payments to use to underwrite loans already. We also benefited from funds flow sequencing—we're at the top of the payments waterfall, so we pay ourselves first before we even deposit the Square sales into our seller's bank account. 

In contrast, we had a loan product where we were lending to businesses outside of the Square ecosystem, and we were lending on bank data…. Our goal was to explore how we could underwrite to the underserved market. But truthfully, we couldn't do it better than anyone else, and our risk was not well managed. We were seeing high default rates. We were seeing businesses with negative bank accounts, and the businesses that were very strong had a lot of financing options, and so would go to competitors who could do things, probably with more friction, but cheaper than we could. So we actually ended up sunsetting that product entirely. 

The second thing that's important is following your customer needs and workflows to assess what products can add the most value to them. When we started our lending product 13 years ago, we knew [that] 10 million small businesses applied for loans in the US each year, but only 3 million were approved through existing solutions. So, the potential was huge…We had a way to underwrite these sellers that no one else had done before. 

Lastly, I think it takes time to evaluate. You need to examine each product opportunity, and then forecast your ARPU lift and attach rate expectations. This helps you consider the level of effort versus ROI. For the partner loans that we ended up sunsetting, it was very expensive for us to manage. The ROI was not there for us.

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How to build a team to go after fintech

Getting the right lawyers and risk managers is mission-critical. Samantha had a few recommendations on how to build the team to pursue fintech.

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“To structure a team, start small, ensure that you have the right product and end team in place. And then, of course, compliance and legal are absolutely paramount, even from the very, very beginning. From a Minimum Viable Product (MVP), you want to build the right foundation and the right culture of compliance, because fintech is such a highly regulated industry. You want to think about what the non-negotiables are for an MVP as well as compliance and legal, of course. But then beyond that, what are you testing for? Is it just demand? Is it product market fit? Do you care about customer experience yet? So, fill your roles in this order and make it explicit what the goals are, but also make sure the non-product or revenue goals like compliance are taken care of.

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Conclusion

We hope you enjoyed this brief recap of Samantha Ku's VSaaS Collective session on fintech.

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This conversation was a part of our VSaaS Collective. These are bi-monthly deep-dive sessions for an invite-only cohort of CEOs and functional execs, aiming to highlight industry best practices and build a trusted community among non-competitive peer operators.