Most fintech companies partner with banks;  Varo became one and says it's paying off

Last month, Varo Bank celebrated two years since gets the status of a national bank. The move made Varo the first all-digital national consumer bank in the US.

The startup launched its banking services in 2017, aiming to make younger consumers comfortable with doing all their banking online. It has raised nearly $1 billion since its inception in 2015 and was valued at $2.5 billion during its last increase in 2021. Its backers include institutions such as Lone Pine Capital, Warburg Pincus and The Rise Fund, as well as U2’s Bono and NBA player Russell Westbrook.

Today, the startup competes with Chime, Current, N26, Level, Step and Moven, among many others. Varro’s move to get a charter separates it from the pack in that instead of partnering with a bank, it became one.

A lot has happened since Varo took over the compound, and dearly, bank charter route. I reached out to Colin Walsh, the company’s CEO and founder, to get an update.

This interview has been edited for clarity and brevity.

TC: Was it worth getting chartered as a company? And if so why?

Walsh: It was 100% worth it. This goes back to why Varo was created in the first place. To me, there was a huge opportunity in a space that the incumbents failed to capture because a lot of it is the economics of their model and misaligned incentives. The world continues, unfortunately, to be made up of haves and have-nots… There are several things you need to do to be able to give access to the system at a lower cost: making payments easier and often a faster way to customers, especially for those who don’t have a lot of money. Help people build credit and access to credit and then over time be able to provide access to things that create a real sense of ownership. As we move customers along this journey, the only way we can truly achieve all of this is to be a bank.

This also came with a price – there were no guarantees that we would succeed. We did, but it was a difficult, long and expensive process. There are many gaps in being a real bank and not just a technology company that partners with a bank, and the flip side of this is that it allows us to control our own regulatory destiny. If you partner with a sponsor, anything can go wrong with any number of those partners, which can create risk to the business and business model. So we’ve effectively cut out the middleman.

Speaking of these uncertain economic times, all financial institutions – including Varo – are obviously operating in a very different market than you were a year ago. One article I read had a headline indicating that Varo may run out of money by the end of the year. What changes have you made to adapt to the new macro environment and avoid running out of money?

Varo took immediate and prudent action to reduce the burn rate through strategic cost reduction measures. These actions began in the second quarter and we expect to significantly accelerate these efforts in the second half of 2022.

Our biggest cost reduction comes from marketing. We reduced customer acquisition costs (CAC) in June by 64% compared to Q1. Although it was a difficult decision, we also reduced our headcount [affecting 75 people] in the second quarter to ensure the long-term health of our business given the current macroeconomic challenges. At the same time, we continue to execute on our robust near-term product strategy to support future growth.

We are still seeing strong customer growth and still have a clear path to profitability.

Before the market shift, you had secured a large round of funding and talked about going public. How did you go from that big increase to being in danger of running out of funds?

We did it really big increase last year which was extremely successful. And we’ve been doing all the things that we said we were going to do on the back of that in terms of recruiting the growth engine. After that, the market has changed very quickly around us. So we’ve repositioned the business to continue to invest and build products that customers will love and deliver on the mission, but we’ve cut back a little bit in other areas of spending.

I think what’s going to be really interesting over the next couple of quarters is to see how the tough decisions we made early on to become a bank really make a lot of sense. For example, I’m the only one who celebrates every time the Federal Reserve raises rates by 75 basis points, and I think some of my non-lending bank friends see it as an existential threat.

Image Credits: Varo. CEO and Founder Colin Walsh

how is business going?

In 2021, Varo’s gross revenue was $74 million. In 2020, it was $41 million.

Today we have 6.8 million accounts, a growth of 196% in two years. Revenues are up 100% and our expenses are up 100%.

Note: The company referred me to its Q2 2022 financial highlights here, showing the company narrowed its loss in the three-month period to $77.1 million, compared to $84.4 million in the first quarter. These highlights also include the following information: “With Tier 1 capital of $219 million and a leverage ratio of 37.2%, Varo’s leverage ratio is in the top 5% of all U.S. banks,” and “Economic conditions warrant additional focus on capital preservation. The measures initiated in the second quarter will significantly reduce losses starting in the third quarter and significantly extend the runway.”

What do you think about all the increased competition, including more niche neo-banks targeting specific demographics, for example?

There’s been this confluence over the last 10 years of these new banking institutions and these new companies getting a lot of funding and spending money on awareness. Along with that, there is a generational shift as you now have Generation Z in their 20s. And you have millennials all the way into their early 40s. So you have a massive population of consumers who have no real built-in loyalty to incumbent institutions and they’re enthusiastically embracing these new solutions and switching to digital banking providers because they grew up with a phone in hand.

Helpfully, the more players involved continue to generate awareness for the category. So from that point of view, I think it’s actually helpful to have more players and everyone has their own angle.

From a business model perspective, they are more difficult to scale. If you’re just focusing on a specific niche market and scale ultimately matters — in terms of being able to serve enough customers that you can cover your costs and you can really get some of those economies of scale. It will be interesting to see in this market environment if these types of more niche games will be able to attract the funding they need to sustain themselves. I think that will be an interesting thing to watch.

There are a lot of good people with good intentions trying to do the right thing and trying to build relationships.

What do you see in the future for digital banks?

From a macro perspective, funding will not be as widely available. You will see some players either consolidate or find other ways to manage their business through the cycle. But I think we are at the beginning. We don’t know how long this economic situation is going to last, and so I think it’s going to really start to weed out business models that are really resilient through different economic cycles and those that are going to struggle.

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