Over the past 10 years, fintech has had an incredible impact on how financial services are offered and delivered. One of the primary drivers of fintech’s continued evolution is the diversity of the companies that are entering the financial services sector. Firms that historically have had nothing to do with financial services are now looking at starting neobanks, offering loans, and introducing crypto services. In the past, if you wanted to offer a financial product you had to either be a bank or be directly licensed by the states you wanted to operate in. Today, it is increasingly easy for non-traditional firms to offer financial services products.
The introduction of banks that offer partnership opportunities (Evolve, Cross River, Bank of the Internet, Finwise) and Banking as a Service (BaaS) firms that offer turnkey solutions have made it easier than ever to become a financial services provider. This range of options for entering the market leads to one of the first questions new entrants must answer - what is the best way to offer financial services products and how much will it cost to launch?Before doing a deep dive on that question, let’s walk through the two primary go-to-market models we see used today:
- Build the network of service providers and infrastructure needed to get into the market yourself. We’ll refer to this model as the Do-It-Yourself (DIY) Model. There are some functions every firm will need to have in place regardless of what products you offer, including regulatory policies and procedures, regulatory infrastructure to monitor ongoing compliance, a KYC service provider, fraud monitoring, and risk management. Depending on the product you want to offer you will also need all or a combination of a bank partner, state licenses, money transfer licenses, and credit card BIN sponsorship.
- Partner with a firm that brings banking partners and/or lending infrastructure to you as well as provides much of the technical and regulatory functions necessary to offer your products and services. We’ll refer to this model as the BaaS Model. Under this model, you can offer a myriad of products or services as long as they are supported by the BaaS firm. You will need to also bring some regulatory and fraud infrastructure but that’s the extent of the heavy lifting.
The Go-to-Market Cost Analysis
We are seeing new entrants participate in all segments of the financial services space - deposits, payments, lending, investing, insurance, crypto, but for purposes of this cost analysis we’re going to focus on deposits, payments, and credit.
Turning back to the question of the best way to go to market and how much will it cost to launch, we believe costs need to be looked at holistically but at a minimum from three different perspectives:
- Control over your products or services
- Hard costs to initially launch and continue to operate
As we start to analyze the costs along these three dimensions, we’ll be comparing the costs across both the DIY and the BaaS models. We will evaluate each of the alternatives on a scale of 1-3, with $ (one being the least expensive) to $$$ (three being the most expensive).
Now more than ever, time to market is critical to success. There is no shortage of capital available for investors to fund competitors. Continued improvements in technology make it easier for competitors to launch. Faster and easier access to products and services provides consumers with more buying power than ever. And while it’s almost impossible to put an exact dollar on value lost by not being in the market, we do know how long each alternative takes to launch and that time can serve as a proxy.
The DIY Model can be very time-consuming with time being a function of the products involved. The approach often requires the need for multiple licenses (e.g., state lending, broker & servicing, money transmitter license (MTL)) or the need to have a bank partnership. Depending on the number of states and products involved, these licenses can take several months to obtain, and then making sure that the differences across states in underwriting requirements, disclosures, and interest rates take additional time.
Putting in place a banking partnership typically takes 3-6 months by the time you get approved, go through contracting and then go live. Additionally, all the items we discussed earlier (regulatory policies and procedures, regulatory infrastructure to monitor ongoing compliance, etc.), that go into the DIY Model need to be built and implemented. Many of those things can be done in parallel but some must be handled serially, for example, you can’t build your KYC processes until you’ve selected and integrated with a vendor. We’ve seen the DIY Model launched in as quickly as 6 months in narrow use cases but typically it takes 7-12 months.
The BaaS Model typically doesn’t require a lot of time or effort. The heaviest lifting in getting to market with a BaaS provider is making sure you have a clear understanding of the product you want to offer and any requested legal documentation regarding funds flow or specific regulatory considerations. Once you’ve selected the BaaS firm that best fits your needs, the contracting process is straightforward, and the implementation process primarily involves plugging into state-of-the-art APIs. You still must build out your front-end and the internal teams and processes you need to support the program, but those activities can usually be done in parallel with the contracting and implementation as can your risk management policies and procedures. Plugging a fraud provider into your flow usually can be done through API. Depending on the BaaS provider you work with, the implementation here can be done as quickly as 6-8 weeks.
Control Over Your Product
The DIY Model gives you a strong degree of control over your product but at a cost: time, and hard cost. You are designing the products you want to take to market and then building them. If you go to market with a bank partner, you’re able to offer a uniform product across all states. A state-by-state licensing model is more restrictive than a banking partner in that you are dealing with different regulators and regulatory structures for each state. You can minimize this disruption by focusing on states that have consistent regulations or offering a product that fits the most restrictive state’s requirements.
A sophisticated BaaS provider is going to partner with multiple banks which increases the chances you have to offer the products that you want. Imagine a situation where you are offering one product with a partner bank and you want to offer a second product that the partner bank doesn’t want to support. Your alternatives are to either scrap the product, go find another bank to partner for that product (timely and expensive), or launch your own under a state-by-state model (also timely and expensive). With a sophisticated BaaS provider, there are multiple banks available to offer that product and a realistic outcome would be that product A is offered through Bank A, but product B is offered through Bank B.
Hard Costs to Launch
Note: All of the alternatives here share common costs, so we’ll focus only on the differentiated costs.
The DIY Model is expensive for many reasons, not the least of which is the sheer number of things that you must deal with and get done on your own. Building a front and back end, putting infrastructure in place, securing and integrating with service partners all takes time as outlined above but individually are also expensive undertakings. Putting a bank partnership in place will cost $200K-$400K in legal and compliance costs, you will pay for their legal expenses as well as your own. If you go the state-by-state route, there is a cost of acquiring and maintaining a state lending license, typically $10K-$15K per state per license (for example, lending and servicing are separate licenses in most states) and many states also require you to maintain minimum liquidity or net worth amounts which can tie up capital. And lastly, you will need to invest in the infrastructure we discussed to support your activities (regulatory, compliance, risk management, etc.), which is considerable, likely ~$2.0M to build it out appropriately and invest in the right systems. Additionally, on an ongoing basis, you will spend a minimum of $1.5M to support the products.
One of the key benefits of launching with a BaaS provider is the lack of upfront investment because, for the most part, those service providers bring turnkey solutions to the table and provide much of the ongoing infrastructure that is needed to run the product. The biggest expense is typically upfront legal and compliance fees associated with making sure you understand the product you want to go to market with and that you have the right perspective on things like money service business licenses which will fall within the range of $25-$50K. After that, the contracting process is relatively straightforward with an MSA and your ongoing infrastructure needs are much lower, so your initial investment costs are much lower $50K-75K depending on the product complexity and things like how high fraud risk will be in your business. The implementation fee is minimal running in the range of $5K-$10K per month from contract signing to go-live date.
BaaS firms have completely changed the marketplace for financial services , effectively allowing any firm (financial services or otherwise) to get into the market quickly, easily and relatively inexpensively. This holds true in absolute terms but also relative to the DIY alternatives that are available to you.
Granted, every situation needs to be measured based on its individual merits but hopefully the framework outlined here provides a useful framework for evaluating your decision.
Next time out we’ll start analyzing how the benefit of BaaS firms can directly impact your bottom line and unit economics.