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Happy Friday, Fintech Takers!

I hope you’ve had a good week.

Mine, to be frank, has been overwhelming. 

The news … it just won’t stop! 

The prediction markets are blatantly lying about random stuff. Brian Armstrong is presenting well-known facts about the banking system as if they’re massive conspiracies (they are loaning out your deposits without your permission!!!) Jamie Dimon is trolling the senior Senators from Massachusetts and Vermont. The CFTC is trying to “future-proof” the commodities market. Ford and GM got approval from the FDIC to proceed with setting up industrial banks. And AI startups are raising so much money in seed rounds that we are no longer allowed to call them seed rounds (I have decided).

And that’s just a small fraction of the stuff happening in my little corner of the store! In the brief moments when I look up and survey the rest of the store (i.e., all world events), I get a very “this is fine” vibe, which seems like it may be the theme for the foreseeable future.

I was planning to take it easy today. We just published an excellent (if I do say so myself) deep dive essay on New Year Predictions/Resolutions/Priorities (sponsored by the good folks at MX), and I figured I’d just do something silly and light for today’s newsletter.

But no!

As first reported by the Wall Street Journal, a big and influential bank is going to buy a big and influential fintech company, and, obviously, we must talk about it.

So, here we go!

- Alex    

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DEEP DIVE

There are a lot of levels to a deal like this, so let’s start by zooming in on the transaction itself, and then we’ll slowly back our way into some of the larger industry implications.

Capital One is buying Brex for $5.15 billion in cash and stock. That’s less than half of what the company was valued at when it raised $300 million at a $12.3 billion valuation back in 2022. However, given Brex’s current revenue run rate (they made somewhere between $500M and $700M last year), it’s still a healthy multiple, and a very good exit. Early employees and investors will do well, and later-stage investors will get their money back.

It’s a satisfying, though perhaps somewhat anti-climactic end for one of the most successful fintech startups in one of the hottest and best-funded fintech verticals of the last decade.

The company was founded in 2017 to help venture-backed startups get corporate cards. A corporate card for startups was the company’s wedge product, but in 2019, it launched Brex Cash, expanding into B2B payments and business banking more broadly. Also, around this time, the company started aggressively expanding the scope of the businesses it worked with, moving beyond venture-backed startups and into the SMB space more broadly (retailers, restaurants, service businesses, etc.)

This pivot did not go well, and in 2022, the company offboarded all of its small business customers that did not have “professional funding,” returning to its roots in the startup ecosystem. It also leaned more heavily into the software side of its business, launching an integrated spend management platform (cards + expense management + bill pay/reimbursements + travel) called Empower.

This move brought the company into more of a direct competition with its archrival Ramp, which had already been pursuing a tightly-integrated, software-led product strategy. And while Brex benefited enormously from the 2023 failure of Silicon Valley Bank, my sense is that this artificial acquisition boost papered over some product and growth challenges that the company experienced during this time. 

To help address these challenges, the company took the somewhat surprising step of embracing an embedded distribution strategy in 2024, making its cards and other payment capabilities available wherever enterprise companies might want to use them. This modular, partnership-focused strategy was just starting to bear real fruit (the Brex-Fifth Third partnership was announced less than two months ago!) when Capital One swept in and took Brex off the board.    

Capital One is on a bit of a roll with acquisitions, and while the Brex deal is significantly smaller than the $35 billion deal it recently completed for Discover, $5 billion is still a chunk of change. Investors will want to see a return. And given that Capital One’s share price dropped by roughly 5% in after-hours trading after the deal was announced, I think it’s safe to say that investors don’t view this transaction as an automatic slam dunk.

So, what is Capital One thinking?

Richard Fairbank, Capital One’s Founder, Chairman, CEO, and President, was asked this exact question during the company’s most recent earnings call.

His answer was very specific — payments: 

From the founding of the company, we have believed that payments will be the tip of the spear in the transformation of banking and financial services.

Over time, we built a payments company encompassing credit cards and banking across consumers and businesses and recently added one of the nation's only payment networks. Business payments have been a growing part of our strategy and investment agenda. We have built the nation's third largest small business credit card franchise, and we have been investing to grow our small business bank. Our announcement today represents an important step change towards our business payments destination in a broader marketplace that we believe is ripe for reinvention.

Business cards represent approximately $2 trillion in purchase volume split roughly between corporate liability, where the business entity is responsible for making payments on the card and personal liability where the small business owner is personally responsible for making payments on the card. And that latter space, the personal liability card is where we primarily play today.

Since acquiring Discover, Capital One has been entirely focused on growing and scaling its own global payments network. It believes that one of the biggest opportunities to do that is by growing its reach in the business credit card market, specifically the portion of that market that sits between true small businesses (where the owner is often personally liable for making the card payments) and enterprise businesses (which tend to get all of their financial products, including corporate cards, from a single provider). Capital One already has a lot of the first group (“the nation's third largest small business credit card franchise”), and it will likely never have the lion’s share of the second group (Capital One’s commercial business is much smaller and less competitive than the ones at the money-center banks and other super-regionals).

So, while Brex’s $13 billion in deposits is nice to have. And the relationships that it has with enterprise tech customers like Anthropic, Robin Hood, TikTok, Coinbase, Toast, Cloudflare, and DoorDash will create some valuable cross-sell opportunities for the bank’s small commercial banking, treasury management, and lending products. The real value that Brex provides to Capital One is A.) its thousands of existing small and medium-sized business customers, B.) a product and a brand that those customers seem to value, and C.) expertise in how to acquire more of those customers.

It’s a compelling thesis. However, I think there are a couple of challenges.

First, if we think about the source of Brex’s strength at customer acquisition, historically, it’s not clear to me how much of it will translate over to Capital One. For most of its life, Brex has acquired customers through a combination of incentives (in the early days, Brex was aggressive in giving reward points for spend, tailored to common tech startup spend categories), brand (Brex’s pitch was essentially “for tech founders, by tech founders”), and product (the software side of Brex’s product is designed for the specific needs of venture-backed tech startups).

Realistically, how much will Capital One benefit from these strengths?

Anyone can offer incentives. Capital One doesn’t need to acquire Brex to get better at playing that game. It’s already quite good at it. 

The brand advantage will likely suffer, post-acquisition. Capital One likes to think of itself as a founder-led fintech startup, but to tech founders in their 20s, Capital One has always been around. They’re the man, not the person sticking it to the man.

And while I believe that Brex’s software product is very good and will help Capital One attract more venture-backed tech startup customers, I have my doubts about how broadly appealing Brex’s product is to the wider universe of SMBs that Capital One clearly wants to acquire. Product-led growth works best when the product in question is tailored to the needs of a specific segment of customers. That’s why vertical SaaS companies like Toast and Housecall Pro have been so successful.

Will Brex’s product be as appealing to restaurants, solar panel installers, and law firms as it is to venture-backed tech startups? Capital One seems to think so. Richard Fairbank noted on the earnings call that over the last 2 years, 60% of Brex’s originations have been to nontech companies. That’s notable, but probably also a bit misleading given that originations do not necessarily correlate to payment volume (which is the metric Capital One cares about). Personally, I doubt that Brex and Capital One will be able to sustain the same level of product-led growth as it pitches the product to the wider SMB universe, and Brex’s failed attempt to expand into that universe in 2019/2020 gives credence to my doubts.

Now, in response to this, you might say, “But Brex figured this out! They adopted a more modular, embedded strategy, and they are growing through those indirect channels!”

And that’s a good point! I’m sure that Capital One is eager to accelerate this embedded distribution strategy and get the Brex product (or components of it) into as many places where SMBs hang out as possible.

However, even within the embedded part of Brex’s business, there will be some conflicts for Capital One to navigate. For example, guess which card network originally partnered with Brex to enable its embedded strategy? I’ll give you a hint — it’s not Discover:

Brex Embedded leverages proprietary APIs and issuing integrations—including Mastercard’ innovative virtual card platform—to enable any software vendor to seamlessly integrate Brex’s global corporate card and payments capabilities directly into their platform, without the overhead of underwriting, onboarding, and credit risk.

“In recent years, large enterprises have transformed the way they do business to meet the fast-paced nature of today’s digital world,” said Sherri Haymond, Co-President of Global Partnerships at Mastercard. “At the forefront of that change is the digitization of B2B experiences and the need for innovative, global offerings to meet those expectations. We’re thrilled to expand our partnership with Brex to launch Brex Embedded, which puts corporations in control with a simple, safe and easy way to manage connected payments experiences.”

I’m guessing Mastercard won’t be as thrilled when Capital One eventually starts steering this B2B payments volume towards its own payments network.

Another example, of course, is Fifth Third, which represents, by far, the biggest win that Brex has gotten with its embedded distribution strategy so far. 

Fifth Third’s plan to white-label a version of Brex’s product wasn’t motivated by a desire to grow its reach in the SMB credit card market, but rather to help it differentiate and grow its commercial banking and lending business. However, despite their differing goals, I doubt that either Fifth Third or Capital One will be comfortable continuing with this partnership for the long term. That will likely prove true with other large, commercially-focused banks as well, which takes a promising avenue of growth (which Brex had just started to crack) off the table.

Finally, as with all bank-fintech acquisitions, there’s an integration concern. Fintech companies and banks operate at very different rhythms. They employ very different types of people. They are motivated by very different incentives. Combining them together is rarely as easy as executives and management consultants think it will be.

Capital One, for its part, believes this is a solvable problem. Here’s Fairbank again:

We are both founder-led companies with a heritage of innovation and entrepreneurship. We've both disrupted the status quo to reimagine markets and drive transformation. And our strategic choices along the way have been guided by strikingly similar core tenets, to invest, to sustain growth and returns over the long term, to work backwards from where the world is going, to build from the bottom of the tech stack up and to search the world to find and hire great people and give them a chance to be great.

Capital One seems particularly obsessed with Brex’s tech stack, which it built in-house. Here’s Fairbank one more time:

Brex has been a beacon for us and we have admired them from afar. As we've gotten closer, we've been even more struck by what they have built. The Brex team has amazing talent. They built a full modern tech stack from the bottom up. Their card and banking businesses run on an in-house, fully modern core, they're 100% in the cloud. While most fintechs we've seen through the years, leverage third-party technology solutions to get there faster, Brex has taken the more difficult and rarest of journeys for a fintech. They've invested in a modern technology infrastructure and data ecosystem that's built to last.

I can see why Capital One would find this attractive. It is similarly obsessed with building its own technology and analytic models rather than buying them off the shelf. However, it may be a misunderstanding of what it takes to win in this market.

Ramp, which is a couple of years younger than Brex, has, by most metrics, been more successful than Brex. It has done so by prioritizing the speed at which it ships new products and features (using tech that is mostly not built in-house). Product velocity is not an outcome that banks’ operating environments are set up to produce, which is a lesson that Eric Glyman, the Co-founder and CEO of Ramp, learned himself when he worked for Richard Fairbanks, after Capital One acquired his previous start-up Paribus. Here’s an amusing anecdote:

As a young entrepreneur acquired to help Capital One think more like a tech company, Eric had regular meetings with Capital One’s CEO. At one such meeting, the CEO told Eric about hockey gloves that he’d ordered for his grandson on Amazon. His grandson was coming over to play hockey the previous Saturday, so the Wednesday before, the CEO ordered him a pair of gloves. They were supposed to arrive on Thursday. They didn’t. Nor did they come Friday or even Saturday. They came on Monday, when it was too late.

Did Amazon have a policy regarding late shipments, he wondered? No big deal, but since that’s the kind of thing Paribus did, maybe Eric could check? Of course, this was the CEO, so not only did Eric check, he checked, found out that Amazon offered refunds for late shipments, and worked with Karim [his co-founder] to rally the troops to build a new feature into Paribus to take advantage of the rule on customers’ behalf in less than a week. Thousands of impacted customers saved money immediately.

The next day, Eric’s direct manager called him into his office and asked whether he was responsible for shipping the product. Eric proudly responded that yes, in fact, that was he and his team! He expected his manager to be happy. His manager was not happy. 

Capital One was a regulated financial entity and a public company. There were processes in place. Eric and Karim had not gotten the proper approvals. They hadn’t told him first. They’d shipped too fast.   

Capital One is smart and ruthless, and they are acquiring a business that is already working well and growing. The strategic intent behind the deal — bring more B2B card spend to its new payment network — is savvy. There is ample reason for optimism.

But I don’t think it’s a guarantee this works out, nor do I think it’s nearly as good an idea as the Discover acquisition.

This one is a gamble.

Over the last decade, there have been few areas in fintech that have attracted as much focus from entrepreneurs and investors as the corporate card and expense management space. Truly, it’s been insane to watch.

It hasn’t been dissimilar to The War of the Five Kings in Game of Thrones. You had Ramp (Tywin Lannister), Brex (Rob Stark), Airbase (Stannis Baratheon), Divvy (Renly Baratheon), and Center (Balon Greyjoy). All but one are gone. Ramp won the Iron Throne.

And now it has to keep it.

I’ll be honest, I’m not sure how this next chapter for Ramp is going to go. The company has raised a staggering $2.3 billion since 2019. Last year alone, Ramp raised $1 billion across three separate funding rounds, bringing its valuation to $32 billion, which is a number that seems completely detached from reality. To extend the Game of Thrones analogy, it feels a lot like the Iron Bank’s level of investment in House Lannister, circa season 5 (Keith Rabois is Tycho Nestoris in this analogy).

What happens next? 

Ramp’s valuation puts it out of reach for basically any potential acquirer. It seems to have no desire to go public, but it can’t stay private indefinitely (right?!?)

And it’s not as if its position on the Iron Throne is completely secure.

The company has been aggressive in adopting generative AI, but generative AI, as an industry, moves at a pace and a level of investment that makes Ramp look slow and underfunded by comparison. Is it possible that general-purpose AI tools like ChatGPT end up displacing, to some degree, more built-for-purpose software tools, such as expense management platforms like Ramp and Brex? I noted, with interest, Gusto integrating and embedding itself within ChatGPT.

And behind the UX layer, Ramp’s core product — a tightly-bundled combination of cards and software — is also under pressure. A growing trend in the B2B payments is modularity, or “bring your own card,” which decouples the corporate card (which enterprise companies often get from the commercial bank they work with) from the software they use to manage their finances.

Can Ramp fend off the disruptive effects of these trends and continue defying gravity? 

Time will tell.

MORE QUESTIONS TO PONDER TOGETHER

Big news for the endlessly curious (yes, you): I’m collecting your fintech questions on a rolling basis. 

What’s keeping you up at night? What great mysteries in financial services beg to be unraveled? Think of it this way, if a stranger is a friend you just haven't met yet, your question is a Fintech Takes conversation waiting to happen. 

One that could headline a Friday newsletter or be answered in an upcoming Fintech Office Hours event.

Drop your question here, whenever inspiration strikes!

Thanks for the read! Let me know what you thought by replying back to this email.

— Alex  

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