Protocol | Fintech

Fintech envy: Software companies race to add payments

The goal is to bulk up their revenue and get more control over customer service. And tech providers are eager to help.

A person accepts payments using Toast

Toast is an example of a software company that turned itself into a fintech.

Photo: Toast

They started out as software companies. They're turning into fintechs.

Take Toast, a prime example. The restaurant software company reported staggering growth Tuesday. Revenue from payments and other financial services more than doubled from $188.2 million to $404.2 million — and rose faster than its original subscription software and hardware businesses.

That kind of transformation goes beyond signing up for Stripe or becoming buzzword-compliant with "embedded finance." A variety of online marketplaces and vertical software companies, Toast among them, are grabbing more control of the payments process. The goals vary, but most hope to generate higher margins and take more control of the customer experience.

To do this, many are becoming payment facilitators. That's the industry term for an entity that offers merchant accounts to other businesses or individuals — their customers — who then collect payments from others.

The upside is considerable: Instead of just charging customers license fees or subscriptions for a software service, businesses that manage payments can take a cut of their customers' revenue that scales up as business grows. The downside is the expense of managing payments — compliance can be costly — and the risk involved in those transactions, including fraud and chargebacks.

"The knock on vertical SaaS, especially for small business, was that software [annual contract values] don't get you to multiple-billion-dollar companies. That's proven to be wrong," said Chirag Chotalia, partner at Threshold Ventures, citing auto, fitness, gyms and barber shops as examples. Beyond payments, these companies are also layering in lending, insurance and other financial services.

Toast's financials revealed it to be a prime example of the software-to-fintech trend. Its IPO filing showed that it made 78% of its revenue from financial services, mostly processing payments — a figure that rose in the third quarter to 83%. It's essentially a vertical fintech company focused on restaurants.

And the biggest example of all is Shopify, which reported last month that nearly half of sales through its customers' storefronts used its in-house payments service. That in turn has made it easier for Shopify to introduce new services like "buy now, pay later" — an example of the increased control over the customer experience that payment facilitators enjoy.

"Shopify is a payments company, not a shopping cart company," said Joe Floyd, general partner at Emergence Capital.

"There's a clear path of laying the tracks with SaaS, then expanding the relationship and value with the customer through fintech," said Chotalia of Threshold Ventures, which has invested in Autoleap and BentoBox, two such vertical SaaS companies.

Becoming a payment facilitator is the key step to unlocking these business advantages. That's an opportunity for companies like Finix and JustiFi.ai, which help companies become payment facilitators. Stripe, too, offers to serves as a payment facilitator for clients, though there are subtle differences in its approach. Others such as Adyen, Worldpay, FIS, First Data and banks such as BofA, Wells Fargo and JPMorgan provide different pieces of the puzzle.

Finix offers 256 different billing configurations, said Jareau Wadé, the company's chief growth officer. This can be important in charging merchants — a lodging marketplace that competes with Airbnb might charge travelers differently than an online fitness service would bill for a streaming spin class.

The Finix executive team Finix is helping software companies make the fintech switch. Photo: Finix

Starting off

A key question is when to switch to becoming a payment facilitator. One rule of thumb is when a company hits $50 million of gross merchandise volume, according to one investor.

Finix's clients typically start off with Finix processing payments for them to get started with payments quickly — Finix itself is the payments facilitator in this scenario. Then, later on, Finix enables companies to transition to become a payment facilitator and handle transactions on their own.

If a company isn't a payment facilitator, its customers may need two accounts. For an accounting-software company that helps its customers send out invoices, it may be happy to have them sign up for their own payment accounts with, say, Stripe, that aren't combined with the software service accounts. For other businesses, a separate account model creates a "disjointed" experience because payments are separate from other interactions with the service, Wadé said.

There are advantages to using Stripe, PayPal's Braintree or JPMorgan Chase's WePay, of course. The big payments providers typically handle know-your-customer checks, manage payment tokens and fraud protection and compliance, which require resources to manage on your own and bring more risk.

"It takes a heavier lift with underwriting, compliance and reporting but you get more economics. That's the ultimate evolution," Chotalia said.

In addition, switching from a processor can be a "big lift," said Floyd, whose firm Emergence invested in JustiFi.ai. Switching to a new provider might mean every end user has to re-enter their credit card, for example.

Owning payments

Lightspeed, a point-of-sale software provider that recently went public in the U.S., used Finix to become a payments facilitator, launching Lightspeed Payments in 2019. Lightspeed, which declined to comment, also uses Stripe in North America and Adyen in Europe.

Lightspeed now manages 11% of its payments in-house, compared to 5% in the year-ago period. In its quarter ending in September, transaction revenue grew 320% to $65 million. Over 50% of new Lightspeed software customers are using Lightspeed Payments, meaning more revenue for the company.

Passport, a parking and transportation-management service, used to route payment authorizations and settlements through third-party gateways and processors — the ones customers were already using. But those customers had problems reconciling payments funding with revenue that was reported to them. In 2018, Passport decided to become a payments facilitator using Finix. This helped its customers better manage and collect funds, said Sarah Ratcliffe, Passport's SVP of Product.

For software companies like Passport and Toast, owning the payments process generates more revenue — a whole new revenue stream — while offering a better experience for customers. While they have to take on more risk to do it, for many it's a risk worth taking.

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