Brex’s decision last year left many SMBs wondering where to turn next. They had drunk the Kool-Aid of simpler financial solutions that targeted their needs, and there was no going back.
When Brex entered the ecosystem, SMBs (like startups) were severely underserved. On average, due to the setup of the financial system, an SMB would use at least six different financial services to run their business.
“That’s the gap that needed to be bridged. One simple interface that brings everything together versus having to rely on three different tools that either they can’t afford or don’t have the resources to manage,” said Andrew Jamison, CEO and co-founder of Extend. “Simplicity is a necessity by virtue of what these small businesses have to get done with very limited resources.”
“They don’t have the luxury of having multiple people running different functions. What they’re looking for is just something that’s clear and transparent, that really just helps them run their business.”
In the two years between Brex’s entry into the SMB market, the ecosystem has evolved. Now, SMBs are faced with a number of fintechs to address their needs.
However, the economy has taken a turn. The original startups like Brex that aimed to disrupt the system have had to take stock of their approach. Cautious valuations and VC dry powder demand a focus on revenue and profits, which have caused some to pivot. In many cases, the high risk, low reward (particularly faced with a possible recession) has left SMBs out in the cold.
Banks, once exacerbating the issue of SMB finance, could support its resolution.
Brex’s retreat to serve core market of startups
Brex entered the market in early 2017, steered by Henrique Dubugras and Pedro Franceschi. Their idea was simple – to bring heightened financial access to startups.
They proposed a 30-day charge card with credit limits based on cash balances. Entrepreneurs could access higher credit limits than traditionally available and receive decisions in under 24 hours. In less than three years hit the 20,000 customer mark.
As the company grew, more solutions were added, and the appeal reached beyond the start-up community. According to Y Combinator, the company turned away 80% of applicants that did not fill the “start-up” criteria. In 2020, Brex opened out their then fully fledged “financial operating system” to the SMBs.
“We were like, “OK, how do we expand from here? What’s the next phase of products?” Brick-and-mortar small businesses seemed like a good way to go,” said Dubugras to Protocol last year. “So we built a lot of our systems to be able to onboard them.”
However, the scale of the startup market is dwarfed by SMBs. In the US, there are an estimated 33.2 million small businesses making up 99.9% of all businesses in the country and 44% of economic activity.
“There are tens of thousands of startups in the U.S. versus tens of millions of small businesses…We realized we couldn’t do both at the same time. We couldn’t serve millions of small businesses around the U.S. and create products for the needs of our best and growing companies.”
Split between their core business of startups and the vast market of SMBs, the company took the decision to step back, focusing on businesses funded by the venture community. In June 2022, the company announced the closure of “tens of thousands” of SMB accounts, leaving a gaping hole for financial products serving the sector.
Pivoting for Stability
The decision was a shock to the system, but “industry insiders” said, “I think that the operational costs, the fraud costs, and the risk costs combined with heavy rewards they were giving out just made it a poor segment.”
Perhaps Brex just decided it was more trouble than it was worth, particularly with the clouds of a possible recession rolling in.
“Now that there’s less venture capital flowing into the system, that’s when companies have to start looking at what their true cost of acquisition is,” said Jamison. “The lifetime value of your clients becomes really important.”
He said that leaning on banks’ SMB customer portfolios could provide fintechs with much-needed stability.
“Banks already have massive portfolios, which have been with them for a long time,” he continued. “They already have a very profitable book of business that, essentially, every year comes back to them. So this is not something that they have to worry about too much.”
Bank’s relationship with SMBs Could Drive Stability
“I think the reality is, banks have stepped in to do their role, which was just to support the whole gamut of customers,” said Jamison.
He explained that SMB’s loyalty to their local bank had worked in the banking system’s favor, making the “middle market” reluctant to leave community banks for their financial needs. “I think what is missing (in banking) is the digital experience.”
Brex and others like it paved the way for fintechs like Extend to partner with banks while still catering to the needs of SMBs through digital expertise.
“I think there was a time that banks would have just built everything themselves. I think that time is gone,” he continued. “The initial fintechs that looked at disruption opened the door for fintechs like ours because banks got suddenly very defensive. Now, banks are very open to collaboration and partnership because I think they’ve realized that their own investment cycles work completely against them.”
Fintechs, lightweight with digital dexterity, could provide the response to clients’ needs while making use of banks’ established infrastructure and balance sheet to weather challenging economic climates.
Isabelle is a journalist for Fintech Nexus News and leads the Fintech Coffee Break podcast.
Isabelle's interest in fintech comes from a yearning to understand society's rapid digitalization and its potential, a topic she has often addressed during her academic pursuits and journalistic career.