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Why fintechs are buying up legacy financial services companies

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Image of a bank vault.
Image Credits: Peter Dazeley (opens in a new window) / Getty Images

Oh, how the tables have turned.

It used to be that if you were a fintech startup or, for lack of a better term, a digitally native financial services business, you might be eyeing an acquisition from an incumbent in the industry.

But lately, fintech upstarts are the ones doing the acquiring. Over just the last year or so, we’ve seen:

So what’s going on here? Why are fintechs now acquiring legacy financial services businesses, instead of the other way around?

Buying into the business

For some companies, an acquisition is all about speed and the ability to gain all the licenses and avoid some of the hurdles associated with building a financial institution from scratch in a highly regulated industry.

Online lender SoFi has been trying for years to get into banking, and after a couple of false starts, it seems like the company will finally be able to offer checking and savings accounts to the 2.6 million “members” who already use its lending and investment products.

While SoFi had filed for and received preliminary approval for a de novo bank charter last fall, the acquisition of GPB would help it move faster than if it had built its bank from scratch, as it expects the deal to close by the end of the year.

For SoFi, an established player that reported more than $230 million in revenue during the last quarter, $22 million was a small price to pay for improved time to market and reduction in regulatory headaches.

Technical flexibility

On the other side of the coin is Jiko, a fintech upstart that was founded in 2016 and spent multiple years working toward the acquisition of a bank. Jiko’s purchase of Mid-Central National Bank certainly wasn’t about speed or time to market, but being able to re-imagine how a bank is architected from the ground up.

That’s not something most fintechs would be able to do; new challenger banks or neobanks are just re-skinned apps sitting on top of partner financial institutions that actually hold deposits and provide the underlying infrastructure and licenses to provide services.

Since it was a new player in the industry, Jiko had a lot of hurdles to overcome, but gaining regulatory approval from the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Bank of San Francisco gave it that technical flexibility.

“Jiko’s vision is to provide a safe and more efficient financial future and become the world’s premier platform for simple and seamless money storage,” Jiko founder and CEO Stephane Lintner wrote in an email to TechCrunch explaining the effort. “You can’t pretend to safely store and have access if you don’t consistently and meaningfully work with regulatory bodies. An OCC-chartered bank, under federal supervision, was the only way for Jiko to deliver on that vision. Acquiring Mid-Central Bank gave Jiko access to the Fed directly and the ability to process debit card transactions ourselves, with no intermediaries. Jiko, as a result, is a fully independent bank holding company with the ability to grow and compete at the highest level.

“Jiko does not need to look in the rearview at partner banks or third-party entities from the technology standpoint. We own everything, front to back, which is a prerequisite to deliver on our mission.”

Improved financials

For LendingClub, acquiring a bank provided multiple benefits: It was able to cut costs related to warehousing its loans, increase interest income gained by being able to hold loans on its balance sheet, and gain confidence from investors as a result of “eating its own cooking.”

In an interview with Protocol, LendingClub CEO Scott Sanborn shared how the Radius Bank acquisition fundamentally changed its financial position.

“For the marketplace portion of our business, where the loans are funded by investors, we used to warehouse loans for that, and pre-COVID, we had $1 billion we paid for at a funding cost of 330 basis points,” he said.

“So that cost goes away because we swap it for deposits, which right now are 30 basis points. That knocks out a big expense. … We also added a whole new revenue stream, interest income. We used to sell all of the loans that we manufacture. Now we hold about 15% to 25% of the loans we originate and holding those loans generates an interest income stream, which is new and independent of origination,” he continued.

“Our interest income went from $19 million in Q1 to $46 million in Q2. Now simply by holding a portion of those on the balance sheet, we’re going to earn three times as much as for the loans we sell. There’s not a lot of extra costs associated with that activity. It’s just a lot of extra margin.”

While the cost of entry certainly wasn’t cheap at $185 million, the acquisition was immediately accretive and LendingClub hasn’t even really begun to create deeper engagement or offer new services to its 3.5 million customers.

Valuation arbitrage

Sometimes, it just makes sense to combine a solid-performing business that may be undervalued with a newer one that is valued at a tech multiple. That is the case with the merger of Figure and Homebridge, where a hot blockchain company joined up with a boring mortgage lender.

Fin VC managing partner Logan Allin said this trend of fintechs acquiring legacy financial services businesses is hugely important — and something we’re likely to see more of.

“If you think about that as an economic arbitrage, you have a fintech company that’s valued on a tech-multiple basis acquiring something that’s being valued at tangible book or a fraction of tangible book value,” he said of the combination of Figure (which is one of his portfolio companies) with Homebridge. “That’s pretty exciting because you just acquired something that is driving meaningful top line and profitability and it’s being valued not on that revenue multiple but on its balance sheet profile.”

Allin noted that because Homebridge is a mortgage business, it has “more information on consumers than literally anybody,” which could lead to “incredible cross-sell opportunities for Figure.”

“You now turn that into a technology company and you potentially 5x-10x that valuation overnight by changing the enterprise value equation. So I think you’re going see a lot more of this, and we’re pretty excited about that trend line for VC investors but also for consumers and commercial customers,” Allin said.

As more fintech companies find their way to higher and higher valuations in both the private and public markets, expect to see more legacy banks and lenders be gobbled up by newer entrants, whether it be for their licenses, balance sheets or even just because they’ll be valued more like a so-called “tech-enabled business.”

The fintech endgame: New supercompanies combine the best of software and financials

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