New Ventures in Financial Services

Focus on Payments and Mobile

Venture Capital Trends

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9 March 2010 

Background Information 

This note is to entrepreneurs in order to provide some perspective on the state of the Venture Capital Industry (www.nvca.org). Venture firms are of tremendous importance to both the US and global economy. In the US alone VC-backed company revenues make up 18% of the U.S. GDP and account for over 10 million jobs. 

VCs are having challenges raising capital as they compete for risk adjusted return. Last year, 125 venture funds in the U.S. collected $13.6 billion, down from 203 funds that raised $28.7 billion in 2008 and down from 217 funds that raised $40.8 billion in 2007. As the data above shows, 10-year return fell to 8.4 percent from 14.3 percent in the previous quarter – and from 40.2 percent one year earlier. 

In the NVCA survey above, the majority of VCs see a substantial shake out in their industry with 90% of VCs predicting that the number of firms will shrink (NVCA chart). 

Plans to tax carried interest are further challenging VCs politically and financially. VCs take “active” roles and put personal capital into their investments. Further, GPs typically face hurdle rates

From Wilson Sonsini – Example Hurdle Rate Allocation

 

Net profits will be allocated: 

  • First, to all the Partners until each Partner has been allocated net profits sufficient to represent an 8% cumulative IRR on such Partner’s contributed (and unreturned) capital;
  •  Next, 100% to the General Partner until total allocations have been made: 80% to all the Partners in proportion to their respective capital commitments; and 20% to the General Partner; 

What does this mean for entrepreneurs? 

 

A: Times have never been tougher in raising capital, VCs are anxious as their RAROC is challenged by potential carried interest tax changes. Net is that the hurdles of getting your plan funded by a VC have gotten much higher (limited capital) and that valuations are tougher due to recent vintage trend data and carried interest tax implications on GP returns. 

Entrepreneurs don’t give up hope, there remains a bevy of options (some outlined here in Inc.): private placements, angels, angel networks, small business loans, existing customers, …etc. Most of these options start with a relationship or connection to your business. If you are having trouble raising capital, my top suggestion is to look at your board of directors. A successful CEO provided a tactless (but useful) approach to evaluating board performance in capital raising: “they either need to be able to give, get or get off”.

Written by tomnoyes

March 9, 2010 at 3:12 pm

Enstream’s Zoompass

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4 March 2010

See

Who said Canadians were only good at Hockey? This is a super service delivered by a consortium of Canada’s 3 largest MNOs. Zoompass has addressed both the distribution and bank connectivity problems that plague most global initiatives.  MNO collaboration provides customers with a consistent mobile application (embed on most phones) which can transfer funds in BOTH card and ACH networks.. both at POS and in a P2P model. Today’s announcement is around Zoompass, an NFC sticker that integrates with the existing Entream payment application shown below.  Canada now has a ubiquitous mobile payment client tied to either card or bank account on any phone … with NFC capability.

If I were to rate mobile payment solutions.. Canada gets the Silver (Japan keeps gold.. also a little bias given the recent US Olympic OT loss perhaps)… this solution is certainly in the top 3 globally with the only issue being the challenge in replicating to other countries. This may be the best kept secret of any mobile payment approach.

The software company behind this is hyperWALLET (www.hyperwallet.com) a Vancouver based payment provider with a comprehensive multi-lingual, multi-currency software platform that can deployed in either licensed or hosted model.  Beyond MNO applications, hyperWALLET also provides cross border solutions to both banks and corporations looking to distribute small value payments (commission, dividend, expense, payroll, … ) SAME DAY globally, across any multiple payment networks. To tell you the truth, I’ve not seen any other company come close to delivering same day cross border multi currency payments via ACH or Card.. their payment network resembles a “mini Citi GTS”.

Kudos to Enstream and the MNOs in their collaborative approach and in selecting a super platform for a starting point.  Man, I hate it when Canadians beat the US…

Written by tomnoyes

March 4, 2010 at 5:36 pm

China Mobile Buys Bank Stake

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3 March 2010

WSJ Article

Financial Times

Tremendous move by World’s largest MNO.

China Mobile Ltd. is in talks to buy a stake in Shanghai Pudong Development Bank Co., a deal that could help the wireless carrier push further into mobile e-commerce.

Expect to see more MNO/Bank tie ups globally (ex. Globe/BPI – Philippines). Banks realize that they cannot tackle the unbanked market without a partner that can profitably serve it (MNOs), MNOs realize that payment regulatory constraints mandate bank licesnses.

I expect to see more Bank-MNO “arrangements” in emerging markets as the entities that profitably serve the “unbanked” (MNOs) develop structures that provide access to non-traditional payment products which enhance the business models of both. The margins associated with the unbanked demographic are not attractive to banks (which is probably why the customers don’t have a bank account in the first place). In order for banks to support low margin payment products, they must be structurally compelled (either regulations or equity). 

In other words, few current retail or card line of business executives would take on an unbanked payment product (priced attractively to market).  There are simply better uses of capital within their existing business. For a bank to support (this low margin business), they must create a team that is structured (and compensated) to support. Given that most corporate investment processes entail selecting ideas that generate the most attractive returns, projects which would support outreach to the unbanked usually don’t make it. In the US legislators have addressed this structural planning issue with laws such as the Community Reinvestment Act (CRA).

However Emerging Markets face many challlenges in pursuing a “US Model” regulatory approach to expanding access: Banks/MNOs have a smaller “high margin” businesses which can support growth down market (20/80 vs. 80/20).  The equity/partnership approach taken by China Mobile and Globe addresses the bank structural issue and creates a common incentive for both organizations to excel in an investment area that has atypical financial performance.

Regulators in the Indian market appear to be advocating a similar approach. Banking and payment in Asia will evolve much differently than the western models. Imagine getting your paycheck, pension, social services payments all on your mobile…. instantly available… no longer will you have to take a 2 hour bus ride to your nearest agent…. and another 8 hour bus ride to go home and give your family money.

Thoughts appreciated

Written by tomnoyes

March 3, 2010 at 10:56 pm

SquareUp – Take 4

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27 January 2010 (updated 4March)

www.squareup.com

Venture Beat – SquareUp

New note from VentureBeat yesterday. Jack has certainly assembled a who’s who of angels. Given that these investors are proven winners I’m trying to guess whether they have “bet on the right horse” or have a plan that I’m not privy to (ex PayPal buyout). If it is the later, my educated guess is that prospects will let this bake for a few years before getting serious. There are too many issues which must be addressed for serious acquisition money to chase a customer convenience play.  Some of which I attempt describe below.

I understand that Jack’s vision for the company is to provide payment services to “craigslist” customers as the market place which will drive volume (an attempt to mimic the paypal/eBay synergy). His story is that everyone has a card in their pocket.. and merchants want to leverage this instrument without the burden of becoming a merchant in the network sense.

Of course Jack is competing with Cash and Checks in this pattern.. much different than the remote Card Not Present (CNP) world which PayPal attacked. I must say that many of my colleagues do not share my negative views on Square, and it has led to some very good conversations.  I certainly agree that issuers want SquareUp to succeed (read: interchange), and Square does have a very nice application, however my strong views are:

  1. There is no compelling consumer or merchant driver. Square will find that changing consumer payment behavior is much more challenging than social networking,
  2. Third party payment aggregation at POS is a moving out of favor with respect to network rules
  3. Fraud rates will be very high (see skimming video below) and bank issuers have ability to shut them down through authorization
  4. Volume will be low (merchant costs, competing methods of payment, charge back rules, …) and business will take at least 4 years to build (with sustained marketing).
  5. Competing bank/MNO sponsored “handset based” payments will overtake this approach in 2-3 years.

PayPal excelled because it addressed a clear gap in payments in a new marketplace where a 4 party system (merchant, consumer, merchant bank, issuing bank) could NOT adapt. This 4 party group, combined with the network and regulators, proved to be ineffective in responding to the “change” presented by online marketplaces.  PayPal did much heavy lifting, building “new rails” to manage merchants.  These eBay merchants were a well organized community which collaborated (generally speaking) and shared best practice. There was a REAL business problem in these pre-PayPal days..

Comparatively Square’s “Craigslist community” is not well organized, and the square payment method is competing with well entrenched behavior (check/cash, a 2 party system) in a person-person sale dominated by checks and cash. What is the problem that Square is attempting to address? My belief is that it is a convenience play, which will have  a much different adoption (and profitability model) then PayPal’s.

Top card issuers would love to see SquareUp succeed in order to drive cards (interchange revenue) further into cash replacement. However network rules (like PCI and merchant agreements) exist for a reason. Square’s approach to lowering the barrier for merchants (a valid market need) risks payment system integrity. In other words, the existing card merchant agreement process represents the rules by which the 4 party system has agreed to. If we take the SquareUp model to the extreme, what will stop every business from ditching their merchant agreement and start using square?  What benefits do acquirers/issuers and network have in supporting this model? Is the potential revenue upside for interchange (in cash replacement) vs. downside in fraud and lost revenue (merchant fees)?

SquareUp is acting as a third party payment aggregator (TPPA), a model which banks have adapted to since their experience with Paypal creating significant new rules and constraints (both ACH and Card). The network PCI rules (and certification process) for devices storing card information are also quite cumbersome, and require sponsor for certification. Perhaps this is why Square’s current customer agreement states:

You are responsible for all electronic communications sent to us or to any third party containing Account Data.

The acquirer that takes this on will likely have a few headaches when the first major craigslist merchant starts using the device to skim and resell card information (among other things). There is a reason for PCI compliance and for my “securing” my physical card and CVV. I can’t wait to see Square’s Payment Services Agreement (PSA). Operationally, the issuer’s have control over card authorization through systems like HNC’s Falcon or SAS Raptor. This means that if SquareUp is found to have contributed to a data loss, or has a high number of fraudulent transactions (see link) customer would see their card transaction declined, or the network (Visa/MC) would shut SquareUp down.

The great thing about the PayPal model is that the customer funded the account after agreeing to terms. In Square’s model, consumers are unregistered, Square is acting as an agent of the merchant. For Square’s investors, there is atypical risk which they will see through “unique” bonding/insurance requirements from the acquirer.  Just as with any company, Square will face unlimited liability associated with loss of consumer information (think TJX). To get an idea for potential mis-use see you tube video below.. crooks invest quite a bit in technology here… will SquareUp make it easier for every iPhone owner to become a skimmer?

The challenge any analyst has in assessing strategy is information. Given Square’s potential to drive electronic payments, either a card acquirer or PayPal interested … certainly a partner capable of managing the remote risk. If I were interested in acquiring, I would certainly let Square burn money gaining adoption,  changing consumer behavior, gaining approval from the networks, finding an acquirer and learning to manage the fraud issue… then if they are successful join in. At GartnerGroup we would call this approach  a  “late follower”. There is no revenue in this business for 3-5 years… my guess is that competing technologies like NFC will step all over this by that time… at least I HOPE SO!

Previous/Related Posts

https://finventures.wordpress.com/2009/12/02/squareup/

http://tomnoyes.wordpress.com/2010/01/26/usregs/

Written by tomnoyes

March 2, 2010 at 6:23 pm

Moneygram settlement

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MoneyGram settles suit for $80 mln over subprime

The regulators and the exec team fell down on the job in this one. Lesson for MTO organizations: don’t put your settlement funds into instruments you don’t understand.

Written by tomnoyes

February 27, 2010 at 2:29 pm

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Mobile Payment: “Picture This”

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23 February 2010 (updated 4 March)

Related Posts

For those that read my blog… I’ve been rather tough on mobile payment start ups run by execs that have no payment background (ex Obopay). Rather then continue to put vendors through the ringer (a penchant from my Gartner days), thought I would talk about something positive. Although I do disagree with most of SquareUp’s approach, I do agree that there is a market need for cash replacement and ease of use in a “Craigslist purchase”.  Banks and the cards networks are actively working to increase use of cards in this space, with the idea that everyone agrees with: enabling cell phones to be a cash register. Although banks and card networks love the idea of expanding card use, merchants have other options that are available today which present both substantially lower costs AND provide for improved fraud management.

USAA has such an application available today: Deposit@mobile and it is just fantastic.

In the background, USAA has integrated into the shared fraud database used by both Telechek and most of the banks (at the teller line). This provides the merchant with ability to see if check is valid, if drawn on a “good account” and assess fraud (among other things). This is what really impresses me… this is not JUST a slick application that was build by some non-bank. This application has solid risk management.  My only recommendation for USAA is to change the restaurant use case to a yard sale or Craigslist purchase. Other potential uses:

  • Any customer that receives any type of check in the mail… no more trips to the bank
  • Landlords
  • Small Merchants doing BIG sales (since it takes 90 seconds)
  • Yard sales/Flee markets/Craigslist purchase
  • People in remote locations (Farms, military bases, …)

Merchant benefits are substantial:

  • No transaction costs (savings of 150-350bps)
  • Simplified sign up
  • Same day availability of funds
  • Fits existing consumer behavior pattern (checks)
  • Instant verification, risk and fraud management
  • Leverages bank imaging systems and processes (regulatory and consumer receipt)
  • Notification/receipt to consumers

Other Vendors such as EasCorp’s Depozip provide similar functionality. Would love to hear from readers… As a buyer, which would you rather do? Let someone swipe your card or give them a check?

As a seller? Take a card (knowing that you bear fraud risk for 60 days) and bear costs of 150-350bps? Or take a check with instant availability of funds and a much more limited risk (no reg Z)?

Written by tomnoyes

February 23, 2010 at 4:31 pm

Western Union 4Q09 – Flat

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23 Feb 2010

From DJ News wire

Fourth-quarter earnings fell 6.6% as the company was pessimistic about business this year. Western Union posted a profit of $223.7 million, or 32 cents a share, down from $239.6 million, or 34 cents, a year earlier. Revenue increased 1.7% to $1.31 billion though it fell about 1% on a constant-currency basis.

Analystsestimates were for earnings of 32 cents on revenue of $1.31 billion.

Operating margin fell to 24.2% from 25.9% because of acquisition costs, reductions in pricing and promotions.

Revenue in the dominant consumer-to-consumer segment rose 1.7% but fell about 2% in constant currencies. Transactions increased 5%, while global-payments revenue grew 4% because of the acquisition of Custom House, a business-to-business payments provider

I would place a solid sell here. WU’s management team may see much opportunity in growing the electronic channel (remitter) from current 2%, however e-channel revenue growth will put them squarely in competition with the banks that serve them (Citi GTS).  This same competitive dynamic will hold for their new business payments group (currently 14% of rev), the core of which is the result of their recent Custom House acquisition.

As they morph their distribution strategy to e-channels and business why are they taking 30% of operating cash ($400MM) for stock repurchases? This does not speak well of internal investment opportunities and a company which  is certain of growth.. It feels like the start of an end game.  Additionally, WU’s current crown jewel (physical distribution) is being threatened in emerging markets by mobile operators leveraging their own agents for money transfer services. Perhaps this is why WU is looking  “up market” into higher margin business payments.

This does not feel like a business plan for a “market outperform” stock to me.  As an investor I would be looking for opportunities that leverage (and enhance their distribution), partnering with other networks (banks, governments and MNOs) will be a key opportunity. Let us see if they the current team can grab it.

Written by tomnoyes

February 22, 2010 at 5:53 pm

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