Flush With Cash

Funding is pouring into payments technology at a furious rate. Now startups and established firms alike are wondering: How long can it last, and what’s the long-term impact?

If one thing is certain about the six years or so that have passed since the financial crisis, it’s that nobody can agree on how well the U.S. economy has recovered. Generally, unemployment is down and the economy is expanding, but the results aren’t good enough to suit some pundits.

Still, there is one segment of the economy that has inarguably boomed since 2009, and by most accounts it’s showing no signs of running out of momentum any time soon.

It’s payments technology. Much of it is brand-new and, so far as profitability is concerned, largely unproven. But it is attracting ever-rising sums of investment capital from a wide array of venture capitalists, private-equity firms, and established industry players ranging from Vantiv Inc. to eBay Inc.

And the more capital flows into this technology, close observers say, the more investors salivate over it. “How much money is there in payments? The answer is, a ton,” says Matthew Witheiler, a Boston-based general partner at Flybridge Capital who keeps a close eye on the payments business. “The market is humongous.”

The Apple Pay Effect

Some 85 venture-capital deals in payments tech worth just over $1 billion had been consummated by the middle of last year, according to the latest numbers available. That set 2014 on course to be a boffo year, likely eclipsing the previous peak year, 2012, in dollar terms if not in deals.

It’s fair to say payments observers haven’t seen the taps turned on like this for a long time, certainly not since before the 2007-2009 recession. “In 2008, nobody was focused on payments,” says Witheiler. “People were very skeptical of payments companies. Then we saw some exits, then some new technology.”

On top of that frothy action came deals like Vantiv’s $1.65 billion acquisition of Mercury Payment Systems, an eye-popping transaction that clinched the huge value payments players are placing on technology these days.

But not just any technology. If anything is driving investors into payments, it’s mobile. Five payments startups have achieved valuations of $1 billion or more since 2009, according to Fortune magazine. And all five—Adyen, Powa, Shopify, Square, and Stripe—are heavily invested in mobile technology rather than the now seemingly quaint desktop.

Adding to the mobile momentum, of course, is the advent of Apple Pay. Apple Inc.’s long-awaited mobile wallet, with its biometric authentication, snazzy near-field communication (NFC) links at the point of sale, and tokenized card credentials, is unleashing even more capital into mobile payments.

“Apple has a lot to do with it,” says Doug Yeager, founder of SimplyTapp Inc., an Austin, Texas-based vendor of technology that processes NFC payments, but with a twist—unlike Apple Pay, it doesn’t rely on card credentials kept in the phone. Instead, the credentials can be loaded remotely by issuers using a cloud configuration.

“[Apple Pay] was a significant game-changer for digital payments,” says Yeager. “A lot of users had no idea what NFC was [before Apple Pay]. Now, a regular person can start to see it working.”

Mozido Inc. agrees. In February, the company, which specializes in mobile payments for the underbanked, took a $2.5 million stake in SimplyTapp, finishing off its Austin neighbor’s $8.5 million Series B round.

It seems the Apple Pay effect can’t be underestimated. Suddenly, investors who were on the fence about mobile payments are huddling with advisors to suss out the technology and what will happen next, says George Warfel, a director at payments consultancy Edgar, Dunn in San Francisco.

“They’re asking us what’s going on and is it for real,” he says. “Apple legitimated [mobile payments] even though it’s still an open question whether it will ever have more than 10% of payments.”

The risk these investors are trying to measure has nothing to do with how much they pour into any particular company, says Warfel. “It’s not, ‘Should we invest in X,’” he notes. “It’s, ‘What’s the risk of not investing in X?’”

Exit, Stage Right

Indeed, if nothing succeeds like success, then, for now at least, nothing triggers investment in payments like investment in payments. And, by all accounts, there’s plenty of cash sloshing around. “The VC guys smell blood, in a positive sense,” says Warfel.

It hasn’t hurt that the industry has seen some huge exits recently. Besides Vantiv’s monster Mercury deal, another eyebrow-raiser was eBay Inc.’s $800 million acquisition in 2013 of Chicago-based developer Braintree Inc.

Braintree, along with its popular Venmo person-to-person payments app, has accounted for much of the action lately at eBay’s PayPal unit. EBay executives credit the combo for 6 percentage points out of PayPal’s 27% growth in payments volume in 2014, to nearly $228 billion. Some 20% of that volume came on mobile devices, a Braintree-Venmo specialty

When eBay, as expected, spins off PayPal later this year, the deal could represent the biggest exit yet in payments. Not an inconsiderable outcome for a 17-year-old company that was itself an innovative startup in its early days.

“PayPal got traction initially in the e-auction space, [which] Visa and MasterCard were almost willfully negligent in serving,” observes Eric Grover, principal at Minden, Nev.-based payments-advisory firm Intrepid Ventures.

Not all exits are by way of acquisition. Some have come as a result of very successful—and widely noted—public offerings among financial-technology startups. One such IPO was that of LendingClub Corp., a Web-based service that matches investors with borrowers. It went public in December at an $8.5 billion valuation. That didn’t escape the notice of payments observers.

‘Boots on the Ground’

At the same time, many investors are getting in on payments-tech firms whose prospects should brighten as merchants convert to EMV, the chip card technology used everywhere in the First World but in the U.S. Retailers have until Oct. 1 to make the conversion or risk assuming responsibility for counterfeit card fraud.

“In 2015, there’s going to be a trend to EMV,” notes David Sica, a vice president at Nyca Partners, a New York City-based VC firm started only last year by Hans Morris, a former Visa Inc. executive and Citigroup Inc. investment banker.

Among Nyca’s portfolio companies are payments startups Affirm, Boomtown, Payoneer, and Poynt, the EMV- and mobile-oriented terminal company founded by former Google Wallet honcho Osama Bedier (“Will Merchants Get the Poynt?” December, 2014).

By investing in EMV, the moneymen are also helping along their stakes in mobile. Most if not all of the EMV terminals merchants are installing come with NFC capability, though the merchants need to turn it on.

Above all, what’s uncorked payments investments in recent years is that many companies in the industry now meet several key criteria for investors, investment sources say. These include scalability, recurring revenue, low customer attrition, and simple pricing models. And sophisticated entrepreneurs are shaping their ventures to satisfy those expectations.

One big trend in that direction leverages cloud computing. That’s how SimplyTapp’s NFC software model, known as host card emulation, works. For years, NFC stalled because it required payment credentials to be locked down in a chip in the phone. This chip, called the secure element, is controlled by either the mobile carriers or the device manufacturers, requiring issuers to pay for access.

By contrast, host card emulation allows issuers to download credentials—or tokens representing credentials—to users’ phones whenever needed. No more messy negotiations with carriers. And suddenly NFC has new life, even apart from Apple Pay.

With Mozido now behind it, SimplyTapp expects to move faster, especially in sales and marketing. “They’ve got boots on the ground all over the world, and we don’t,” says Yeager. “We’re basically 10 coders and engineers.”

‘Meet in the Middle And Dance’

Indeed, despite this cataract of capital, not all of the benefits flow one way, toward the investor. Yeager’s point underscores another reason investors are putting more money into payments tech: they may lack payments expertise, but they typically know how to finesse regulations or make the right introductions to key people, assets startups often lack.

That can be worth an extra million dollars or more to a portfolio company. “The table stakes are pretty high in financial services,” says Nyca Partners’ Sica. His firm’s pitch, he says, is, “Let us help you with regulations, let us help you work with the banks.”

Nyca Partners’ very name—a conflation of New York and California—stems from its recognition that the new world of tech and the old world of high finance have been strangers to each other. “We’re trying to bridge two worlds,” says Sica, who, like his boss, also once worked at Visa. “The two don’t know how to meet in the middle and dance.”

Right now, the payments business just doesn’t want the music to stop. For now, not many players see much risk of a bubble forming. “You’re seeing a very healthy economy and a very healthy market,” says Flybridge Capital’s Witheiler. “There’s still lots of opportunity to create value in payments.”

The difference between this market and, say, the heady days of 1999-2000, is that investors now are making carefully controlled investments in payments propositions that have substance. “We will continue to see a lot of capital being put to work in payments,” pronounces Grover of Intrepid Ventures. “The payments space is real.”

That’s not to say there won’t be flops. But observers look for a hiccup rather than a crash. “If and when [the market] deflates, it will bleed down a little, valuations will come down a little bit,” continues Grover. “In contrast to the foolishness that went on back in the dotcom days, here most of what’s going on is pretty plausible.”

Even with Bitcoin, where startups so far have harvested a remarkable $550 million in capital in a mere three years, experts see a soft landing. This is despite the digital currency’s wild swings in value and, more important, what some see as permanently limited adoption among both consumers and merchants.

All that may not matter if the technology underlying Bitcoin, the so-called blockchain, can be harnessed for broader money movement. The blockchain is the public ledger that tracks each Bitcoin transaction. Some see it doing for money transfer what the Internet has done for moving documents.

“In order to move money,” says Gil Luria, an analyst who follows payments for Wedbush Securities Inc., Los Angeles, “we’ve needed big institutions like Visa, Western Union, the Federal Reserve, Bank of America. Now, you’ll be able to move money and value freely. That’s what’s revolutionary about Bitcoin.”

Right now, Luria says, investors are curious: “They want to know what’s going on with the technology and have an option to buy if it looks good.”

‘Meat on the Bones’

Rather than a bubble, what this flood of payments investment is leading to, in the short term, is a string of high-profile exits. Founders and early-stage investors will seek to extract their value either with sales or IPOs. Since lucrative exits attract more investment, that trend will keep the taps wide open, observers say.

Already, there has been plenty of action on that front. Exits in payments tech peaked in 2012 at 69, up from 44 in 2011, according to CBInsights. Numbers for 2014 weren’t yet available as this issue went to press. Almost all the exits were the result of mergers and acquisitions.

To some extent, there’s also pent-up demand. Successful startup companies have been staying private longer than in the past, “building up more meat on the bones,” says Witheiler. “But at some point the IPO or exit event has to happen.”

What impact is all this money having on the payments business? Certainly, it’s funding lots of startups that might otherwise starve for want of capital. And it’s greasing the skids for M&A activity that wouldn’t otherwise happen.

But some observers say it’s having another, less obvious, effect, one that could have long-term implications. It’s making it harder for established payments companies to attract and hire top developer talent.

Instead, the best developers are responding to the flood of money, and the allure of billion-dollar valuations, by starting their own companies, say sources who follow the market. Then, they’re hiring more coders like themselves.

Not all of these startups, of course, will succeed. But no company founder, at the time of the founding, believes his will be the company that fails.

The only way old-line companies will get their hands on this talent, some say, is to buy their startups. That’s already started, with deals such as First Data Corp.’s acquisition two years ago of Clover, a developer of app-based mobile point-of-sale systems (“Behind the Acquirers’ M&A Spree,” November, 2014).

‘Real Money’

Then there’s the unwarranted optimism startup money can bring, especially as valuations rise. Call it the revenge of the Establishment. Startups that have been founded by payments veterans have a better handle on this.

“This is a hard space,” warns Alfred “Chip” Kahn, founder and chief executive of 7-month-old Boomtown Inc., which sells support services for mobile POS systems. “You’ve really got to know what you’re doing.”

Kahn’s advantage over most founders is that he has come by this wisdom by hard experience. In 2004, he started IP Commerce Inc., a Denver-based payments-platform provider, and ran it for eight years.

Not knowing well enough what you’re doing, combined with a stockpile of cash in the bank, can lead to a dangerous naivete. Grover thinks he detects some of that in the movement forming to speed up automated clearing house payments.

It’s not so easy, Grover argues, to rearrange the plumbing embedded in existing settlement systems. “If we were starting from scratch, sure, but we’re not starting from scratch,” he says.

Exhibit A for his case is the Federal Reserve’s own recent white paper on faster payments, which projected what the Fed called “neutral to net-negative results” over 10 years for certain types of transactions settled at near real-time speed and at 27 cents each. In other words, little or no profit.

For his part, Kahn predicts more startup stumbles than some of the more optimistic sources Digital Transactions spoke to. “The failure rate is probably going to be higher” than many expect, he says without naming names, because the startup money isn’t always coming with solid advice from payments veterans on the startup team or with the venture-capital firm “who know what’s plausible.”

Don’t get him wrong. Like others, he’s not predicting any sort of bubble. “There’s lots of firms creating real value,” he says. “There’s real money to be made.”

It’s just that we shouldn’t be surprised to see more disappointed investors than some are figuring on. Says Kahn: “I go back to the fact it’s a hard space [in which] to get adoption.”