There’s a lot of money to be made in poor people.
KPMG reports that the 88 million U.S. consumers who are “unbanked” (who have no bank account) or “underbanked” (no credit) earn $1.3 trillion a year. What’s more, the Center for Financial Services Information estimates people who operate outside the banking system still spend $45 billion in fees and interest, alone. This is for services such as check cashing, pay-day loans, money transfers, rent-to-own and prepaid debit cards.
Today, there are more check-cashing outlets in the United States than there are McDonald’s and Starbucks—combined. They target low-income people and charge high fees—sometimes as much as 300 percent. And they’re self-perpetuating. They often grow their market by making poor Americans even poorer.
But now a new wave of venture-backed startups is giving low-income consumers somewhere to go other than the check-cashing shop. By bringing new technology innovations like social media and big data to this market, startups Zebit, PayNearMe, Lenddo, Plastyc and Progreso Financiero think they can better serve the unbanked and end some of the exploitative practices that are the hallmarks of the industry.
“When someone who is underbanked goes to pay bills or cash a check, what happens to them? They get trapped in debt,” says Mike Harris, a partner Core Innovation Capital, a new venture firm targeting startups that serve the underbanked. “Go to a payday lender and see what the interest rates are. It’s ridiculous. It’s a vicious cycle.
Core Innovation manages a $45 million “double-bottom line” fund that seeks top-flight financials returns while improving the lives of the underbanked.
“This is a huge marketplace,” Harris says. “It’s the emerging middle class of the United States. Look at the sheer numbers. One in four Americans, or basically 60 million adults in the U.S., is underbanked. The market is highly fragmented with lots of companies that frankly could provide a lot more value to consumers.”
In other words, VCs are willing to bet on the unbanked.
“People have realized there is an opportunity to serve this community in new ways,” says David Hornick, a partner at August Capital, which invested in PayNearMe, which raised $16 million in its latest round.
Of course, there are serious challenges when targeting this market. The long-held perception of the unbanked is that they are very hard to reach. They aren’t active online. They live in the shadows. They don’t like to change their behavior. And, for the most part, they are unbanked because they have no money. But these notions are not exactly accurate, say market observers.
Bryan Stolle, a general partner at Mohr Davidow Ventures, which has backed Zebit, notes that about 70% of the underbanked actually have smartphones. Just because they are underbanked does not mean they are not in society, he notes. They are students and waiters and cab drivers. They are young adults who grew up during a recession and don’t trust the banking system.
“They are not just the unemployed, they are people who often just work for cash or are self employed,” Stolle says. “I wouldn’t underestimate the growing segment of unbanked. They are not unsophisticated people.”
“They are not just the unemployed, they are people who often just work for cash or are self employed. I wouldn’t underestimate the growing segment of unbanked. They are not unsophisticated people.”
Mohr Davidow Ventures
In May, MDV led a $25 million round in Zebit, a micro-lending platform that enables customers with low or no credit to make online purchases, like an apprentice carpenter who needs to buy a new set of tools so he can grow his business. Zebit lends money for individual transactions on an as-needed basis.
The company has not formally launched in the United States, but has seen success in the United Kingdom. Consumers get started by telling Zebit what they want to buy, how much it costs, why they need it, and how much they’d like to borrow. Zebit offers loans of up to £800 ($980) to new customers. Approved customers then get a virtual Zebit card loaded with funds on it, which they can use at any retailer’s website.
Zebit customers can set up a repayment schedule and even get up to 25% cash back for repaying on time. The rates tend to be much lower than customers would pay at places like Rent-A-Center, Stolle says.
“Zebit is finding ways to give good credit to people without taking advantage of them and charging anymore than they have to,” he says. “In the past, just being part of this broad group of underbanked meant your cost of credit was higher. But it doesn’t have to be that way.”
PayNearMe is another startup that addresses a segment of the underbanked population that wants to shop online or pay bills over the Internet, but does not qualify for a credit card.
“The ability to solve that problem creates huge opportunity for the companies that can address it,” Hornick says.
The company has created an arrangement whereby consumers without a credit card can still buy stuff on sites like Amazon or pay their utility bills online. Here’s how it works. Online merchants who sign up with PayNearMe give consumers the option to pay in cash. Customers who choose this option receive a barcode on their PC or smartphone. The customer then walks into a store, say a 7-Eleven, and the clerk scans the barcode just as it would any other item. The customer pays in cash, and then the vendor is automatically notified the funds have been received, and the transaction is completed.
PayNearMe makes money by taking a small cut of each transaction. The cost for consumers to pay bills or wire money via the service is cheaper than current alternatives, such as money orders or Western Union transfers, according to company officials.
While most startups in the space are targeting the unbanked in the United States, some, like Lenddo, are going after the global market. Lenddo, which in June raised an $8 million Series A round from Accel Partners, Blumberg Capital and iNovia Capital, among others, sees a big opportunity in the massive growth of the middle class in emerging markets of Latin America, Indonesia and the Philippines. These are societies where banks have long catered to the elite, while ignoring the vast underclass. But now, says Lenddo CEO Jeff Stewart, the growing middle class is coming online and joining the global economy.
They have smartphones, they are active on social networks (in fact, Bogota, Colombia, has greater social media usage than Manhattan, Stewart says), and they are working in upwardly mobile jobs, such as software development and call centers.
“Banks in these emerging economies don’t have a good strategy for targeting the emerging middle class. What gets us excited is substantially improving what is available for the 1.2 billion who are underbanked and offering something that is breakthrough.”
“Banks in these emerging economies don’t have a good strategy for targeting the emerging middle class,” Stewart says. “What gets us excited is substantially improving what is available for the 1.2 billion who are underbanked and offering something that is breakthrough.”
Lenddo’s ideal customer is a 20-something or 30-something white-collar knowledge worker that wants a life-improvement loan for education or health care or relocation expenses. The loan range is typically a month’s pay. Lenddo uses social networking and crowdsourcing techniques to judge the trustworthiness of its members. Users can vouch for their friends and family on the system. So if someone you recommend doesn’t repay the loan, your score on the Lenddo system takes a hit. This kind of peer pressure leads to high repayment rates, Stewart says.
Though Lenddo has set up affiliates that currently manage the lending, the company would rather be a platform that establishes the creditworthiness of members for third-party lenders and banks.
“We want to prove that our platform is an efficient way to judge character and lend money effectively,” Stewart says.
Another interesting play in the space is Plastyc, a Core Innovation portfolio company that delivers 24×7 access to FDIC-insured accounts through any Internet–connected computer or cell phone. It is basically a bank account in the cloud for the underbanked. It has a low-fee structure and doesn’t allow overdrafts, so customers can’t rack up extra debt. Startups attempting something similar include PerkStreet Financial, backed by Globespan Capital Partners, and SaveUp, which last year secured $2 million in seed funding from BlueRun Ventures and True Ventures.
And then there is Progreso Financiero, which offers unsecured credit to underbanked Hispanic families that lack FICO scores, credit histories, and traditional banking relationships. But instead of charging them exorbitant interest rates, Progreso provides loans at competitive interest rates, typically about 20 percent. The company also offers loan contracts in Spanish and sets up small weekly or bi-weekly payment schedules to help customers better manage their cash flow and loan obligations.
Saar Gur of Charles River Ventures, which backed Progreso, says many people in the Hispanic community have been burned by financial institutions. By providing a positive experience, Progreso hopes to forge an emotional bond with these consumers and build life-long customers, potentially offering them a host of other financial instruments down the road.
“One of the great things about the Latino market is that it’s inherently viral,” Gur says. “The community is very tight-knit and families tend to live together. If you provide a good experience to one person, they’re likely to tell many others.”
The company combines the “high-touch” world of microfinance with the “high tech” world of automation, statistical scoring, and CRM modeling to make its loans.
“We are interested in this space because of the potential for big disruption and the use of technology to replace traditional banking relationships,” says Gur.
Core Innovation thinks VCs can really bank on the unbanked. The firm’s two partners, Harris and Arjan Schutte, have pegged their pay not just to the financial performance of their companies, but to the social impact their investments make. They collect information from their portfolio companies and submit it to an independent audit committee, which then helps to determine the partners’ compensation.
“Companies we invest in help people go from a vicious cycle to a virtuous cycle—and can still make money doing it,” Harris says.
Tom Stein is a Palo Alto, Calif.-based contributor. He can be reached at email@example.com.