Ever since the advent of money—dating back at least as far back as 3000 B.C.—there has always been industries that thrived while attempting to separate people from their currency.
However, since the ancient Mesopotamians traded barley for rare metals, never has the process been as efficient as it is today.
These days, it’s possible with swipe of a chip-enabled phone, the scan of a credit card, the passing of a paper buck, or the texting of a person-to-person transfer to separate oneself from one’s money in so many ways it’s a wonder anyone has an account balance left to spare. With a new generation of short-range wireless technologies in the early stages of rollout by smart phone developers, the options for efficiently emptying one’s wallet will only grow greater.
It’s a trend that hasn’t gone unnoticed by VCs.
In the last year, venture firms have invested upwards of $440 million in post-seed funding in companies developing technologies and services tied to payments, billing and consumer lending, according to Thomson Reuters (publisher of VCJ). Angels and VCs have been active at the initial funding stage, as well, wagering tens of thousands of dollars to a few million in payments startups, with a particular focus on business models tied to mobile and digital goods transactions.
Deal flow, meanwhile, shows no signs of slowing.
“On the transaction side, there are almost endless opportunities and challenges involving mobile payment, and the integration of loyalty and rewards programs and virtual gift cards,” says Lewis Gersh, managing partner at Metamorphic Ventures, a New York-based seed fund focused on digital media and transaction processing.
And for those with money to put to work, he says, “the quality and quantity of seed stage deal flow is like nothing that’s ever existed.”
Much of the enthusiasm currently surrounding payments stems from a convergence of trends, including greater mobile and smart phone penetration, growing commerce in virtual goods transactions, and a heightened demand for electronic payments in developing countries. While none of these trends is new by any stretch, investors say, each is reaching an inflection point at which applications once seen as before their time now look poised for large-scale adoption.
Take mobile payments. Enthusiasm around its prospects dates back to at least 1997, with the installation of two mobile-phone enabled Coca-Cola vending machines in Finland. Venture investors backed a number of so-called m-commerce companies early in the last decade, including a number of money-losers, such as Quixi, a now-defunct New York based provider of consumer mobile commerce services that raised $35 million in 2000, and Viafone, a provider of mobile commerce software that raised $33 million the same year, before selling itself two years later to another software company two years later for one-third that amount, according to Thomson Reuters.
Prior calls for widespread mobile commerce adoption have also proven overly optimistic. In 2002, for instance, industry forecasters were predicting mobile transactions would reach $75 billion by 2006 according to a report by Innopay, a payments market research firm. Four years later, they predicted the market to reach only $14 billion by 2010. As of 2008, it’s been estimated the global mobile payments market represented less than $7 billion.
This time, the case can be made that things really are different. In some developing countries, where most people don’t have bank accounts or easy access to branches and ATMs, phones are already becoming a core means of money transfer. In 2010, mobile phone owners in poor countries accounted for two-thirds of the world’s 4.77 billion phones, according to the World Bank. In addition, researchers found an emerging market consumer is two times less likely to have a bank account in their name than own a mobile phone.
Everyone knows there are going to be some very big companies created here. But no one has a handle on which is going to be the next PayPal.”
Don ButlerManaging DirectorThomvest Ventures
The ubiquity of mobile devices underpins the success of service such as M-PESA, a mobile-phone based money transfer service for Vodafone that launched in Kenya and claimed to have more than 7 million subscribers in mid-2009.
That’s helping to spur efforts to ramp up mobile payments in more populous countries, such as India, where two venture-backed companies are rolling out services: Obopay (which raised about $100 million from AllianceBernstein, Elephant Capital, ONSET Ventures, Redpoint Ventures and others) and Paymate (which has raised more than $14 million from Kleiner Perkins Caufield & Byers, Mayfield Fund and Sherpalo Ventures).
In developed countries with robust financial services infrastructure, next-generation payments is driven more by the rise of smart phones and by demand for lower-cost, more convenient options for borrowing money, buying digital goods, and transacting with customers.
One capitalizing on most of these trends is Square, a San Francisco-based mobile payments startup co-founded by CEO Jack Dorsey, who previously co-founded and served as CEO of Twitter. Square distributes a free card reader for iPhone and Android devices and charges merchants a 2.75% fee on swiped transactions.
As of early March, according to a Dorsey tweet (@jack), Square was handling more than $1 million in transactions per day.
Other companies that closed competitive rounds include PayFone, which is developing a platform for billing purchases to a mobile account, Boston-based Paydiant, which provides a mobile payment service to merchants, and Mountain View, Calif.-based Kwedit, a service for buying virtual goods without a credit card.
“It’s obvious that there’s quite a bit of disruption,” says Don Butler, managing director at Thomvest Ventures, which is exploring investments in the payments space, and is seeing valuations escalate, sometimes during the fund-raising process.
“Everyone knows there are going to be some very big companies created here,” he says. “But no one has a handle on which is going to be the next PayPal.”
Big Up Rounds
That uncertainty hasn’t prevented VCs from funding some very sizeable up rounds for companies with demonstrated traction, star founders, or some combination of the two.
At least eight companies in the payments and alternative lending spaces raised rounds in excess of $20 million in the past six months, according to Thomson Reuters. Competition for hot deals is escalating, notes Butler, who says that rounds for some companies his firm has explored have been oversubscribed, with founders pressing for more favorable terms during the course of fund-raising.
“Things have definitely picked up some on valuations,” says Gersh, who notes that robust supply of companies seeking funding does appear to have diminished investor demand for stakes in favored startups.
In addition to mobile, well-funded startups are capitalizing on changes in consumer behavior, with some tied to the hangover from the financial meltdown of 2008 to 2009, which has fueled a growing consumer interest in reducing debt or at least, the interest rates they pay for it.
The trend that I see is that people are becoming more responsible with their money and what they’re doing with the money they borrow.”
Rob GarciaDirector of Product StrategyLending Club
Consumer demand for better loan terms is fueling U.K.-based Wonga, which closed the largest round in its sector in recent months, raising $117 million in February from Accel Partners, Balderton Capital, Dawn Capital, Greylock Partners, Meritech Capital Partners and Oak Investment Partners. The company offers small, short-term loans online, at rates that are lower than what consumers typically get at high-interest payday lenders.
VCs are also buying into the growing person-to-person lending arena. Lending Club and Prosper, two U.S.-based startups, have raised $54 million and $55 million, respectively, in venture funding over the past six years, with both closing sizeable rounds last year. Both offer platforms through which people can make loans that are paying above-market interest rates or borrow money at 3-year rates that are typically lower than credit card companies charge.
“The trend that I see is that people are becoming more responsible with their money and what they’re doing with the money they borrow,” says Rob Garcia, Lending Club’s director of product strategy. Over 63% of the people who take out loans through the site, he says, are looking to pay down their credit cards.
The sub-sector where VCs are most active continues to be mobile payments. Square is one of the largest venture recipients in that category, closing a $27.5 million round in January from backers including Khosla Ventures, First Round Capital and Sequoia Capital. Payfone raised $11 million last year from the BlackBerry Partners Fund and RRE Ventures, while Paydiant raised $7.6 million in February from backers including General Catalyst Partners and North Bridge Venture Partners.
As for VCs who placed their bets in alternative payments and credit space a few years ago, they’re already tallying up a few payoffs.
One of the most recent returns came from Playspan, developer of a payment system for the online gaming industry, which sold to Visa in February for $190 million. The Santa Clara, Calif.-based company previously raised $46 million from backers including Menlo Ventures, Easton Hunt Capital Partners, Novel TMT Ventures, STIC Investments and Vodafone Ventures.
VCs also made a quick return when Google purchased Jambool, developer of a social media payment product called Social Gold, for an undisclosed sum in August. San Francisco-based Jambool raised $5.7 million in 2008 and 2009 from Bay Partners, Charles River Ventures and Madrona Venture Group.
A few months earlier, investors notched another M&A exit with Revolution Money, operator of a peer to peer money transfer service, which was acquired by American Express in January, 2010 for $300 million. The St. Petersburg, Fl.-based company had previously raised $107 million from backers including U.S. Venture Partners, RRE Ventures, Morgan Stanley, Goldman Sachs, Deutsche Bank and Citigroup.
Investors have had a couple of IPOs in the space, as well, most notably two prepaid card providers—NetSpend Holdings and Green Dot—which went public in October and July, respectively. Though their shares are down some from their post-IPO highs, the companies have sustained significant market capitalizations, with Green Dot valued at $1.9 billion and NetSpend at $900 million as of mid-March.
Going forward, Gersh says he’s optimistic the pace of exits will pick up, as will investment, fueled by enthusiasm around consumer adoption of new payments platforms and advances in near field communications technology for mobile phones, which is in the early stage of rollout in iPhone and Android devices.
“After many fits and starts,” he says. “We believe the time really has come to embrace this.”