Vertical SaaS Platforms are the New Community Banks
Community banks have long been the fuel powering America’s small business engine. While these financial institutions offer many of the same services as larger commercial banks such as checking accounts, credit cards, and business loans, they differentiate themselves by only serving SMB customers in a limited geographic area.
Research suggests that community banks are able to form a stronger relationship with their SMB customers compared to larger commercial banks because they are better equipped to underwrite loans and other financial products on the basis of “soft information.” Unlike “hard information,” which can easily be reduced to numbers and simplifies comparison across businesses, soft information is highly context dependent and more difficult to quantify. This can include information such as the prior work history of a SMB owner, their business plan, or the general business environment in a small town.
Soft information is difficult for large commercial banks to process efficiently, which makes them reluctant to extend credit to SMBs that lack sufficient hard information about their business. But over the past decade, the rise of vertical SaaS has helped millions of SMBs digitize their workflows and provided them with an abundance of hard information about their business. These SMBs and their vertical SaaS providers now have unprecedented access to data about their customers, employees, and suppliers that would typically be needed to access loans and other financial products from large banks.
The digitization of SMB workflows laid the foundation for vertical SaaS providers to begin offering financial products and services directly to their customers. Because of their direct access to their SMB customers’ workflow data, vertical SaaS platforms are able to offer the speed and low costs associated with large commercial banks and the strong customer relationships offered by community banks. The only thing that was missing was the technology to enable vertical SaaS platforms to provide financial services to their customers.
Enter the payment facilitator model. Rather than each SMB opening its own merchant account with a bank, payment facilitators — or payfacs — aggregated many SMB accounts under their own merchant account with the bank. The time it took for SMBs to open a merchant account and begin accepting payments dropped from weeks to a few hours.
In recent years vertical SaaS companies such as Toast have opted to bypass third party payfacs like Square or PayPal and become payfacs themselves. While it is still a time consuming process for a vertical SaaS company to become a payfac, this is quickly becoming easier thanks to companies like Finix and Payrix that offer turnkey payfac solutions for vertical SaaS providers. Now vertical SaaS companies can easily offer their SMB customers a tailored payments solution on a single platform and SMBs can accept payments without ever interacting with a bank or third party payfac.
The payfac model created an opening for vertical SaaS platforms in the banking ecosystem, but it was just the beginning. Today, this model is being replicated for a variety of financial products and services including banking mainstays such as card issuance and lending. By integrating these financial services directly into their software platform, vertical SaaS providers are able to offer their SMB customers a faster, cheaper, and more comprehensive banking experience that is underwritten by hard information generated when the SMB interacts with the software.
The fintech revolution has fundamentally changed vertical SaaS and its impact on the wider SMB ecosystem cannot be overstated. If recent experience is any guide, it seems increasingly likely that in the future many SMBs will forego banks entirely and conduct all of their financial transactions in their core workflow software.