Corinne Riley & Sarah Guo | BNPL for Businesses

Hi everyone. Welcome to Gray Matter, the podcast from Greylock, where we share stories from company builders and business leaders. I'm Corinne Riley, an investor at Greylock. On today's episode, we're sharing an audio version of an essay I co wrote with Greylock investor Sarah Gullah. You can read the essay on our website greylock.com blog and you can find all Gray Matter episodes by subscribing on SoundCloud, Spotify, YouTube, or wherever you get your podcasts. BNPL for Businesses the potential of better Access to Business Payments Financing Sarah Guo and Corinne Riley Consumers no longer view digital payments as one option among others, but as the expected default, this expectation has carried over to buy now, pay later financing that has become commonplace over the last five years and consumers have come to view the ability for seamless digital financing, order tracking and interactions via mobile friendly channels as a given for business to business commerce. However, the innovation has not been so swift. The cumbersome paper intensive payment process that consumers have all but forgotten still persists in the B2B commerce world. Financing is laborious and underwriting models poor. The high friction associated with the use of checks and ACH that still dominate B2B payment methods, unstructured communication channels, high potential toil across multiple systems and manual reconciliation have left businesses eager for modern tools. We believe the adoption of online transactions, digital finance operations and Digital payments in B2B is inevitable and we are looking to invest across the landscape. Yet the path to this more efficient, data rich, automated, lower cost to transact future is complex. Untangling a portion of fintech will let us identify areas of opportunity for innovation. Let's dig in to discuss one hot topic in fintech B2B payments financing. B2BNPL is essentially a rebranding of the centuries old process of invoice factoring. BNPL was a hit in consumer markets. However, many underpinnings of its success need to be rethought in B2B because offering instant digitized financing continues to be a challenge from a product distribution and risk assessment perspective. That said, over the next decade we expect the B2B shift towards online transactions to accelerate and companies who are able to lower the customer barriers to purchasing will win market share. The current state of net terms is flawed. This shift towards a B2B financing ecosystem that looks more like the consumer commerce ecosystem is being led by entrepreneurs who deeply understand the myriad flaws within the current state of B2B financing as it is today. At the most foundational level, financing options today are simply a cash flow burden shift to suppliers. In many B2B transactions, net terms or the option to pay after 30, 60 or 90 days is the status quo. The ability to purchase on credit lowers buyer cash flow requirements and therefore has the potential to increase overall volume for the seller. However, a naive approach to financing simply shifts the cash flow burden to the supplier. This is where historically invoice factoring or the practice of selling invoices at a discount to a third party in exchange for upfront cash has been a valuable tool. When a supplier offers traditional net terms to a customer, they go through a credit rating process, pulling data from Dun and Bradstreet, Experian or Equifax, and then perform trade references to determine the credit worthiness of their potential customer. The supplier is effectively offering a short term loan, thereby taking on risk that the customer will default or pay late and incurring additional administrative costs of managing complex accounting. Since many companies don't have the cash flow to offer these loans, they turn to invoice financing or factoring. They sell the invoice to a factor at a small discount 2 to 6% in exchange for 80% of the invoice in upfront cash and the remainder when the Invoice is paid. WholesaleCo delivers Widget X to Acme Inc. And issues an invoice to Acme for $100. After Wholesaleco does a business credit check and runs trade references, they decide to offer Acme Inc. Net 30 terms. Wholesaleco then submits the outstanding invoice to a Factor company. Factor gives $80 to Wholesaleco up front for the purchase of the invoice. After 30 days, Acme pays the $100 to a reserve account Factor company takes a fee of about $4 between 2 to 6% typically and pays the remaining $16 to Wholesaleco. The scenario described is not only a bad sale experience for the customer who has to provide unstructured information over email, offer trade references and wait for credit approval, but also a cumbersome, expensive and risky burden on the supplier. Many markets and companies are unable to use factors entirely due to their smaller transaction sizes. Opportunity Shifting the Burden Away From Suppliers New players are emerging in B2B factoring who effectively absorb much of the cash flow burden and risk away from the suppliers by acting as a critical intermediary to and technical infrastructure between the payer and payee. So called B2BNPL companies embed themselves in their supplier sale process and offer quasi instant net terms to end customers. Suppliers get paid 100% of the invoice upfront minus the fee above about 2% of the invoice per month and are not responsible for collecting payment. The BNPL company therefore manages all credit decisioning, bears default risk and manages collections while making the net terms process process easier and faster for the end customer. A number of venture backed companies have emerged worldwide to build this product such as Balance Slope 2, Vartana, Resolve, Billy and others and we expect the pace to continue over the coming years where B2B BNPL moves the needle B2B BNPL companies take on the burden and cost of underwriting in administrating trade credit in theory creating customer value in three ways. Let's dig deeper into each. Decrease administrative Cost to Companies by outsourcing the net terms process to a B2BNPL company, suppliers are able to significantly decrease the administrative burden that accompanies decisioning credit and collecting invoices. This benefit can be disaggregated into four 1. Absorbing default risk with traditional invoice factoring, suppliers are still exposed to credit default risk because a portion of contracts aren't received until the customer pays in full. B2BNPL companies absorb that risk entirely by paying the full cash payment upfront and are able to do so because they bring the credit decisioning and risk burden in house. 2. Improving credit decisioning Shifting the burden of traditional business credit checks from suppliers to third parties isn't a huge factor for two primary reasons. 1. Suppliers only do credit checks for the initial sale. Once a relationship is established, subsequent purchases can be done with no additional credit check. Many business relationships are repeat. 2. Sellers go through a simplified diligence process for established brands. Still even naively transferring risk assessment ownership from the company to the B2BNPL player is a win win because it alleviates the supplier of the burden that is non core to their business. A much bigger unlock would be fundamentally improving business credit decisioning. The current business credit scoring system is less reliable than the consumer credit system and as such first generation B2B tech enabled lending companies such as Kabbage and Ondeck struggled with repayment. The data used to underwrite trade credit today is very limited and it is not hard to imagine better credit underwriting based on real time financial data or or richer transaction history. 3. Improving checkout we are still very early in B2B purchasing and payments automation and there's an opportunity to both improve conversion and dramatically reduce operational toil for both buyers and sellers. The future will certainly look more like a one click Amazon style checkout with programmatic payments, integrated affirm afterpay like options and automated accounting and other internal financial workflows to based on captured transaction context. 4. Managing collections Most companies would prefer to outsource the complex administrative burden of collections. Growing companies have been built on the promise of streamlining AR collections and payments like Melio, so bundling it with trade credit as an entry wedge seems like a compelling opportunity. Increasing average order volume through better customer experience most B2B BNPLs claim they help suppliers increase AOV and stickiness. However, we would challenge that notion in markets where net terms are already the status quo and question how much a better customer experience affects overall demand unless they are driving up application approval, Take up rates and economics on the consumer side, BNPL actually shifts demand because one the actual economic terms of their purchase is changing. They used to have to pay upfront and now they don't and two consumers are more sensitive to UI improvements, particularly for discretionary and impulse purchases with better checkout conversion rates. However, in B2B markets where net terms are ubiquitous for large buyer and supplier relationships and actual economic turns are not changing, small changes in purchasing UX are unlikely to have a significant impact. We Believe tech enabled B2BNPL can affect top line for suppliers in the following ways. Speed if a rapid financing process increases buyer application and take up rates Administrative burden if collections are settled programmatically with more automation and better data and visibility for suppliers Flexibility in economics if B2BNPL can offer better rates, longer terms and new payment methods like better fees for early payback. Increased approval rate. Financing today is often only offered to large trading partners and access could be expanded to the long tail and new markets if B2BNPL is offered in markets where net terms are not common today. Broadening financing access Opening new markets A potentially significant unlock lies in enabling businesses to provide financing in segments and markets that were otherwise excluded from net terms and invoice factoring broadly smaller ticket items and smaller buyers with less repeat buying history with a single supplier. The lack of financing is a short term cash flow constraint that holds many businesses back from further growth. As an example, a consumer durables company is selling to doctors with average ticket prices of about 7k where customers don't want to use personal credit to purchase the equipment, but where it's untenable for the company to externalize the credit risk the challenge of distribution Another contrast to the consumer purchasing world that is a major blocker. There exists no checkout page, no shopify to integrate into BNPL inherently happens at the point of sale. But today most B2B transactions still do not live online in the long arc of technical progress B2B transactions will inevitably shift from email, phone and even faxed invoices to software and digital payment. Rails Embedded Instant flexible financing could be a trigger to accelerate payments digitization in our hunt for investable opportunities, we're focused on distribution for B2BNPL of four types. 1. Marketplaces B2B Marketplaces Embed B2B BNPL at checkout for all their brands. Some marketplaces might build this themselves. Fair very notably provides net 60 terms in house. 2. E commerce Many manufacturers are opting to sell directly to their end customers through their websites. 3. Distributors since distributors are getting continuously squeezed by manufacturers trying to improve margins, they've had to significantly improve offerings and services. Embedding terms may improve customer satisfaction in purchasing, particularly if coupled with smart software like Recurrency that allows distributors to anticipate customer reorders, automate upsells, and optimize pricing. 4. Offline friendly for offline sales, the rep can send customers a payment link where they fill out basic company information so that the B2BNPL company can assess the credit and offer terms apart from the point of sale. Startups attacking B2B financing can specialize by vertical or set of similar verticals to build more specific features and become more intelligent in risk assessment. Example of vertical specializations include E Commerce Merchants settle Clearco offers fast funding at E Commerce brands. Food marketplaces such as Vori or Choco are great example customers for B2BNPL. Construction Flexbase is a construction specific card with no personal liability Health equipment Historically large segment for both financing and leasing where we expect B2BNPLs to focus on where B2B BNPL goes from here. While we're beginning to see startups address demand for better B2B financing, it is a large and global opportunity and we're in the early innings. We predict there will be several geo specific companies taking into account local differences from payment methods to tax reporting. There are also many related areas for tile for innovation, the checkout experience, AP and AR automation, and moving transactions to marketplaces. We're excited to see B2BNPL companies with a point of view on how to distribute to their customer, vertical or segment of interest who are building sticky workflows around AR management and who are innovating in underwriting. Financing is the engine of business growth. That concludes this episode of Gray Matter. If you liked what you hear, Please subscribe at SoundCloud, Spotify, YouTube, or wherever you get your podcasts. To find all of our content, check out our website at Greylock com and follow us on Twitter at greylockvc. I'm Corinne Riley. Thanks for listening.