Welcome to Scaled and Failed! My name’s Amil Naik and I’m an aspiring VC and founder at The University of Texas at Austin. I write about startups that scaled and startups that failed to draw insights about the patterns of startup failure and how to avoid them. Everything is clearer in hindsight, so it’s worth looking back.
If you haven’t subscribed already, do it here:
TLDR
Today’s Topic: Neobanks
Scaled: SoFi; Built traction in peer-to-peer student loans, slowly expanded to using institutional money and diverse financial products, went public this month.
Failed: Xinja; Successful equity crowdfunding, eventually gained licensing to be a neobank, ran out of money amidst a failed fundraising because it was burning capital with no way to bring in revenue.
Lessons Learned: Traction with users is good, but revenue plans become increasingly more important as a startup grows; make sure there’s a plan and priority to start making money. Use an initial service or product as a launching point to expand offerings across an industry.
Today’s Topic: Neobanks
Fintech has been a hot space on both the consumer and enterprise sides in recent years, with innovation affecting every aspect of how financial institutions operate. Banks especially have been affected; from the technology powering their operations to the options they offer consumers, banks have rapidly transformed. There has also been a rise in a new type of bank: the neobank. Neobanks offer banking services purely online and/or through an app, though most are a bit limited compared to the average traditional bank. The lower overhead requirements allow neobanks to often offer lower fees and better interest rates. Many companies in the neobanking space started out offering a niche, specific service and then expanded out with wider offerings. Some are truly independent, chartered banks, but many opt to partner with existing banks to insure deposits and provide their services, particularly early on.
SoFi didn’t start as a neobank; founded in 2011, it launched as a way for Stanford students to get alumni-funded student loans and then added more lending products. Over time, it expanded its offerings to become a one-stop provider of financial services. The company went public via a SPAC earlier this month and shows no signs of slowing down. Xinja, an Australian neobank launched in 2017, was among the first players in the country and provided regular bank accounts, a high-interest savings account, and most recently planned for an account for trading shares called Dabble. Late last year, Xinja ran out of money when a massive financing round fell through and was forced to close down its banking services. Despite great promise, Xinja couldn’t live up to the SoFi story.
Scale: SoFi
SoFi (short for Social Finance) began its student loan business with a test run at Stanford GSB in 2011, where the four founders had gone to school. With $2M in funding for its proof of concept, SoFi registered as a lender in California and got $2M from 40 Stanford GSB alumni, loaning the capital out to nearly 100 graduate students. SoFi offered lower rates on its loans than many sources, making it an attractive offering. With the success of the pilot, SoFi started putting together the same alumni-funded loan system for students at other universities early the next year with plans to offer loans to students at 40 schools soon after. The CEO at the time, Mike Cagney, described the goal of the system:
We believe that the stronger the social fabric, the lower the defaults and the higher the alumni realized returns.
By connecting alumni and students, SoFi hoped to lower the risk of default and provide better returns for alumni investors while giving better rates and network connections to students. The startup hoped to originate $150M in loans in 2012 and began providing refinancing options as well. A $77.2M Series B flowed in late in 2012 as the company gained traction. The following year saw further growth fueled by more capital, with a $60M line of credit from Morgan Stanley and an additional $41M from Bancorp supporting the demand for SoFi’s loans. By September of 2013, SoFi had provided around $200M in loans and refinancing to nearly 2,500 different borrowers. The company then launched a securitization product, pooling investor funds and available credit to provide the option for investing in loans using leverage. While riskier, SoFi’s customer demographic has centered around young, well-funded people that are highly unlikely to default, making it an appealing offering overall. By this point, the alumni funding model was becoming a smaller piece of the pie compared to institutional money flowing in. To help maintain the “social fabric” of its original idea, SoFi also hired a dedicated career transition expert, helping borrowers find new jobs as needed. This was a win-win, making default less likely and being a unique offering not commonly found among loan providers. With a solid foothold in the student loan market, SoFi’s next step was to start pushing into different lending products. Early in 2014, the company raised another $80M in a Series C to push this expansion, hoping to move into personal loans and mortgages. Those products rolled out quickly as SoFi continued to gain traction as a peer-to-peer loan provider.
With its $200M Series D early in 2015, SoFi became a unicorn. As demand continued to grow for its lending products, SoFi’s capital needs did as well. The startup had expanded across several states by this point, with plans to march into more the same year. Later that year, SoFi pulled in a whopping $1B Series E led by Softbank and reached the $5B in loans funded milestone. This was the start of SoFi’s transformation from a loan provider into a full-blown neobank that would challenge traditional players. Financial regulations would be one of the startup’s greatest challenges to navigate as it expanded its services; it’s not surprising SoFi decided to hire former SEC chairman Arthur Levitt to help tackle the regulatory landscape. In 2016, the company smashed another important achievement: a AAA rating from Moody’s on a bond securitization product, the first ever given to a marketplace lender. This opened SoFi’s products to a wider variety of risk-averse institutional investors. 2016 saw the launch of a new type of product from SoFi in the form of SoFi at Work, a platform that allowed employers to assist with student loan repayment as a form of job benefits. It took some time, but this type of contribution became tax-free recently, accelerating the adoption of student loan assistance as a benefit. In addition to SoFi at Work, the startup introduced investment management products under SoFi Wealth (now SoFi Invest). Things had gone well until this point, but the next few years would tarnish SoFi’s growth story.
2017 started out as a good year, with a $500M Series F led by Silver Lake to help SoFi further diversify its product line and enter markets outside of the US. Unfortunately, in the time SoFi had been growing rapidly, it had also grown a toxic work culture that resulted in CEO Mike Cagney resigning in September. Inappropriate and aggressive executive and management behavior, questionable business practices, and sexual harassment from Cagney and other leaders were all among the allegations. SoFi responded to the linked article, denying many of the accusations and launching an external investigation to look into the others. With the CEO spot open and plans for full bank status delayed due to the leadership shakeup, SoFi needed leadership that would take the company in a different direction. Anthony Noto, previously COO of Twitter, took on the CEO role early in 2018. His vision was to push the company to become the financial one-stop it is today and to challenge traditional consumer banks on all fronts (though this seemed to already be in the works). 2018 also saw a shakeup in staff numbers: both the beginning and the end of the year had layoffs ahead of a restructuring of the mortgage business. On top of all that, SoFi ran into some trouble with the FTC regarding false advertising claims about savings from student loan financing (though there weren’t serious consequences). After these bumpy years, it was back to the usual success.
SoFi launched zero-fee ETFs early in 2019 in its quest to become the single solution for various financial needs and raised $500M more in funding led by the Qatar Investment Authority just a few months later. The round didn’t push the valuation higher than the previous one, which can often be a sign of trouble for a startup, but SoFi continued to recover and grow. Investment products like crypto trading and cash accounts also joined SoFi’s suite of services, In a bit of a puzzling move later in the year, the startup bought the naming rights for a newly built football stadium in LA for a reported $400M. 2020 was another big year for SoFi’s external spending, though transactions that year were more relevant to the business. The payment technology startup Galileo was acquired for $1.2B right at the start of the pandemic along with Hong-Kong based investment app 8 Securities not long after. The end of the year also finally saw SoFi’s preliminary approval for a national bank charter, which would allow it to operate independently. To speed up the process, SoFi finalized the acquisition of the community bank Golden Pacific Bancorp early in 2021 with hopes of getting its charter by year-end. After many years, SoFi had gone far beyond its student loan roots and created a portfolio of financial products suited to its target audience of wealthy Millennials and Gen Zs. At the beginning of this month, SoFi went public via a SPAC. Noto had his ideas about why the company had succeeded:
At the very top of our funnel is what I call our financial services products. That's SoFi Money, SoFi Invest, SoFi Credit Card, and SoFi Relay. Those are broadly appealing products that have high frequency and large engagement, and they have really low customer acquisition cost. When we bring people into that funnel at the top and then they cross buy into loans, we really drive the lifetime value quite meaningfully higher than any company that we think we compete with in the financial technology space on a dollar basis, because of the profitability of the loans and the fact that we're also not paying a second customer acquisition cost there.
Fail: Xinja
Across the ocean, neobanks were taking off in Australia too. Rather than take traditional venture capital funding, Xinja opted to initially raise through equity crowdfunding. Legislation was passed in Australia during 2017 to allow this type of funding from retail investors and Xinja was the first to take advantage of the new laws, raising A$2.4M. Unlike SoFi, Xinja was set to become a neobank from the start. The first funding round was to launch prepaid debit cards as a trial run as the company focused on building Australia’s first fully digital bank designed for mobile phones. The app itself was simple and barebones in the beginning but was designed iteratively around customer feedback. Around the time of Xinja’s initial raise, the Australian government decided it would reduce barriers for entrants to the banking industry to promote competition, including allowing companies with less than A$50M in capital to be a bank. Early in 2018, Xinja gained its Australian Credit License and raised additional capital in its Series B, this time with institutional investors. By the end of the year, Xinja had 22,000 people signed up for its app and prepaid card and finally secured a restricted banking license. With that license, Xinja could hold up to A$2M in deposits of less than A$250k each, though it had some strong restrictions on its operations. Traction was good so far, but the neobank space had heated up in Australia. Xinja was now facing competition from the likes of Volt and Up Bank, and all of the neobanks were facing down against Australia’s Big 4 banks. Xinja’s CEO Eric Wilson was not a fan of the Big 4 at all, particularly their illusion of competition and the way they had been partnering with other fintechs:
We have had a Productivity Commission in Australia and the government says competition was stifled by lots of different brands but all owned by three or four businesses. It’s called a ‘marketing smokescreen’ to hide a lack of competition, and that worries me a bit.
The big four are now direct competitors. We wouldn’t accept money from them as that’s not appropriate. We are keen to avoid them as their brands are under attack at the moment via the Royal Commission. It’s all a mess at the moment.
With Xinja’s work cut out for it, the startup launched another equity crowdfunding round early in 2019 and raised A$2.6M. In the latter half of the year, Xinja finally got what it needed to ramp up its operations: a full banking license. Around the same time, it raised further funding in its Series C. Unfortunately, it had fallen behind a number of its competitors who had partnered with established banks or obtained a license already. Wasting no time, Xinja announced its plans for a transaction account within its app, a savings account called Stash, and lending products along with intentions of raising its Series D financing. That transaction account ended up launching the very same day the license was obtained and Stash became a reality early into 2020. Traction was great for Stash especially; nearly A$300M in deposits were collected in about 7 weeks of launch and the company had to halt the opening of more accounts to maintain its 2.25% interest rate. 2020 was off to a great start, and things looked bright for Xinja as it continued to grow.
In March, Xinja announced a whopping A$433M fundraising from an investment company in the UAE set to be disbursed over two years, with A$160M coming in initially. The pandemic was just starting to wreak havoc globally, but all seemed well for the neobank pending approval from regulatory authorities for the deal. Given that Xinja had decided to exit banking by the end of the year, all was not in fact well. At first, it seemed like the pandemic had just caused some delay in the capital influx. Xinja’s leadership assured everyone that progress was still being made and that the money would come. The money never materialized, and Xinja ended up burning through its remaining capital, returning all deposits, and closing customer accounts. Though there were plans for the rollout of a US share trading platform called Dabble, but amidst the shutdown and other problems, it never appeared. With no money and no viable pivot, Xinja’s neobanking story was over. Although the pandemic was scapegoated as the reason for failure, other popular neobanks in Australia were able to tighten their belts and continue on. There were also suggestions that Xinja had been burning cash on unimportant things. The total dependence on fast, fresh capital was a risky move for Xinja that ultimately didn’t pay off.
Lessons Learned
I’ve written a lot about startups that have had funding fall through at the last minute or mismanaged their money, but Xinja had more foundational errors in its business model and roadmap that led to failure. The minimum capital requirements for banks are set in stone (relatively), so you either need enough revenue coming in to offset your burn or a reliable pipeline of capital to run one. Xinja didn’t have either and really didn’t make attempts at the first at all. Stash was a great deal for customers with its incredible rates, and with interest rates crashing globally due to the pandemic, Xinja’s decision to maintain above-market rates was tough financially. That was all money flowing out the door along with the overhead for the rest of the business, and nothing was bringing it back. While there was a possibility of the US stock trading platform bringing in some money, the obvious answer to the revenue question in banking is loans. That’s where SoFi started, and that’s where Xinja should’ve looked to in its product development. Xinja’s competitors did just that, weathered the pandemic, and have come out with strong growth.
Ultimately, not prioritizing this was a weakness in Xinja’s business model of building strong user traction at the expense of anything else; when would they make money? The potential investment from the UAE would have been used for that lending product given that it’s tough to launch one without a lot of money, but SoFi managed to hold it together on a smaller scale with less capital early on. The misalignment between the deposits and potential revenue sources was a critical failure that necessitated intense fundraising endlessly. Traction among customers is important, but a plan to bring in revenue is important too. Especially with the volume of deposits Xinja was handling, the company couldn’t afford to not make money. Founders have to be ready to turn traction into revenue when it becomes necessary. At the end of the day, customers giving you money is the best traction you can have, and you’ll need to make the call on when it’s time to transition from free trials, beta tests, and costless products to a sustainable business model. If you don’t, you’ll likely end up like Xinja in the Cascading Miracles pattern of failure, praying you can keep fundraising and that everything will go your way.
SoFi’s expansion across financial products reflects what many large companies do when they have the traction, brand, and capital necessary to do so. Use your initial business as a launch point to slowly diversify across an industry (and maybe across industries eventually). When the potential exists for such an expansion, it’s a good idea to understand what the next logical step is long before you have to do it; Xinja could have certainly used that sort of insight. For SoFi, student loans naturally transitioned into mortgages, personal loans, and other lending products before it was ready to take on broader banking operations piece by piece. Taking advantage of that potential is how startups become giants; understand where your business needs to go to keep growing and reach that level, even it’ll be a while or if that plan will change. It’s worth understanding what the next goal is so you don’t stagnate or make an uninformed decision reactively.
More Reads and Info
Thanks for reading! What has your experience been like with neobanks? If you found this interesting, consider sharing it with friends and subscribing if you haven’t already!
Cheers,
Amil