Last year, the world of fintech startups, the main players in 2021's venture capital heyday, began to unravel as venture capital funding tightened. Now, as we move into mid-2024, much of the sector is in turmoil, especially the banking-as-a-service sector, which ironically was what experts were talking about as a bright spot last year.
The collapse of banking-as-a-service (BaaS) fintech company Synapse is perhaps the most dramatic thing happening right now. It's not the only bad news of course, but it shows how dicey things can get in the often interdependent world of fintech when one of the major players runs into trouble.
Synapse's problems have hurt many other startups, pushing them into bankruptcy and impacting consumers across the country.
To summarize, San Francisco-based Synapse operated a service that allowed other companies, primarily fintechs, to incorporate banking services into their own offerings. For example, a software provider specializing in payroll for companies with a lot of 1099 subscribers used Synapse to offer instant payments capabilities. Other providers used it to offer specialized credit and debit cards. Synapse offered these services by acting as an intermediary between its banking partner, Evolve Bank & Trust, and clients such as business banking startup Mercury.
Synapse has raised just over $50 million in venture capital in total, including a $33 million Series B led by Andreessen Horowitz’s Angela Strange in 2019. The startup was rocked by layoffs in 2023 and filed for Chapter 11 bankruptcy in April this year, hoping to sell its assets to another fintech company, TabaPay, in a fire sale for $9.7 million. But TabaPay backed out. It’s not entirely clear why. Synapse heavily blamed Evolve and Mercury, but the companies threw up their hands and said they weren’t to blame. Synapse CEO and co-founder Sankaet Pathak, who was once responsive, no longer responded to requests for comment.
But as a result, Synapse is now facing being forced to liquidate entirely under Chapter 7 bankruptcy protection, with many other fintech companies and their customers paying the price for Synapse's collapse.
For example, teen banking startup Copper, a Synapse customer, had to abruptly suspend its bank deposit accounts and debit cards on May 13 due to Synapse's difficulties, leaving countless consumers, mostly families, unable to access the funds they had trusted into their Copper accounts.
Copper, meanwhile, says it's still open for business and that another product, financial education app Earn, is unaffected and running well.But the company is now working to pivot the business into a white-label family banking product that it hopes to launch later this year in partnership with other, as yet unnamed, large U.S. banks.
Crypto app Juno's funds were also affected by the Synapse collapse, according to CNBC. Maryland teacher Chris Buckler said in a May 21 filing that he had been blocked from accessing funds held by Juno due to issues related to the Synapse bankruptcy.
“I'm feeling increasingly desperate and not sure where to turn,” Bakker wrote, according to a CNBC report. “I'm stuck with nearly $38,000 because transactions aren't being processed anymore. It's taken me years to save this money.”
Meanwhile, Mainvest, a fintech lender for the restaurant industry, will indeed close its doors as a result of the Synapse disruption, leaving countless employees without jobs. The company said on its website that “Unfortunately, after considering all options, a confluence of internal and external factors has led to the difficult decision to cease operations at Mainvest and dissolve the company.”
Synapse's filings suggest that up to 100 fintech companies and 10 million end users may have been affected by the company's collapse, Jason Mikula, an industry observer and author of Fintech Business Weekly, estimated in a statement to TechCrunch.
“However, the total damage may be an underestimate as some of our customers run payrolls for small businesses,” he added.
The long-term negative and profound impact of what happened with Synapse “will be profound for fintech as a whole, and consumer-facing services in particular,” Mikula told TechCrunch.
“While regulators do not have direct jurisdiction over middleware providers such as Unit, Synctera or Treasury Prime, they can exercise authority over their banking partners,” Mikula added. “We expect to see increased focus on ongoing due diligence on the financial health of these unprofitable middleware vendors, as well as an increased focus on the business continuity and operational resilience of banks engaged in the BaaS operating model.”
Perhaps we shouldn't lump all BaaS companies together, something Peter Hazlehurst, founder and CEO of another BaaS startup, Synctera, is quick to point out.
“There are mature companies out there with legitimate use cases being served by companies like us and Unit, but the damage from some of the fallout you've reported on is only now rearing its ugly head,” he told TechCrunch. “Unfortunately, the issues many are experiencing now were built into the platform years ago, went unseen until the very last moment when everything collapsed at the same time, and have only worsened over time.”
Hazlehurst says early players made a classic Silicon Valley mistake: people with computer engineering knowledge tried to “disrupt” the old, stifled banking system without fully understanding it.
“When I left Uber to start Synctera, it was clear to me that early players in the BaaS space were building platforms as a quick fix to jump on the neobanking or challenger banking 'trend' without actually understanding how to run a program or the risks involved,” Peter Hazlehurst said.
“Banking or finance, no matter what it is, is a serious business. It takes both skill and ingenuity to build and run. There's a reason we have regulators to protect consumers from bad outcomes like this,” he added.
And during that early headwind, he says, their banking partners (who should have known better) didn't act as a backstop when it came to choosing fintech partners: “Working with these players seemed like a really exciting opportunity to 'evolve' their business, so they blindly trusted.”
To be fair, it's not just BaaS operators and the neobanks that rely on them that are in trouble. There have been a series of news reports about banks coming under scrutiny for their relationships with BaaS providers and fintechs. For example, The Information reported that the FDIC was “concerned” that Choice Bank was “opening accounts in legally risky countries” on behalf of digital banking startup Mercury. The agency also reportedly chastised Choice for having overseas Mercury customers “open thousands of accounts in a questionable way to prove their U.S. presence.”
Healy Jones of Kruze Consulting believes the Synapse situation “isn't a problem” for the startup community going forward, but he thinks regulatory clarity is needed to protect consumers.
“The FDIC needs to provide clear language about what is and isn't covered by FDIC insurance for neobanks that use third-party banks on the back end,” he said. “That would help keep the neobanking sector calm.”
“Synapse's story highlights the need for fintech companies to maintain high operational and compliance standards. As a middleware provider, you need to ensure accurate financial record-keeping and transparent operations,” Gartner analyst Agustin Rubini told TechCrunch.
From my perspective having covered the ups and downs of fintech for years, I don’t think all BaaS players will go bust, but I do think that this situation, combined with increased scrutiny, may make banks (traditional and fintech banks alike) hesitant to work with BaaS players and opt to build direct relationships with them, as Copper hopes to do.
Banking is highly regulated and incredibly complex, so when Silicon Valley companies get it wrong, it's everyday people who suffer.
The rush to deploy capital in 2020 and 2021 has seen many fintech companies move quickly as part of an effort to satisfy greedy investors looking for growth at all costs. Unfortunately, fintech is a space where companies, especially those who are non-compliant, cannot move fast enough to take shortcuts. As we can see from Synapse's story, the end result can be disastrous.
The fintech sector was already seeing a decline in fundraising, and the failure of Synapse will very likely impact the future of fundraising for fintech, particularly banking-as-a-service companies. The fears of a new meltdown are real, and frankly, right.
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