Brex announced that it no longer wants to lend to small businesses. In fact, it went a step ahead and closed accounts of small businesses. They have three months to go elsewhere. Brex lends through its corporate card. Expense management software is free. Money is made through interchange fees (simplistically, the fee the credit card issuer charges you), interest from lending (venture debt), cash in its customer bank accounts, and partner referrals.
So why stop what seems to be working? The market.
We had a low-interest rate era for a long time. Money was cheap. You could get a loan and pay next to no interest on it. When interest rates are low, people with no money want more of it (because it is cheap) and people with money invest want a better place to invest (because they get almost no interest income). People with money invest in venture funds. They, in turn, have to deploy that as fast as they can. The last bull run was just this – low-interest rates, lots of money in the system, and some more money from the government in the form of PPP loans and stimulus checks.
Inflation of prices of everything (startup valuations to consumer products).
Ironically, with prolonged low-interest rates, we ended up creating a metaverse – with companies selling emojis and lenses, ugly apes, and meme coins. We didn't build more roads or more affordable houses. Thank God, that cycle is over before we attempted to create a virtual metaverse inside that real metaverse.
The Fed raised the interest rates by 75 basis points. Simply put, that is 0.75%. Interest rates will continue to rise until people spend less money on things. Inflation will drop down. We will have a boring economy for some time until the next bull run. The government wants people to spend less. The second-order effect is that demand for products and hence revenue for businesses will slow down.
Small businesses have a perfect tornado coming their way – Falling demand, reduced cash flow, increased cost of borrowing, rising labor costs, and increasing cost of goods. It's risky to lend to businesses that depend on monthly cash flow to run their businesses, in the climate we are in.
Brex is signalling that lending to small businesses is a long trek of exhaustion. It depended a lot on the interchange fees – the fees that depend on businesses spending more and more through their corporate card. For the next few years, that spending is not going to be more and more. With easy money, Brex's valuation ($12.3B) belies the revenue (definitely under $300M). For Brex to grow into its valuation, it needs to continue to make money that is predictable and would not slow down. Ergo, the enterprise focus.
Underneath the easy blame on the economy, almost all modern lending companies have one blame to take. Their underwriting depends on how well they know the small businesses and to do that they threw in the spend management software for free. But when the spending is going to be low, who wants a spend management software – that too, one that is not going to be free for long. Businesses need loans. Everything else is a complexity created to serve the lender.
eCommerce platforms like Amazon and Shopify will fill the vacuum. They will need these businesses to survive and thrive. 85% of such businesses are small. They don't have to go look for customers for their loan products. They don't even have to underwrite by observing their total spending. They control several parts of the value chain and know exactly where the risks are. In turbulent times of slowing consumer demand and risky balance sheets, the ones with low loan processing overhead and the ability to control where the dollars are spent within a business win.
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