DEEP DIVE is a series of in-depth articles on FinTechtris that explores a particular fintech leader, discussing its history, products / services, and how it has grown to be an industry leader.

It’s been quite a journey for Square, Inc. over the last 10 years. As a giant in the payments sector of financial technology (FinTech), the unicorn made an immediate impact with its software app and square-shaped card reader that connected to mobile phones (via the audio jack). The appeal of Square’s no-contract, transaction-only pricing for new merchants provided immense growth.

The brand name in merchant services has become a complete financial services company. Square added new products for merchants, multiple partnerships, broaden its scope to consumers, become a public company, enter the cryptocurrency market, and now an independently licensed bank. In this month’s Deep Dive, we explore the origins of this fintech pioneer, product and services, business models, and what’s next as a bank for SMBs (small and medium-sized businesses).

HOW SQUARE GOT STARTED

Square was founded in 2009 by Jack Dorsey and Jim McKelvey, who launched its app the following year. Targeting the painpoint of merchants accepting cards as payment anywhere, the company created a square-shaped card reader that attached to mobile phones and tablets. Dorsey also remained the leader of another start-up he co-founded (Twitter).

Early angel investors included Shawn Fanning, Biz Stone, Marissa Mayer, Kevin Rose, and Dennis Crowley. Future founding rounds came from Khosla Ventures, Sequioia Capital, Kleiner Perkins, Goldman Sachs, and Citi Ventures. By 2014, the company's valuation was $6B.

The following year, Square went public (SQ) on the New York Stock Exchange with a valuation of $2.9B (less than half from the prior year). The payments company had not made a profit yet, but its losses year-over-year were decreasing (from 44% of revenues to 16% in the last half of 2015). By 2018, Square lowered annual losses to $38M on annual revenues of $3.2B. Its share price went from $75 in 2018 to $130 in 2020.

square’s PRODUCT and service OFFERINGS

Here’s a timeline of new products and lines of business for Square over the last decade:

SQUARE READER: The first card reader (in 2010) connected via a phone’s audio jack, enabling the majority of mobile devices to become card processing terminals. The explosion of smartphones and digital payments aligned seamlessly with Square’s hardware and software solution. The card data transferred was unencrypted and argued by competitors as insecure and prone to account compromise. Square would provide fraud protection and add robust encryption that was PCI (Payment Card Industry) compliant. When EMV chips became the new industry standard for cards (2014 - 2015), the firm added functionality for chip-enabled and contacless payment. In 2018, ApplePay was added as a payment method.

SQUARE STAND and SQUARE REGISTER: The reader helped create a point-of-sale setup for a merchant with a physical location. Launched in 2015, the bluetooth-enabled device worked for Android and iOS tablets. Three years later, Square Register debuted for small businesses with multiple locations — it offered both a consumer and merchant tablet with readers (for swipe, chip, and tap to pay). In 2018, “Terminal” was the new, all-inclusive checkout that included display, receipts, and card reader.

Virtual gift cards: In 2012, Square began to allow merchants to issue virtual gift cards using QR codes from a customer's phone (to make payment); physical cards would follow in 2014;

Square Market: Launching in June 2013, this online storefront was available for sellers to accept payments online quickly. The following year, Square allowed these sellers to accept bitcoin as payment (without risk from price fluctuation).

Square Cash (now CashApp): Available back in October 2013, Cash App is Square’s peer-to-peer (P2P) transfer tool that competes with Venmo and PayPal. In 2015, an upgraded version was launched that allowed transfers with a user’s $cashtag. Bitcoin was later added in 2018. Card issuance is the latest feature for users;

Square Capital: Launched in 2014, Square Capital offers financing to merchants using Square (based on revenue);

Square Payroll: Square Payroll rolled out in 2015 for small businesses to run payroll for employees. With availability in over 50 states, the product manages withholdings, tax payments, and filings;

Square Financial Services: Its biggest announcement yet came recently (March 2021) with its approval (from FDIC and Utah’s Department of Financial Institutions) to become a bank.

SQUARE’s Business models

Square’s core business centered on its card reader (available to merchants of all sizes and volumes). The equipment was initially sold at $29 (for the reader) and $99 (for the stand) — the reader can now be ordered for free. There’s no monthly fee to use the reader or app to process card payments.

The company charges flat processing fees of about 2.6% plus $0.10 on every transaction (with different rates for online payments and manual entry). For lower volume merchants, Square charges less in total monthly fees than traditional card processors (with contracts and fixed costs or minimums). Card payments are sent directly into a merchant's external bank account within 1-2 business days. If there are issues related to fraud or chargebacks, deposits may take longer to post.

As Square added other lines of business, the company generated monthly subscription revenue (from Square Payroll, Square Register, and its online booking service). CashApp builds revenue on transaction processing and issuance of its debit card. Adding bitcoin acceptance capabilities allows Square to earn additional margin income (exchanging BTC below market prices). With lending, Square generates loan interest revenue from the financing it provides merchants.

how a bank charter adds to SQUARE’s bottom line

Square’s milestone in obtaining a bank charter is rare for tech companies. As speed and availability of banking partnerships propels any firm towards embedded banking, independent licenses keeps Square ahead of competitors (such as PayPal) in the small, medium-sized business sector. Being able to run its own bank, Square can launch custom products and services to market quickly.

Expanding from its core business of payment processing to digital banking, the fintech will start with FDIC-insured accounts and loans to SMBs. The new industrial bank, Square Financial Services, can underwrite and originate the loans in its Square Capital offering. In Q4 2020, about 57K loans with a total of $254M were provided by Square Capital. Over this next year, the fintech can migrate these loans away from current partnership structures. Existing Square merchants continue to be the primary target for financing solutions.

The data collected on a merchant’s transaction history provides quality info for loan underwriting and payment terms. Since this access is built-in and real-time, there’s no need for separate reporting to be provided by a seller — figures on revenue and overall performance are readily available to Square. Its agility as a fintech creates an efficient application & approval process over traditional banks and increases financial inclusion to SMBs owned by women and minorities.

DIVERSIFYING THROUGH ACQUISITIONS AND PARTNERSHIPS

Besides new products, services, and business functions, Square also expanded through acquisitions and partnerships:

CAVIAR (Restaurant delivery service): In August 2014, Square acquired Caviar (a startup that delivers meals from high-end restaurants) — similar to existing platforms such as DoorDash and UberEats. The focus on top restaurants that don’t traditionally deliver was a key differentiator. It’s app and website enabled ordering and delivering in 18 markets. Caviar then expanded to corporate catering by purchasing the platform, Zesty. Restaurants paid a subscription fee and received additional services such as menus, tip management, and table locations. In 2019, DoorDash acquired Caviar from Square.

CREDIT KARMA TAX (Tax Filing Services): Square announced it was acquiring Credit Karma Tax (no-cost DIY tax-filing service that competes with TurboTax) for $50M. This tax service would be added to Cash App.

RETAIL PARTNERSHIPS (Starbucks and Whole Foods): Square partnered with Starbucks in 2012 (for card processing) and Whole Foods in 2014 (to use Square Register at its in-store cafe, deli, and wine bars).

CAPITAL PARTNER (Victory Park Capital): In 2014, the asset management firm enabled capital access for Square Capital’s financing program. VPC increased its initial commitment by 3x the next year. Over $1B was loaned out by 2016.

CRYPTO HOLDINGS: Last October (2020), Square diversified holdings by putting 1% of total assets ($50M) in bitcoin. An additional purchase of $170M would be made in February 2021.

MUSIC STREAMING: Earlier this month, Square acquired a majority ownership in Tidal (music streaming service led by Jay-Z and other top artists) for $297M. The company will provide payment processing and banking to Tidal’s artists.

BANKING SCOPE AND OUTLOOK

Just as retail shopping shifted towards ecommerce, a similar trend has banking transitioning to digital and mobile channels. Even though the cost to switch banks may be higher (i.e. changing auto deposits and payments, updating new account numbers), the ability from fintechs to open a new deposit relationship with ease is reducing this painpoint.

Large banks can maintain their set of loyal customers that come to the branch. Only by bridging the digital experience gap will these institutions grow over the next decade. Revamping mobile experiences, helping customers acheive financial goals, and connecting online and offline channels would be the next level.

Top retailers and ecommerce brands (such as Walmart, IKEA, Target) have already boosted their digital presence and are exploring banking services for their clients. Walmart has launched an internal fintech initiative led by industry veterans, and IKEA purchased a large stake in a bank to allow for partnerships. The trend of “bank where you shop” is starting to take off as customers are already comfortable with these platforms for monthly spend.

Square is uniquely positioned with a large community of business users that it understands well, and a history of releasing new products and services to help these clients run their business. By being able to act independently as a bank, the same agility and innovation can expand to depository, lending, and card programs. Square’s vast network of partners can also create a compelling rewards solution to keep merchants spending in Square’s ecosystem of business services and partners. It’s truly exciting to watch how Square will develop its banking solutions and the actual conversion rate of payment customers becoming bank clients.

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