Signals: Where does neobanking go from here?

Building a neobank in 2021 was wild. There was free-flowing capital, lots of excited customers flush with extra cash, and BaaS-stack companies popping up everywhere to service demand. I felt like the most popular girl at school at Money 2020, seeing Daylight cards being used in the wild and people I’d admired in the industry recognizing the name of my company and telling me how impressed they were. 

Then, in early 2022, everything changed. In the space of a month, VC money suddenly dried up and the business plan of “Raise tens of millions, don’t worry about burn, just scale,” was no longer valid. We went from adding multiple new team members a week to cutting our team in half in a brutal, messy layoff. I remember crying upstairs in an Airbnb at a bachelorette party over a spreadsheet of our business model realizing that in this market, the math just wouldn’t work without a massive change in our unit economics and our revenue sources.  

If you need 100,000 customers to start earning meaningful interchange, and it costs you $100 to acquire a customer and $10 to onboard a customer, then you need $11,000,000 just to onboard customers. If the run-cost of servicing those customers is $5, then you need $500,000 a month to keep them happy. Once you start adding in things like activity rates and churn, you start to see how this model very quickly becomes unsustainable in a fundraising market that’s dried up. This doesn’t even speak to becoming profitable; these figures are just the starting point for making revenue on interchange.

During my time at Daylight, I got close with many other neobank founders and realized that everyone is facing the same problem: Customer acquisition is too expensive and the unit economics suck. After Daylight was acquired, I’ve been able to maintain these relationships and advise them on strategy moving forward, but I wanted to share more detailed thoughts here on the problems neobanks are facing, and how we might solve them.

We were very proud of our community-driven acquisition strategy at Daylight. The problem for us was that it either seemed to require a lot of upfront investment or didn’t seem super scalable.

Digital ads worked to some degree, they gave us a simple equation of “Add more money, get more leads”, but typically generated low-quality leads and led to a lot of inactive accounts. 

On-the-ground marketing worked a lot better for us in terms of quality but required a lot more upfront investment. We had three in-person launches in three cities that were moderately successful, but ultimately, they didn’t yield us enough of a return to keep going. It just didn’t feel scalable.

The uncomfortable fact is that the majority of people don’t want to change their banking products unless they are having a really terrible or expensive experience with their current providers. The trad banks have caught onto this and gotten rid of the typical churn-inducing fees like overdraft charges, and as such, it’s super hard to convince someone to switch their financial relationships over.

When I fully switched my primary bank account over to Daylight, I was struck by how much harder and nerve-wracking this would’ve been if I didn’t have the financial cushion to protect me from worrying about which bills were getting paid from where as I waited for my paycheck to fully switch over. If you are someone that can’t afford that cushion (as many Americans can’t), I imagine the cost/benefit ratio of switching is very hard to justify. 

I think product-led growth is the only reliable way to scale a neobank. People didn’t sign up for Chime because they had a cool app and funny marketing; they signed up because they offered no fees and early paycheck access in an industry that didn’t do those things at the time.

The other way to do this is to catch people at the point of signing up for their first account. The majority of Americans sign up for a bank account at or before college-age. They typically go for either their parent’s bank or the one with a branch on their campus. I still think there’s a way to pre-empt that process and come in even earlier, and there are some startups already taking this approach. I’m excited to see how fruitful that is. 

If I was in the position that many launched neobanks are in now (having already launched a fully-fledged neobank but struggling with acquisition or share of wallet), I would focus on developing acquisition-focused features. Ask yourself: “What do we have that no other neobank has that would make someone go through the effort of switching bank accounts?” Don’t bother with table stakes features. No one is going to sign up to your neobank if you have early paycheck at this point.

One of the value-props of neobanks is typically that you will get a personalized experience from your bank account, one that understands and anticipates your needs. Where this often falls apart is with customer support. We built out a system at Daylight that was hyper-personalized and human, allowing the team freedom to help people out and talk to them like real people. But this was super hard to scale, and to be honest I’m not sure what the solution is here for this beyond doing it the hard and expensive way.

Chatbots/AI only goes so far, while they do a great job at talking to the user and making them feel heard (and often that is all a customer needs), when it comes to making a judgment call, or servicing an account, there is yet to be a compelling product that either surfaces these calls to a human or does the actual servicing part of it. Often, a lot of the messages we’d get would be questioning transactions and that requires interpretation and knowledge of transaction data that is beyond a chatbot at this time. 

I think if I was to do Daylight over, I would focus on building tools that customers would pay for first (we got a lot closer with Daylight Grow with a product that focussed on helping customers navigate accessing fertility treatments both logistically and financially, but alas; too little too late). Striking the right balance between being ambitious with what you’re building and building the smallest, most helpful (and ideally, revenue-generating) version of the product first is hard in neobanking. I would question if at this point anyone needs to start with a fully-fledged neobank. There are plenty of BaaS providers who let you launch part of a neobank (whether that’s card issuing, savings, credit, etc.) as an embedded finance experience and my guess is the unit economics look a lot nicer that way. 

If you are servicing low-income customers with low transaction volumes, you are going to struggle to make money. For the obvious reason (lower income === lower transaction volumes === lower interchange) but also for a less obvious reason: These customers aren’t going to pay for a higher quality service. It’s not that they don’t want better service, but it’s just that they cannot justify $10+ a month for a service that they can get for free elsewhere. 

So you are stuck with an ethical dilemma: Do you go after high-income customers and have a shot at making some money, or do you build for the people who most need it and try and cut your way to profitability? 

I have always believed the solution here is to build products that aim to eventually support all income brackets, with the higher-revenue-generating customers subsidizing the lower-revenue-generating customers. The trick we missed at Daylight was getting distracted by internal moral debates about the “right” way to do things. But there is only one right way: The way that ensures the survival of your business. 

I think easy VC money made us all lazy and hand-wavy about where the money was going to come from. Indeed, we were encouraged by VCs to not worry about that “right now”. This led to us building “interesting” products and helping those “most in need” (when in reality, the lowest income bracket of our country needs more money, not another free banking app). Build useful products for people who will pay for them, and then think about how you can use your profitable business for the good of those most in need (spoiler alert: it’ll be more money in their pocket and not another free banking app). 

When we pivoted to a stronger revenue model with Daylight Grow, I was very struck by how it no longer made sense for us to have a neobank because it was all cost, with very little differentiated customer value. If neobanks are continually forced to expand revenue sources, I think a lot will come to similar conclusions, and we will see many neobanks pivot away from bank accounts as their main offering towards adjacent financial products.

The elephant in the room here is that all this is much harder when you don’t own customers’ deposits. I think a lot of sponsor banks and BaaS providers are going to face a very similar existential crisis where they realize that passing on too many of the costs of servicing to their neobank customers is going to mean that more and more neobanks will fold because getting to profitability is so difficult, and they can’t access any of the revenue that comes with owning the deposits themselves.

I think if sponsor banks/BaaS providers are smart, they will realize that their existence is reliant on their neobank customers being able to make meaningful revenue to stay alive and will change their business models accordingly. Interchange is never going to be an adequate revenue source on its own, but it’s the bread and butter of running a neobank and without it, you have to ask yourself ‘is this worth it’. I’ve heard good things about some newer BaaS providers in the space taking this approach already.

I think there are also some smart players in the trad banking space that are realizing that they can compete by offering “neobanks” that are fully owned by the backing bank. Nymbus Labs is doing a great job of servicing this demand, and I wonder if we will see some neobank acquisitions by larger banks to this end too. In my opinion, short of a more neobank-friendly revenue share between sponsor banks and neobanks, this is the only way the niche neobank as we know it will survive.

I was proud of the work we did at Daylight; we pushed the industry forward towards inclusivity and niche financial products for often-overlooked communities. We were loud and uncompromising, but I fear this may have been not to our benefit. When you are stuck between helping those who most need it and those who can ensure the existence of your company, you end up pissing off at least one group of people.

At the end of the day, I want everyone in America (and the world, but let me get there) to have access to quality financial services, and I’m excited to continue pushing that mission forward in whatever I do next. If you’re struggling with these kinds of problems, reach out to me and let’s chat.