The booming “buy now, pay later” business looks like consumer credit and looks like point of sale payment too. As practiced by some of the leading fintechs in the business, it competes with traditional bank and credit union financing, but it’s not quite the same under the hood.
The economics of BNPL plans work much differently, as does the funding behind such credit. But as an exclusive interview with the co-founder of BNPL leader Sezzle reveals, these fast-moving fintechs are already eyeing deeper incursions into banking.
Right now, BNPL has an appeal to Millennials and Gen Z that keeps growing because for many it’s a preferable alternative to traditional credit cards and consumer loans. But Sezzle and others, such as Klarna and Affirm and Square, which just acquired BNPL pioneer Afterpay, may offer other forms of credit as consumers grow older and more financially able.
“BNPL is not just another credit offering,” says Paul Paradis, Co-Founder and President of Sezzle in an interview with The Financial Brand. “It’s very different from the way that consumer credit has been offered in the U.S., historically.” Indeed, while it is often spoken of as a modern form of the old layaway plans, for retailers BNPL is actually much different.
Paradis says the seeds of Sezzle’s approaches to BNPL began when his co-founder, Charlie Youakim, was running another startup. Youakim noted how younger generations leaned toward debit cards for purchase almost exclusively. When Sezzle first launched, in 2016, it began as a means of enabling payments via transaction account balances but in a way that provided cashback and other rewards. Their target was young debit card users who had been missing out on rewards because they didn’t use credit cards.
But before too long, “we decided our hypothesis was wrong,” says Paradis. Younger generations had formed their view of traditional consumer credit based on reduced credit availability under the CARD Act of 2009 and the wave of mistrust of banking and credit overall after the Great Recession. This guided them towards BNPL as an alternative, a shift the company made in 2017.
As of the end of the first half of 2021, 2.8 million consumers were actively using Sezzle’s BNPL plan — about double the year-earlier level. Most are repeat users.
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‘Creditizing’ Debit Cards
“We realized what was needed was a new type of credit that was easier to understand and more consumer friendly,” says Paradis. This brought Sezzle to its core offering, “pay in four,” that is, using the service to arrange a plan making four payments over six weeks.
“Some of our competitors try to shy away from labeling what they offer as credit. But at the end of the day, we’re lending money to consumers, with a different way of paying it back, in short-term, interest-free installments.”
— Paul Paradis, Sezzle
More informally, Paradis says what Sezzle is doing is “‘creditizing’ consumers’ debit cards.” He explains that 90% of consumers using Sezzle begin by paying with their debit card. They put 25% down, and then spread the rest of their purchase over the next six weeks in three 25% installments. This form of credit truly is different from using a credit card and rolling over, because there is interest on the BNPL charges but the consumer doesn’t pay them. The merchant pays the interest charges, using Sezzle to increase sales. Consumers only pay fees if they either miss payments or specifically request an extension of their original plan.
How the numbers work: Sezzle makes 80% of its revenue from the merchant fees. These generally are 6% of the financed amount plus 30 cents for processing. About two-thirds of Sezzle’s retailer partners are online-only companies, with larger omnichannel players like Target, GameStop and Bass Pro Shops more recently selecting the service as a checkout option in-store and online.
Paradis says larger merchants receive discounts based on the higher volume they bring to Sezzle. Rates may also vary by the types of products sold and the longevity of the company, according to Sezzle’s merchant pages. (Merchants are paid up front and any consumer delay is absorbed by Sezzle.)
The remaining 20% of Sezzle’s revenue comes from consumer fees. Consumers can reschedule payments on any given charge once for free, up to two weeks after starting a plan. After that, there is a $5 rescheduling fee.
“It’s meant to be a stick, to prevent them from continuing to kick the can down the road forever,” says Paradis. A second fee covers account reactivation. The way Sezzle is set up, if a consumer misses an installment they lose the ability to make further Sezzle charges until that’s rectified. Reactivation of charging privileges costs $10. (There are also failed payment fees, say if there’s an insufficient funds issue, which can be waived.)
How Sezzle Funds Its Lending Programs
Like most nonbank lenders, Sezzle does not have the ability to raise deposits.
The largest source of regular funding comes from a $250 million receivables facility with Goldman Sachs Bank USA and Bastion Funding IV LLC. This is more than double the credit line Sezzle initially had. In mid-2021, Sezzle issued shares to facilitate a $30 million investment from Discover, with which it is partnering for certain services.
An interesting facet of Sezzle’s funding mix for its buy now, pay later lending is that merchants themselves have the option of ‘lending’ to Sezzle.
Here’s how this works. Merchants receive proceeds of sales through Sezzle financing up front.
“Our merchants can actually choose not to withdraw funds from their holding accounts,” says Paradis. “If they choose not to withdraw, we will pay them a yield on that balance. So our merchants are essentially lending us money.”
Merchants don’t commit to any term. They can withdraw deferred payments on demand, up to a point, and beyond that level can get their funds within seven days. While the funds are on loan to Sezzle merchants earn interest based on LIBOR.
This feature has been part of Sezzle’s arrangement with merchants since it entered the BNPL business, according to Paradis. In mid-year 2021 these deferred payments, available for funding, came to $79 million — nearly a third of the size of the receivables facility.
In late August 2021 Sezzle announced that it had filed a confidential registration for a proposed initial public offering. No further details on the numbers of shares or the offering price have been announced.
Sezzle Creates Variations on the BNPL Theme
A key promotional point about Sezzle has been that applying for a “pay-in-four” does not impact a consumer’s status with credit bureaus. The company only performs a “soft check” when vetting would-be users.
Paradis says that half of Sezzle’s users don’t want their BNPL transactions reported to credit bureaus, which is part of the “pay in four” plan’s promise.
The other half of users would like to improve their standing with credit bureaus through their performance on their repayment plans.
“You need to build your credit score to be able to get cost-effective loans in the future for home purchase, buying cars and more,” says Paradis.
To meet this need, the company created a variation on its original product called “Sezzle Up Consumer Credit Builder” in cooperation with the TransUnion. Once a consumer completes one repayment plan successfully, they are eligible to opt-in to have their credit performance on subsequent purchase plans reported. The plan itself is the basic “pay in four” Sezzle offering.
“The vast majority of people who have entered the Sezzle Up program have seen their scores go up considerably,” says Paradis.
A variation on the original BNPL Sezzle plan is Sezzle Long-Term Installments, a type of plan that Sezzle makes available for merchants for credit ranging from 6 to 24 months’ duration. These loans are financed by Ally Bank. Details vary among merchants, depending on the arrangement that they want to offer to consumers. In some variations consumers may pay explicit interest with their installments and in others the merchant may opt to offer financing interest-free to consumers, according to Paradis.
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Competitive Picture for BNPL and Sezzle
When asked about competition, Paradis ticked off many of the nonbank BNPL providers like Affirm, Afterpay, Klarna, PayPal and Zip. He says banks don’t come up when Sezzle’s sales force works with merchants who are interested in offering some version of BNPL.
While he says he knows some banks have offerings playing off the interest in such programs, their activity seems to be focused on plans to feed into their credit card offerings. To the degree that they are in the merchant market, he says, banks appear to favor longer-term programs. Indeed, in a blog, “Bank Partner or Fintech Partner: Which is Retailers’ BNPL Best Bet?,” Citizens Bank notes that its Citizens Pay BNPL can offer merchants longer lending terms and bigger ticket sizes.
Up until now, the growing popularity of BNPL among consumers has been the strongest factor in the growth of Sezzle’s merchant base. “The most common source of signups is a merchant seeing Sezzle on another merchant’s site and then going to sign up on our website without any outbound contact from us,” he explains.
Once a merchant is on board, there are ways that Sezzle will work directly with them on ancillary functions. For example, some of Sezzle’s consumer marketing, to drive usage, relies on influencers who talk up both products and using Sezzle to pay for them over time. In addition, a small but growing new source of revenue, also used by some fintech competitors of Sezzle, is promotion of participating brands on its website and in other marketing channels.
Paradis says the initial pattern has been for merchants to offer a single BNPL option at checkout. However, an increasing number are adopting more than one such solution. Paradis expects that before long most will offer multiple BNPL programs at checkout, much like they do with credit cards.
“Merchants will want to accept all of the largest BNPL platforms so they are not losing consumers who have a preference for one company’s options over another’s,” says Paradis.
He sees more categories of retailers coming to BNPL.
“Up until now, it has primarily penetrated into fashion apparel, beauty, cosmetics, health and nutrition,” says Paradis. But he sees untapped potential in low-ticket health care, home improvement, sporting goods and even groceries.
Quest for Stickiness Will Drive Expansion Beyond BNPL
Banks serve both businesses and consumers, but part of what sets the fintech BNPL players apart is that they have created a parallel financing world. They make the installment process possible as part of checkout at merchants and they also cultivate the audience that wants to use that option multiple times at multiple merchants.
BNPL Lovers Love It A Lot:
The top 10% of Sezzle’s users opt for BNPL on an average of about 50 times a year.
Paradis predicts that as more BNPL players have a presence at retailers and competition mounts, they will seek to offer other financial services to make their platforms stickier. Checking and savings accounts with debit cards designed to segue into BNPL options would be a natural, he says.
“I would be surprised if within the next 12 months all the large buy now, pay later companies aren’t offering a broader set of financial services to their consumers,” says Paradis.
As for Sezzle, “eventually we will offer more traditional credit products because there’s a time and place for those,” says Paradis. “I don’t think a pay-in-four solution solves every credit problem out there.” While many of the company’s clients are Millennial and Gen Z consumers, he sees their needs corresponding with additional types of credit, and believes Sezzle can add new programs that will cater to those evolving needs. This could be through a partnership with a large bank, he suggests, or in some other format.