With the collapse of a16z-backed Synapse, fintech BaaS is a disaster and 10 million consumers could be affected

Last year, the world of fintech startups – star of the 2021 venture capital heyday – began to collapse as venture capital funding tightened. As we approach the middle of 2024, large swathes of the industry are now in complete disarray, particularly the area of ​​banking as a service which, ironically, experts told us last year that he was the positive point.

The bankruptcy of fintech Synapse as a banking service (BaaS) is perhaps the most dramatic thing happening right now. While this is certainly not the only bad news, it shows how dangerous things are for the often interdependent world of fintech when a key player runs into trouble.

Synapse’s problems have hurt and brought down many other startups and affected consumers across the country.

To recap: San Francisco-based Synapse operated a service that allowed others (primarily fintechs) to integrate banking services into their offerings. For example, a software provider specializing in payroll for 1,099 outsourcing-heavy companies used Synapse to provide instant payment functionality; others have used it to offer specialized credit/debit cards. It provided these types of services as an intermediary between banking partner Evolve Bank & Trust and business banking startup Mercury, among other clients.

Synapse has raised a total of just over $50 million in venture capital in its lifetime, including a $33 million Series B round in 2019 led by Angela Strange of Andreessen Horowitz. The startup faltered in 2023 with layoffs and filed for Chapter 11 in April of this year, hoping to sell its assets in a $9.7 million sale to another fintech, TabaPay. But TabaPay worked. We don’t really know why. Synapse placed a lot of blame on Evolve, as well as Mercury, who both raised their hands and told TechCrunch they weren’t responsible. Once responsive, Synapse CEO and co-founder Sankaet Pathak no longer responded to our requests for comment.

But the result is that Synapse is now on the verge of being forced to liquidate entirely under Chapter 7 and many other fintechs and their customers are paying the price for Synapse’s demise.

For example, Copper, the teen banking startup client of Synapse, had to abruptly discontinue its bank deposit accounts and debit cards on May 13 due to Synapse’s difficulties. This leaves an unknown number of consumers, mostly families, without access to the funds they had confidently deposited into Copper’s accounts.

For its part, Copper says it is still operational and has another product, its financial education app Earn, which is unaffected and working well. Yet it is now working to pivot its business toward a white-label family banking product, in partnership with other as-yet-unnamed major U.S. banks, which it hopes to launch later this year.

Crypto app Juno’s funds were also affected by the collapse of Synapse, CNBC reported. A Maryland teacher named Chris Buckler said in a May 21 filing that he did not have access to his funds held by Juno because of issues surrounding Synapse’s bankruptcy.

“I am becoming more and more desperate and don’t know where to turn,” Bucker wrote, as reported by CNBC. “I have almost $38,000 tied up due to transaction processing stopping. This money took years to save.

Meanwhile, Mainvest, a fintech lender for restaurant businesses, is shutting down due to the mess at Synapse. An unknown number of employees are losing their jobs. On its website, the company said: “Unfortunately, after exploring all available alternatives, a mixture of internal and external factors led us to the difficult decision to cease operations of Mainvest and dissolve the company. »

Based on Synapse filings, as many as 100 fintechs and 10 million end customers could have been affected by the company’s collapse, industry observer and Fintech Business Weekly author Jason Mikula estimated in a statement to TechCrunch.

“But that might underestimate the overall damage,” he added, “because some of these customers are doing things like running payroll for small businesses.”

The long-term negative and severe impact of what happened at Synapse will be significant “across fintech, particularly consumer-facing services,” Mikula told TechCrunch.

“Even though regulators do not have direct jurisdiction over middleware providers, which include companies like Unit, Synctera and Treasury Prime, they can exercise their power over their banking partners,” added Mikula. “I would expect an increased focus on ongoing due diligence regarding the financial condition of these types of middleware providers, none of which are profitable, and an increased focus on business continuity and operational resilience banks engaged in BaaS operating models.”

Maybe not all BaaS companies should be lumped together. This is what Peter Hazlehurst, founder and CEO of another BaaS startup, Synctera, is quick to point out.

“There are mature businesses with legitimate use cases served by companies like us and Unit, but the damage from some of the fallout you’re talking about is just starting to emerge,” he told TechCrunch. “Unfortunately, the problems many people are experiencing today were built into the platforms several years ago and have gotten worse over time, not being visible until the last minute when everything collapses at once .”

Hazlehurst says some classic Silicon Valley mistakes were made by early movers: people with computer engineering backgrounds wanted to “disrupt” the old, cumbersome banking system without fully understanding it.

“When I left Uber and founded Synctera, it became very clear to me that the early players in the “BaaS” sector built their platforms as quick fixes to exploit a “trend” in neo/challenger banking without any real understanding of how to do it. running programs and the risks involved,” said Peter Hazlehurst.

“Banking and finance, in all their forms, are serious business. Its construction and operation requires both skill and wisdom. There are regulatory bodies that protect consumers from such negative outcomes for good reason,” he adds.

And he says that in those heady times, banking partners – those who should have known better – failed to act as a safety net when choosing fintech partners. “Working with these players seemed like a really exciting opportunity to “scale” their business, and they trusted them blindly. »

To be honest, BaaS players, and the neobanks that rely on them, are not the only ones in difficulty. We continually see news stories about how banks are being scrutinized in their relationships with BaaS providers and fintechs. For example, the FDIC was “concerned” that Choice Bank “opened… accounts in legally risky countries” on behalf of digital banking startup Mercury, according to a report from The Information. Officials also reportedly chastised Choice for letting overseas Mercury customers “open thousands of accounts using questionable methods to prove they had a presence in the United States.”

Healy Jones of Kruze Consulting believes that Synapse’s situation will be “no longer a problem” for the startup community in the future. But he thinks regulatory clarity for consumer protection is necessary.

The FDIC needs to “provide clear language about what is and is not covered by FDIC insurance at a neobank that uses a third-party bank on the back end,” he said. “This will help maintain calm in the neo-banking sector,” he said.

As Gartner analyst Agustin Rubini told TechCrunch: “The Synapse case highlights the need for fintech companies to maintain high operational and compliance standards. As middleware providers, they must ensure accurate financial record keeping and transparent operations.

From my perspective, as someone who has covered the ups and downs of fintech for years, I don’t think all BaaS players are doomed. But I think this situation, combined with all the increased scrutiny, could make banks (traditional and fintech) more hesitant to work with a BaaS player, choosing instead to establish direct relationships with banks, as Copper hopes to do.

The banking industry is highly regulated and very complicated, and when those in Silicon Valley get it wrong, the people who suffer are ordinary human beings.

The rush to deploy capital in 2020 and 2021 has led many fintechs to move quickly, in part in an effort to satisfy hungry investors, seeking growth at all costs. Unfortunately, fintech is an area where companies can’t move so quickly that they take shortcuts, especially those that avoid compliance. The end result, as can be seen in the case of Synapse, can be disastrous.

With funding already declining in the fintech sector, it is very likely that the Synapse debacle will impact future fundraising prospects in fintech, particularly for banking-as-a-service companies . Fears of another crisis are real and, let’s face it, valid.

Want more fintech news in your inbox? Sign up for TechCrunch Fintech here.

Would you like to give us some advice? Email Aria at aria.techcrunch@gmail.com or message me on Signal at 512-937-3988. You can also send a note to the entire TechCrunch team at tips@techcrunch.com. For more secure communications, Click here to contact uswhich includes SecureDrop (instructions here) and links to encrypted messaging apps.