With a16z-backed Synapse’s collapse, BaaS fintech is a mess and 10 million consumers could be hurt

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Last year, the fintech startup world — star of the 2021 venture capital heydays — began to unravel as VC funding grew tight. As we step into mid-2024, large chunks of the sector today are a downright mess, especially the banking-as-a-service area which, ironically enough, experts last year told us was the bright spot. 

The bankruptcy of banking-as-a-service (BaaS) fintech Synapse is, perhaps, the most dramatic thing going on now. Though certainly not the only bit of bad news, it shows just how treacherous things are for the often-interdependent fintech world when one key player hits trouble. 

Synapse’s problems have hurt and taken down a whole bunch of other startups and affected consumers all over the country.

To recap: San Francisco-based Synapse operated a service that allowed others (mainly fintechs) to embed banking services into their offerings. For instance, a software provider that specialized in payroll for 1099 contractor-heavy businesses used Synapse to provide an instant payment feature; others used it to offer specialized credit/debit cards. It was providing those types of services as an intermediary between banking partner Evolve Bank & Trust and business banking startup Mercury, among other customers. 

Synapse raised a total of just over $50 million in venture capital in its lifetime, including a 2019 $33 million Series B raise led by Andreessen Horowitz’s Angela Strange. The startup wobbled in 2023 with layoffs and filed for Chapter 11 in April of this year, hoping to sell its assets in a $9.7 million firesale to another fintech, TabaPay. But TabaPay walked. It’s not entirely clear why. Synapse threw a lot of blame at Evolve, as well as at Mercury, both of whom raised their hands and told TechCrunch they were not responsible. Once responsive, Synapse CEO and co-founder Sankaet Pathak is no longer responding to our requests for comment.

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

For instance, Synapse customer teen banking startup Copper had to abruptly discontinue its banking deposit accounts and debit cards on May 13 as a result of Synapse’s difficulties. This leaves an unknown number of consumers, mostly families, without access to the funds they had trustingly deposited into Copper’s accounts. 

For its part, Copper says it’s still operational and has another product, its financial education app Earn, that is unaffected and doing well. Still, now it’s working to pivot its business toward a white-labeled family banking product partnering with other, as yet unnamed, larger American banks that it hopes to launch later this year.

Funds at crypto app Juno were also impacted by Synapse’s collapse, CNBC reported. A Maryland teacher named Chris Buckler said in a May 21 filing that he was blocked from accessing his funds held by Juno due to the problems related to the Synapse bankruptcy, 

“I am increasingly desperate and don’t know where to turn,” Bucker wrote, as reported by CNBC. “I have nearly $38,000 tied up as a result of the halting of transaction processing. This money took years to save up.”

Meanwhile, Mainvest, a fintech lender to restaurant businesses, is actually shutting down as a result of the mess at Synapse. An unknown number of employees there are losing their jobs. On its website, the company said: “Unfortunately, after exploring all available alternatives, a mix of internal and external factors have led us to the difficult decision to cease Mainvest’s operations and dissolve the company.”

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

“But that may understate the total damage,” he added, “as some of those customers do things like running payroll for small business.”

The long-term negative and serious impact of what happened at Synapse will be significant “on all of fintech, especially consumer-facing services,” Mikula told TechCrunch.

“While regulators don’t have direct jurisdiction over middleware providers, which includes firms like Unit, Synctera, and Treasury Prime, they can exert their power over their bank partners,” Mikula added. “I’d expect heightened attention to ongoing due diligence around the financial condition of these kinds of middleware vendors, none of which are profitable, and increased focus on business continuity and operational resilience for banks engaged in BaaS operating models.”

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

“There are mature companies with legitimate use cases being served by companies like ours and Unit, but the damage done by some of the fallouts you’re reporting on are just now rearing their ugly heads,” he told TechCrunch. “Unfortunately, the problems many folks are experiencing today were baked into the platforms several years ago and compounded over time while not being visible until the last minute when everything collapses at the same time.”

Hazlehurst says some classic Silicon Valley mistakes were made by early players: people with computer engineering knowledge wanted to ‘disrupt’ the old and stodgy banking system without fully understanding that system.

“When I left Uber and founded Synctera, it became very clear to me that the earliest players in the ‘BaaS’ space built their platforms as quick solves to tap into a ‘trend’ of neo/challenger banking without an actual understanding of how to run programs and the risks involved,” Peter Hazlehurst said. 

“Banking and finance of any sort is serious business. It requires both skill and wisdom to build and run. There are regulatory bodies protecting consumers from bad outcomes like this for a reason,” he adds.

And he says that in those heady early days, the banking partners – those that should have known better – didn’t act as the backstop when choosing fintech partners. “Working with these players seemed like a really exciting opportunity to ‘evolve’ their business, and they trusted blindly.”

To be fair, the BaaS players, and neobanks that rely on them, aren’t the only ones in trouble. We are continuously seeing news reports about how banks are being scrutinized for their relationships with BaaS providers and fintechs. For example, the FDIC was “concerned” that Choice Bank, “had opened…accounts in legally risky countries” on behalf of digital banking startup Mercury, according to a report by 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 U.S.”

Kruze Consulting’s Healy Jones believes that the Synapse situation will be “a non-issue” for the startup community moving forward. But he thinks that regulatory clarity for consumer protection is needed.

The FDIC needs to “come out with some clear language about what is and is not covered with FDIC insurance in a neobank that uses a third party bank on the backend,” he said. “That will help keep the neo-banking sector calm,” he said.

As Gartner analyst Agustin Rubini told TechCrunch, “The case of Synapse underscores 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 point of view, as someone who has covered fintech’s ups and down for years, I don’t think all BaaS players are doomed. But I do think this situation, combined with all the increased scrutiny, could make banks (traditional and fintech alike) more hesitant to work with a BaaS player, opting instead to establish direct relationships with banks as Copper hopes to do. 

Banking is highly regulated and highly complicated and when Silicon Valley players get it wrong, the ones who get hurt are everyday human beings.

The rush to deploy capital in 2020 and 2021 led to a lot of fintechs moving quickly in part as 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 ones that shirk compliance. The end result, as we can see in the case of Synapse, can be disastrous.

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

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News Article Courtesy Of Mary Ann Azevedo »