In today’s Finshots, we explain why a fintech startup that was once the poster child of the Buy Now Pay Later movement is in all sorts of trouble.

The Story

Lending 101 is pretty simple really.

You find prospective borrowers who aren’t frauds. Then you apply data and logic to determine if they can pay you back. You set up a contract demanding a certain rate of interest and a repayment schedule. You dole out the money. And then you cross your fingers and wait for all of it to come good.

From moneylenders to banks, this is how it has always worked.

Even today, if you want to set up this business, your core proposition is the same. You’ll say that you’ll tap the underserved market for small loans. You’ll go to the people that banks ignore and you’ll use words like ‘digital’ and ‘aspirations’. So you tell the story of reaching out to people who’re buying things online for the first time in their lives. You’ll talk about people aspiring to a better lifestyle and how you’ll tap physical stores where they shop.

You’ll claim you’re democratising credit. But since traditional lending is boring, you package this within a tech shell. You wax eloquent about your amazing tech chops that will dole out credit. And then you quote a $1 trillion digital lending market size to investors.

“Buy now, pay later.” It’s a great tag line. And investors lap up your story. They want a piece of this fintech business that’s in vogue too. So they throw money at you.

Until one day, the music stops. Everyone wakes up and realizes that it’s not really a tech company. It’s still a financial services company. And lending 101 is still as relevant for this as it was to a moneylender 500 years ago.

And while many companies have been forced to reconcile with this harsh reality, ZestMoney was perhaps one of the bigger players that many people believed would ride the storm. After all they had raised over $130 million since 2015. They were celebrated in fintech circles. They were expected to turn into a unicorn. But 2023 hasn’t been kind. The funding dried up. PhonePe, which was all set to acquire it, backed away citing concerns. ZestMoney had to lay off over half of its workforce. And finally, on Monday night, even the 3 founders decided to hang up their boots.

But what went wrong?

Well, we don’t know for sure. But one theory is that it’s all down to the business model.

See, if somebody wanted to make a purchase of ₹1,000, ZestMoney would promise to take care of the bill at no cost. And then they’d ask the customer to pay it back in instalments over a 3–6 month period without any interest.

So how did the company make money then?

Well, ZestMoney would pass along this customer information to one of its 27 partners. These were the folks who would disburse the money. And ZestMoney would pocket a fee for sending them a customer, doing all the necessary KYC checks, and handling customer care too.

At the backend, ZestMoney would pay the merchant immediately. But instead of settling the full ₹1,000, they’d pay something like ₹950. The merchant agrees to take the hit because they can immediately push the purchase. And giving the option to pay in easy instalments could be a psychological trick to boost sales. Meanwhile, the ₹50 cut is the fee for ZestMoney’s service. But it can’t keep it all for itself. A big chunk of this goes back to the lending partner.

And finally, if a customer delayed a payment, ZestMoney would penalize them and collect a fee.

So, it basically had these 3 revenue streams.

And because people loved easy credit, ZestMoney claims to have disbursed over ₹7,500 crores in such loans over the years.

But here’s the thing. Lending is always easy. It’s the recovery that is hard. And for the loans it doled out through partners, ZestMoney was liable. It had to bear a big part of the loss in case of default. And as per The Ken, the rate of default was sky-high at the company — at 13% (although the company has contested this figure by claiming that the NPAs were under 1.5%). Typically, BNPL companies need to keep it below 2.5%, so you can imagine that this wasn’t a good thing.

In fact, it had an item in its financial statements called ‘service deficiency charges’ — a cost for paying for all these bad loans. And this was at a whopping ₹244 crores in FY22. If you want to know how bad this is, ZestMoney made just ₹143 crores of income.

Not to forget that even acquiring customers in the first place was a hard task.

There were ads it had to splash and an employee workforce to deploy on the ground. It was a costly affair. ZestMoney spent around ₹1,000 rupees to acquire a single customer. And folks in the industry say that in order to make money, ZestMoney needed each customer to opt for at least 4 BNPL loans in a year. Instead, its customers opted for just 2 loans on average. It wasn’t enough. (ZestMoney however has disputed this figure).

So yeah, combine massive acquisition costs and ballooning defaults and you have a massive problem. And the only way to really run this business is to keep raising money from investors. And when the funding tap dries up, well…nothing works anymore.

Oh, and then there was the Reserve Bank of India’s regulatory scrutiny on BNPL companies too. It tightened the screws and laid down guidelines on digital lending in September. And word is that ZestMoney’s monthly loan disbursals fell by 75% after that.

So what’s next for the company now that the founders have stepped away?

Well, we don’t know yet. They seem to have set up a new leadership team picked from within the organization itself and whether they can turn things around is anyone’s guess.

But there is still one silver lining for those looking for one.

ZestMoney might have raised all those millions of dollars selling the fintech story. And it probably failed in the ‘fin’ part of things or Lending 101. In Tech 101, however, it still might have succeeded. Because while PhonePe may not have bought ZestMoney, it still licensed some of their proprietary technology. Rumours say for $8 million.

Until then…

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Note: The previous article noted that the NPAs at ZestMoney stood at 13%. However the company has contested this claim. We have amended the article to note the same.

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