Square, the payment processing company run by Twitter’s Jack Dorsey, is buying buy-now-pay-later (BNPL) business Afterpay for $29bn. The companies expect to complete the transaction by the end of March 2022.

“This deal is a major coup for Square, as it brings into the fold a superstar, fast growing company,” Tosin Agbabiaka, fintech investor at Octopus Ventures, tells Verdict.

The deal will enable Square to tap into the instalments segment of the financial services industry, which is expected to be worth $166bn by 2023, according to GlobalData’s Thematic Research.

While Square buying Afterpay will enable it to take a slice out of the highly lucrative BNPL market, the deal also comes attached to a number of challenges.

Firstly, the point-of-sales fintech will have to deal with growing competition from businesses like BNPL quadradecacorn Klarna and payments giants like PayPal.

Secondly, the BNPL market is also facing growing regulatory scrutiny after widespread criticism over how the sector risks putting people’s financial wellbeing at risk.

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At the same time, though, Square buying Afterpay will up the pressure on the other companies in the BNPL space.

Square buys Afterpay

US fintech Square announced plans to acquire Australian Afterpay for $29bn on Sunday. The price is based on the closing price on common stock on July 30.

Square CEO Dorsey founded the $112bn company in 2009. He is also the co-founder and CEO of Twitter. The Silicon Valley celebrity celebrated the acquisition, saying it would enable strong synergies between the two ventures.

“Square and Afterpay have a shared purpose,” Dorsey said.” We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”

Square plans to integrate Afterpay’s BNPL solutions into its own Seller and Cash App ecosystems once the deal has closed. This will enable merchants to access instalments solutions like the ones offered by Afterpay.

Afterpay at a glance

Anthony Eisen and Nick Molnar founded Afterpay in 2015. Today they serve as co-CEOs of the company. Afterpay today counts more than 16 million consumers and nearly 100,000 merchants in its global network.

Contrary to many other fintechs in this space, such as Klarna, that are still mulling over whether and when to go public, Afterpay hasn’t rested on its laurels. It listed on the Australian Securities Exchange in 2016.

Afterpay has since the launch expanded to the US, Canada, New Zealand and the UK. It is called Clearpay in the UK. Eisen and Molnar plan to leverage Square’s acquisition of Afterpay to keep growing its business Stateside and across the globe.

Echoing Dorsey, Eisen and Molnar added: “The transaction marks an important recognition of the Australian technology sector as homegrown innovation continues to be shared more broadly throughout the world. It also provides our shareholders with the opportunity to be a part of future growth of an innovative company aligned with our vision.”

Eisen and Molnar will join Square upon completion of the transaction and help lead Afterpay’s respective merchant and consumer businesses, as part of Square’s Seller and Cash App ecosystems.

Why is Square buying Afterpay?

Dorsey’s Afterpay deal comes as Square is busy expanding its financial services. In fact, the payments giant seems to be heading towards becoming a digital bank offering a wide range of services.

Earlier this year, it acquired Spotify rival TIDAL for $297m. The deal was interpreted as the fintech paving the way to offer cryptocurrency payments and to give artists a way for getting paid using non-fungible assets, or NFTs.

Those speculations seemed to, at least partially, bear fruit the other week when Dorsey tweeted about Square’s plans to open a bitcoin wallet.

Then, Square took another step towards becoming a bank in July when it announced plans to open its Square Banking service for SMEs. Through Square Banking, small businesses would be able to save and manage their business accounts, manage cash flow and connect it with a Square Debit Card.

Square buying Afterpay fits into this trend. The San Francisco-headquartered fintech will use the deal to tap into a younger customer base who skirt traditional credit cards.

The payment paragon said buying Afterpay would enable it to leverage Afterpay’s global network to scale. In return, Afterpay is said to be able to benefit from Square’s large and growing customer base.

“Square has continued on its push to build out a full suite of financial services for merchants and their customers alike,” says Agbabiaka. “BNPL has proven to be a major boon for merchants looking to drive up customer conversion at checkout, and consumers have taken to the flexibility it offers.

“There is a clear alignment here between Square’s focus and customer and Afterpay’s.”

Crowded market

Dorsey’s side-hustle will face a number of challenges buying the credit company. Firstly, it will have to square off against a lot of competition. Startups and major players are already busy cutting into the instalments sector. Secondly, regulators and lawmakers are increasingly putting the sector in their crosshairs.

Let’s start with the growing competition in the market. Up until recently, BNPL was predominantly a place for startups that focused on offering merchants and customers instalments solutions. Over the past decade, Klarna, Affirm and Afterpay have all become leading brands this way.

The growing competition has also caused tension at times, especially between Klarna and Afterpay. Following Klarna’s entry into the Australian market, its CEO Sebastian Siemiatkowski accused the competitor of forcing retailers to pay “extortionate” fees to use the company’s services, according to the Australian Financial Review.

Eisen fired back by calling the claims “disingenuous and desperate”, Stockhead reported.

Not just BNPL firms

And it’s not just the bigger firms that Afterpay and Square have to deal with. Smaller startups like Zilch have also entered the fray in recent months.

Moreover, fintechs that haven’t traditionally offered BNPL services have also joined the fray. Danish challenger bank Lunar is a good example of one company that has added instalment to its services.

It goes the other way too: Klarna has also been busy diversifying its offering of late. The Swedish $45.6bn company has been on an acquiring spree to this end. It reportedly acquired loyalty card startup Stocard earlier this summer, having bought HERO, a social shopping platform just weeks earlier.

What may be more alarming for Square and Afterpay are the number of bigger businesses stepping onto the scene. PayPal, Mastercard and American Express are just some of the companies providing BNPL services.

Apple is also rumoured to be eyeing a BNPL service of its own. Shopify, one of Square’s competitors, tapped Affirm earlier this summer to offer instalments.

“Large financial institutions have taken notice of BNPL providers’ success and significant growth, as well as their ability to own and grow the relationship with merchant,” says Agbabiaka. “It’s therefore no surprise that they also wish to enter into this market too.

“These companies are also conscious of the threat that BNPL poses to credit card use, particularly in the younger demographic. So, for some, there is a need to get in this space is a defensive move. We’re bound to see more announcements from large players entering this space.”

That being said, Square buying Afterpay also cuts both ways. It gives Afterpay’s competitors reason to look over their shoulders as well.

“[This] deal suggests that the US battleground for BNPL is going to get more fierce, as Afterpay is getting a big boost to expand in the US,” says Agbabiaka. “This should be a cause for concern for Affirm, as the US homegrown BNPL solution has seen middling success since its IPO, and will now go into battle with a formidable opponent. Klarna, less directly in the crosshairs, is on notice as well.”

Stricter rules

Square has more than competitors to worry about as it brings Afterpay into the fold. Lawmakers are increasingly putting the squeeze on the BNPL sector. They are growing concerned about the risk of credit companies putting people’s financial health in jeopardy.

They have reason to be worried. Nearly 40% US customers who’ve used BNPL services have missed a repayment, according to Credit Karma research. Market stakeholders expect the White House to tighten the rules around the sector as a result of these concerns.

The UK government has already pledged to do the same. It made the promise after the Financial Conduct Authority published a review into the sector. These rules will, among other things, force BNPL providers to carry out affordability checks on customers.

Sweden has similarly introduced a law in 2020 that banned ecommerce sites from pre-selecting credit-based payments at checkout.

In an exclusive comment to Verdict in July, Afterpay responded to this criticism buy essentially saying that at least it wasn’t as bad as credit cards.

“We believe we have lifted the standards when it comes to best practice – we don’t know of a credit card offering that freezes a customer’s account as soon as a payment is missed, to prevent the customer from taking on more than they can afford,” an Afterpay spokesperson said.

“This is in stark contrast with credit cards, where very low minimum payment requirements mean that consumers can extend their credit card debt over many years (or decades) at interest rates of 20% or more.”