Business Breakdowns
· Fraser
[00:00:00] S1: Max's biography deserves its own podcast and a book as well, because he's lived a pretty extraordinary life. But even going back to pre-PayPal, because I think it gives you a sense of the grit. Max was born in Ukraine to a family of physicists and scientists. They left Kyiv when Max was about ten, after the Chernobyl nuclear disaster. He tells this story of arriving in Crimea and he set off a Geiger counter because he had a radioactive thorn in one of his shoes. And they spent five years there with his grandparents and then moved to Chicago right before the fall of the Soviet Union. Max can obviously speak English when he moves to Chicago, but he does tell some great stories about the translation issues in those early years. He wanted to apply to MIT and accidentally called it MTI in the application letters, for example. So he ends up going to University of Illinois where, fun fact of history, Marc Andreessen had just launched Mosaic, the early web browser. So Max enters university thinking he's going to be an astrophysics professor and ends up being bitten by the startup bug and immediately starts businesses and wants to be an entrepreneur. And it's actually in that period of time that the idea for Affirm is seeded, because coming from the Soviet Union, he didn't really have a concept of credit cards and credit and how it all worked. And so he basically grabbed a credit card while he was at university and started funding his startups using credit cards and was paying them back late. Inadvertently, he was doing a lot of damage to his credit rating. Now, unlike a lot of people who never recover when they ruin their credit rating, Max would subsequently go on to be wildly successful, as you mentioned — early 20s, as the CTO and one of the co-founders of PayPal, working alongside Elon Musk and Peter Thiel and all that cast of characters. But Max's poor credit rating still haunted him through this period despite being very successful. The story he tells is he flew to LA after the PayPal IPO to buy a convertible car to impress his then girlfriend, now wife. And the car dealer declined the loan because his credit score was so bad. And this is despite — he could pick up a magazine and he was on the front page as a 20-something-year-old. So he had to sit there at the car dealer and wait for a wire to clear before he could drive away.
· Fraser
And he also talks about his friends pranking him for years at restaurants by having staff pretend his card had been declined. So he had these very personal experiences of the credit card system not really working for him and for a lot of Americans and people around the world. A decade after he left PayPal, Max started Affirm with a mission that still stands today, which is to deliver honest financial products that improve lives. So there's no late fees, no compounding balances, no deferred interest, no fine print. When he first started the business with that mission and he was speaking to people in the industry, they thought he was completely insane, because there is a lot of profitability and economics charged in the industry on those types of mechanisms. He's still known as Max, the founder of PayPal, but if we roll forward the clock five years, ten years, we think he will well and truly be known as Max, the founder of Affirm, because this business will ultimately, we think, be more influential than his act one. And it's important to know that Max is obviously very technical. I mentioned he was the CTO of PayPal. They were early pioneers in fraud detection and cryptography and all these really interesting parts of processing payments on the internet. The culture and the DNA and the people that Affirm hires is deeply technical. Max wanted to set out securing the type of mathematical talent that otherwise ends up in scientific research or hedge funds building models to make money in split-second decisions. He's been able to attract a lot of talent both because he is technical, but also the mission of the business is to dramatically improve the credit ecosystem around the world.
· S0, Fraser
[00:00:00] S0: Are there other ways where the spirit of Max shows up in the business? One is maybe he's technical, so he hires very high-caliber technical talent. Are there other ways that seem significant? [00:00:00] S1: The biggest one for us is Max talks about this framework he has in his head of starting businesses — the problem to be solved has to be hard, valuable, and fun. [00:00:00] S0: HVF was the name of his incubator, which is how Affirm got started too. [00:00:00] S1: Yes. I think the hard in HVF is really interesting. Max leans into solving hard problems, and that goes to — we want to solve the problem of unsecured lending large amounts over long periods of time to consumers and not have get-out-of-jail mechanisms like late fees and compounding balances and those sorts of things. The business has been running almost 15 years, and they've nailed that and continue to evolve and improve and get better. But Max's personal DNA of leaning into hard problems, you see throughout the whole organization. And despite in its early days, particularly as a listed business, being pretty high on the stock-based comp offenders list and those sorts of things, they have gone through the process of getting much more disciplined. Headcount has been flat for a number of years now. G&A has been flat for half a decade. Stock-based comp has been flat for half a decade. They're willing to actually make hard decisions and do the hard things to make their business stronger for the long term.
· S0
[00:00:00] S0: When we did this with Alex Rampell, who actually happens to be a co-founder of Affirm, a couple years ago on Visa, what we did was we walked through an example of a simple card transaction — when someone taps their card, how the money moves, who's involved, which intermediaries are taking a piece of it. So I'd like to start with doing that, but for Affirm. Let's say I'm online, whether it's Shopify or Amazon, and I want to buy a couch. So I go ahead, I click Affirm in the checkout. Let's assume I click monthly payments. Can you walk us through exactly what happens from there on out? Who are the people involved? Where's the money flowing through? Who's on the hook for the actual payments? Just go through that in as much detail as you can.
· Fraser
[00:00:00] S1: At the highest level, we think of Affirm as the American Express, or the payment network, built for the internet and e-commerce. And so if we walk through a transaction, I'll help give a sense of why that is the case. To use your example, a consumer's on a merchant's website — Amazon, Target, whoever it may be — and they want to buy something typically reasonably material. The average purchase price for an Affirm transaction is about $250. So let's say it's a couch. Let's assume this person is not already an Affirm customer, but when they get to the checkout, they see the offers for Affirm financing. So there might be a 0% interest loan over three months, a 20% interest loan over six months, and a 25% interest loan over 12 months. Now, at this point, these are just theoretical offers, because Affirm hasn't actually pulled your credit history yet. And so the consumer decides that these loan terms sound interesting, and so they click on the Affirm button at checkout to set up an account. They provide a few details like their mobile number, name, date of birth, and the last four digits of their Social Security number. Affirm then matches not only the data from the transaction — so what is the merchant, what is the basket size, what are the SKU details — with the data from the credit pull to finalize the terms of those offers. Assuming Affirm is still happy to underwrite the transaction and the consumer is still happy with the finalized terms, the consumer selects the offer that they're happiest with and they check out. The consumer then pays that plan in line with the terms agreed at the point of sale. And that's a very key distinction versus a credit card. The interest rate is fixed, the repayment schedule is fixed, and the balance is paid to zero according to the rundown of the plan. In terms of the actual flow of funds on the merchant and the Affirm side, let's say the purchase price was the $250. Affirm pays the merchant the $250 less whatever fee they agree Affirm receives for the transaction. So let's say it's $5, and that's called the merchant discount rate, or the MDR. That MDR varies widely depending on the merchant and the type of loan, but we can get into the specifics of that later. In this instance, let's say Affirm keeps the $5 and sends the $245 to the merchant.
· Fraser
Affirm then also makes money on the interest payments paid by the consumer when it is an interest-bearing loan. So the merchant's happy — they've potentially secured a transaction from a customer that they otherwise wouldn't have converted. The customer is happy because they were able to purchase this couch on attractive terms. And so collectively, the mechanism makes a lot of sense for all the parties involved. Now, on the funding side, about half the loans Affirm originates get sold to third parties and moved off balance sheet, and about half remain consolidated on balance sheet but still utilizing third-party facilities. So the things we would highlight in that transaction — the customer acquisition is extremely efficient. You can imagine the more merchants that have Affirm checkout, the more customers see those offers, the more customers Affirm acquires. There's very real network effects, very much like an American Express. And the second thing we would highlight, and we're going to probably talk a lot about this, is just how different that credit underwriting process is to a credit card and how different that customer experience is to a credit card as they're paying back the loan. Half of US credit cardholders today have a revolving balance. The average credit card balance in the US is $7,000. There are mechanisms with credit cards — whether it be variable interest rates, compounding balances, late fees — that mean people can end up in really unfortunate scenarios where they're constantly trying to pay down debt over many, many years. That process does not happen with Affirm. Every loan is underwritten on a transaction-by-transaction basis, and they're designed to be paid down to zero. So these are much better for consumers, and the data shows they end up with much better underwriting outcomes.