Thinking about Square’s acquisition of Credit Karma’s tax unit

Back in November 2020, Square announced its agreement to buy the tax unit of Credit Karma for $50 million in cash. Unlike Turbo Tax, which is infamous for slyly inducing tax filers to pay for its services, Credit Karma doesn’t charge users fees. Here is from the press release

Consistent with Square’s purpose of economic empowerment, Cash App plans to offer the free tax filing service to millions of Americans. The acquisition provides an opportunity to further digitize and simplify the tax filing process in the United States, expanding access to the one in three households which are unbanked or underbanked. The tax product will expand Cash App’s diverse ecosystem of financial tools — which currently includes peer-to-peer payments, Cash Card, direct deposit, as well as fractional investing in traditional stocks and bitcoin — giving customers another way to manage their finances from their pocket.

“We created Cash App to provide more access to the masses of people left out of the financial system and are constantly looking for ways to redefine our customers’ relationship with money by making it more relatable, instantly available, and universally accessible,” said Brian Grassadonia, Cash App Lead. “That’s why we’re thrilled to bring this easy-to-use tax product to customers as we continue to build out the suite of tools Cash App offers. With this acquisition, we believe Cash App will be able to ease customers’ burden of preparing taxes every year

Source: Square

There are several reasons why I think Square made a big splash on Credit Karma’s tax business.

Customer acquisition

In the same press release, Square claimed that 80 million people in America file taxes online every year, yet Credit Karma’s customer base is only 2 million. As of Q4 2020, Square’s Cash App monthly active user count stood at 36 million. Even if all Credit Karma’s current users are on Cash App and all active Cash App users file taxes online, by offering a decent free tax-filing service, Square can appeal to 44 more million tax payers in America at the top of the sales funnel. In the latest earnings call, Square disclosed that its Cash App user acquisition cost is less than $5 per user. At that rate, Square only needs from the acquisition of Credit Karma’s tax tool 10 million new users to break even on the $50 million in cash paid, let alone other benefits discussed later in this entry. Obviously, the conversion rate from being a tax filer to a Cash App user won’t be 100%, but a relationship to some extent with customers is still much better than no relationship at all. As of now, Paypal is Square’s arguably biggest rival with very similar offerings. However, Paypal doesn’t have an offering equal to what Credit Karma can offer to Square, yet. Perhaps, it can be a useful differentiator.

Customer retention

Engaged customers are often the more profitable customers. Filing taxes is, in most cases, a once-a-year activity for individuals. Given that Credit Karma is a free service and that Square essentially declares its intention to keep the service free, it won’t be a revenue center. Nonetheless, it doesn’t mean the new acquisition can’t help Square grow the top line. Here is how Square currently makes money with Cash App:

  • Whenever customers use Cash Card with Cash App to pay businesses for purchases, Square makes a small interchange fee
  • If customers want to expedite deposits to their bank accounts, there is a fee. If they can wait 2-3 business days, the deposits will be free
  • Customers are charged a fee when they make a P2P transaction using a credit card
  • Square imposes a small mark-up on Bitcoin’s price before selling it to customers through Cash App

In essence, it benefits Square when customers have balance in their Cash App. The more balance there is, the more useful Cash App is to customers and the more revenue & profit Square can potentially earn. I imagine that once Credit Karma’s tax tool is integrated into Cash App, there will be a function that directs tax returns to customers’ Cash App. When the tax returns are deposited into Cash App, customers can either spend them; which either increases the ecosystem’s value (P2P), or deposit the fund back to their bank accounts. But if customers already direct the tax returns to Cash App in the first place, it’s unlikely the money will be redirected again back to a checking account. As Cash App users become more engaged and active, Square will look more attractive to prospect sellers whose business yield Square a much much higher gross margin than the company’s famous Cash App.

Additionally, there is nothing that stops Square from giving customers immediate access to tax returns in exchange for a small fee. Tax returns, after being approved, only hit bank accounts after a few days. Square can entice customers to pay a small fee to access the money immediately in Cash App which they can use to invest or make payments. It’s a win-win for everybody.

Figure 1 – The more engaged customers are, the more valuable they are to Square. Source: Square
Figure 2 – Seller offers a much higher gross margin to Square than Cash App. Source: Square

A great source of data

With Credit Karma’s tax tool, Square can have access to a reliable source of demographic data such as age, location, status, income, education, reasons for tax credits and investing behavior. Individual tax filers don’t often try to deceive Uncle Sam in their tax forms. Hence, any information derived from tax filings through Credit Karma is accurate and can be very useful to Square in designing and offering new products. Last year, Square got approval from FDIC to open a bank in Utah and a few days ago, it announced that its industrial bank named Square Financial Services already began its operations. According to the press release, the bank will first focus on underwriting and original loans to existing Square Capital customers and potentially all sellers in the future.

Nonetheless, it won’t surprise me at all if Square’s bank ventures into consumer banking products such as mortgage, credit cards, savings or checking accounts in the future. If they do, information derived from tax forms will be very valuable. I am working for a bank now. We are often frustrated by the lack of demographic information on customers. When they apply for a credit card, sometimes they disclose their annual income, along with other basic information like age or street address, but that’s about it. After they enter our system, it’s almost impossible to receive updated information in their income, their status or other information that a tax form can reveal such as security trading, cryptocurrency trading or donations. What could possibly give a financial institution that kind of information accurately, reliably and regularly on an annual basis than a tax form?

In summary, I do think this is a good strategic acquisition by Square. Personally, I can see some useful applications that Credit Karma can offer and really look forward to how it actually pans out in the near future.

Disclosure: I have a position on Paypal

3 thoughts on “Thinking about Square’s acquisition of Credit Karma’s tax unit

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