Nobody Wants An Online Bank (And Other Wisdom From Investing $100 Billion In Fintech)

OBSERVATIONS FROM THE FINTECH SNARK TANK

Frank Rotman, Partner at QED Investors, posted a Twitter thread about venture investing, which included:

“Founders’ pitches describe a problem, their solution to the problem, and the financials the business will generate over time. Investors need to ask: How much can you learn, how quickly, and for how much money? There’s been a recent trend to raise a lot of money and then quickly add more capital at higher valuations. The critical question to ask: What has the company learned since the last valuation?”

A great question. It begs a broader question, though:

What have VCs and fintech entrepreneurs learned after the last five years’ rounds of financing?

Projecting out from the $21 billion already invested in fintech this year, more than $100 billion will have been invested in fintech in just the past three years.

The Wisdom Of $100 Billion in Fintech

Here are four lessons that VCs and fintech entrepreneurs have learned—or should have learned—after all this investment:

1. Different isn’t better—better is better.

Many fintech founders—especially those starting challenger banks—expected to capitalize on what they thought was a high level of consumer dissatisfaction with banks, particularly the large banks.

That dissatisfaction was never there.

Two of the three megabanks—Bank of America, JPMorgan Chase—saw big jumps in their customer satisfaction levels between 2015 and 2019.

And according to JD Power’s 2020 Bank Satisfaction study:

“Big banks not only lead in satisfaction with digitally delivered advice, but also with face-to-face advice. Overall customer satisfaction with the advice provided by a primary retail bank increased by 14 points to 833 (on a 1,000-point scale) in 2020 from a year ago. The increase was driven by the big bank segment.”

This misconception about consumers’ satisfaction with their banks leads to one of the most deeply-held—but erroneous—beliefs in the fintech world: That consumers want a digital bank.

Granted, for the vast majority of interactions and transactions, digital wins in terms of convenience and speed.

But incumbents can do digital, even if it takes them a little more time to do so.

The lesson learned is that consumers don’t want a digital bank—they want a better bank.

2. Specialization sells.

If the newer money is smarter than the older money, then fintech startups with a narrowly defined target market are where it’s at.

Recent challenger bank funding rounds support this trend towards specialization include: 1) Aspiration which attracts socially and environmentally aware consumers; 2) Qwil serving gig economy workers; 3) Lili focusing on freelancers; 4) Tenth, a new challenger bank for Black Americans; and 4) youBelong, serving the banking needs of disabled consumers.

The move towards specialization isn’t just about market segment—it’s also about product scope.

While early players attempting to reinvent wealth management with robo-advisors tools have hit limits to their growth and are now pivoting to banking, new entrants are finding narrowly-focused pain points to address.

Atticus, for example, has created a mobile app to address the probate and estate settlement process. With the impending Baby Boomer transfer of wealth over the next 20 years (despite my insistence that I’m taking it with me), this will address a growing consumer need.

In many ways, the niche trend is the antidote to the digital bank movement: Focusing on the unique needs of a defined segment, to offer better products, better services, and a better experience.

3. Revenue matters.

Sometimes there is no learning between funding rounds because a startup goes out of business.

An article titled 8 Reasons Why Fintech Startups Fail included reasons like: 1) under-funding; 2) choosing the wrong VC; 3) overlooking compliance; 4) overlooking legal aspects; 5) competing on cost; and 6) ignoring economic cycles.

Those might be mistakes fintech startups make, but they’re not the overriding reason why they fail.

The biggest cause of failure? The failure to make money.

Unless you’re developing a new technology, revenue matters. Startups that develop a foundational technology that others can monetize can succeed without revenue, because someone will acquire them.

Others will have to do it, as John Houseman used to say, the “old-fashioned way” and “earn it.”

Fintech founders and their VCs are finding out the hard way, however, that that’s easier said than done (actually, if you try to say it the same way Houseman did, it’s not that easy).

Reality: The top of the funnel is a lot easier than the bottom of the funnel. Fintech founders that brag about the number of people on their waiting list are deluding themselves.

The lesson learned from fintech funding is that while business models may morph over time, there needs to be a business model in place that includes how to make money. Revenue matters.

4. B2B Beats B2C.

Speaking of the importance of a business model and revenue, the fintech world is learning that it can be more lucrative to sell to financial institutions than trying to displace them.

The B2B space is getting hot. In October 2019, LiveMint wrote:

“Fintech startups catering to businesses have, for the first time in the last five years, raised more capital this year than their consumer-facing counterparts, according to fundraising data.”

And in its State of the Fintech Industry, Toptal’s Natasha Ketabchi observed:

“The focus of younger companies appears to be moving from B2C to B2B with companies finding traction in capital markets infrastructure and compliance/ regtech.”

Underscoring this shift from B2C to B2B, an analysis of fintech funding so far this year reveals that 21% of the total has gone to firms building financial technology to support financial institutions and other fintechs.

Recent funding rounds highlight this growing trend with capital raises for:

• Episode Six. The startup’s software platform enables banks, fintechs, and payment services providers to design, develop, issue and manage financial and payments products. The startup has raised $10 million so far with a $7 million round completed in June 2020.
• Numerated. This digital lending platform for small businesses was birthed in Eastern Bank’s digital lab. Management wisely saw bigger potential to spin it out, and it has raised $32 million to date, nearly half of it in September 2019.

It shouldn’t come as a surprise.

There’s a strong level of dissatisfaction among many financial institutions with existing vendors. And the Covid crisis has forced many incumbent institutions to accelerate their digital plans.

Who are they going to turn to?