Fintech startups: who buys them and why? They’re expensive, lossmaking and overvalued. Why people even pay for them?
By Igor Pesin, Partner at Life.SREDA
I would like to start by explaining how and why the fintech industry appeared. It’s not more than 3 or 4 years ago that this industry emerged and started to draw a great deal of attention from the new entrepreneurs, clients, journalists, banks, telecoms, and web giants. This was associated with fast-developing technologies, especially mobile-first services, that were massively changing the customers’ preferences, and those of generation “Y” customers in particular. And traditional banks started legging behind these changes for several reasons:
- Regulators all over the world request that the banks should be money-making right here, right now, not at some point, whereas in the technology sector, everyone understands that developing a new technology or service can take long, and in the meantime you don’t make any profit and have no idea when and how you finally start making money
- The sentence above would sound absolutely absurd for bankers who only have owners and bank heads in their world, and, for obvious reasons, they all want an increasing profit. Startupers don’t found their companies by hitting bosses or stockholders with questions, but by asking the client where the shoe wrings – and then they help to solve the problem. In the technology sector, the widely accepted practice is to build the service by asking the client questions, looking for the best solution and then understanding how to make money with this solution (the Silicon Valley paradigm: if you solve someone’s problem well, then it’s much easier to understand how to make money out of it, and this understanding will come eventually).
- Whatever the bankers say about their openness to online services, the banks are always offline, because even if they have (suddenly) managed to develop the best mobile bank, you need to go to their office and sign the documents in order to get access to it. Bank branches are, and have always been, the center of the bankers’ solar system. And startupers only need a mobile phone: you can simply download your bank through AppStore or GooglePlay and start using it. The same holds true to banks as clients: they don’t use cloud systems, instead they buy lots of servers, and the servers need to be taken care of by employees, this creates some kind of significance and increases the salary of IT Head.
- There are times when it takes so long to build something that, in order to change it, it’s easier to destroy it and start from scratch. Take a look at the back-end and IT-infrastructure of any big bank: they seem like a pile-up of the broken condoms. Anyone knows that if a condom is broken, you should take it off and put on a new one. And the banks just write a new adscript every time, which results in a huge stack-up of adscripts. Often nobody even remembers their history, because “that guy” has already been fired. Whereas all new services are built from scratch, as it should have been in a perfect world, in line with the principles of open architecture and free interaction with other online services.
- Banks have always worked with bank services only, while the new generation of the clients asks for a cocktail of financial, entertainment, informational, tourist, medical and plenty of other services. As a result, other sectors (e.g., retail) are learning fast to work with financial services, and in the meantime the banks keep stagnating.
- Finally, there are the people who work in banks. They can be anyone, sometimes even good specialists and as honest men as ever lived, but they are not entrepreneurs. But the new economics (like in cases of Tesla or Apple!) requires companies to have a new way of internal structure: small self-organized teams that can work without a precise plan and under uncertainty, that can generate new ideas and test them, that are challenged by their mistakes and failures. There is a very popular related joke by Dilbert:
What do corporations acquire in the traditional sector when dealing with regular companies? They mainly buy future cash flows based on how the company has been generating and gaining them. In the fintech industry, most companies are lossmaking while being valuated at a sight of money, according to experts. It’s your choice how to take things you don’t understand: either the others are idiots or you are not smart enough. So, either the people who buy them are bananas or they pay for something else. I’d like to give a few examples of what these market players are driven by.
- They buy customer acquisition. Banks all over the world offer the same products, only rates may differ a little, that’s why the customer acquisition becomes more and more expensive. If a bank in USA buys an SME customer for USD 200 and a startup for USD 20, the latter is purchased with a view to cut the expenses for customer acquisition by a factor of 10. After that, the clients are also offered traditional services and products, but with a higher margin.
- To buy a differentiation. Big banks spend tens of millions dollars annually on their advertising, millions go to campaigns, and billion dollars cover the fees of the creative agencies. Except that the commercials don’t differ much from one another: here is a smiling family with a dog, and there is another one without a dog; here’s a businessman looking to the future with confidence, and here you have a relaxed and happy businessman giving a hug to his wife while staring at the horizon. Fintech startups let you stand out in this advertising splutter by promoting a bank with a new product. We know that the clients’ memory is organized in a way that, having received a new and unusual message, they will set you aside from your competitors and project the image of innovativeness and sophistication to all your other products.
- To buy lower risks. Another constant pain for the banks is how to lower the risks for the provided loans, which are the main and the most profitable bank service. With fintech startups, it is possible to gather a lot of various information about the clients before offering them a loan. You will be able to provide the loan at a lower risk, and it will be more targeted if you are aware of the client’s financial status, the amount of his own clients and the relationship with them, his choice of the range of services for his enterprise, his friends in social networks and the way of communicating with them, his special offers and his clients’ feedback, as well as thousands of other factors that shows the overall attitude and quality of the business in perspective.
- To buy time. You can of course get inspired by the best practices in your country or worldwide, go to your IT-department and ask them to copy everything. Even if this seems cheaper and to a good quality, you have just spent lots of time on copying yesterday’s practices, and the market is already ahead of you. So everything depends on how ambitious you are: either you want to create the future or constantly try to catch up.
- To buy talents. You can buy a specialist, maybe a good one, even a lot of good specialists, but you can’t buy entrepreneurs and teams. Entrepreneurs want to be independent and work for themselves, while a set of specialists can’t just make a team when asked to do so by their boss – this is only possible if they have a common goal, spend time together, and share similar values. When BBVA were asked why they had bought the unprofitable company Simple for USD 117 million, they said they had just bought 36 outstanding specialists who know where to go (forward), how to go there; they don’t need a plan or a set of trainings to become a team. By the way, buying startups is the main HR source for Google, Facebook, and Yahoo.
- To buy knowledge and access to new industries. A great attention is being paid to fintech startups abroad not only by the banks, but by telecoms and web giants. They have money, strong customer base and desire to offer more and more online products to their clients. Currently, financial sector is a sweet spot for them, but they don’t buy banks while are eagerly buying startups.
- To buy internal company changes. Traditional banks often have several thousands or even dozens of thousands of employees, who mostly work well and make profit. There is no point in firing them, but it would be so hard for HR departments and core management to change their way of thinking and seeing the new world. In this context, buying a startup seems like a blood transfusion to resuscitate an ageing body.
- To buy “surprise”. If you haven’t yet seen the show about the invention of a portable PC “Halt and Catch Fire”, I strongly advise you to do so. Those days, the idea itself seemed very risky and there wasn’t enough financing, while giant corporations laughed at it. In Season 1 episode 4 we see the product leader writing the fourth word on the board listing the target characteristics of the computer: “lighter”, “cheaper”, and “faster”, and this last word is “to surprise”. Vladislav Solodkiy, Life.SREDA VC: “Here is the story of my mistake: when LoopPay company came to me, I didn’t invest in it, because, while realizing that it is really unique, I considered it to be overvalued and its sales to be too low. Three months later it was acquired by Samsung with the following comment: “We compete with Apple and can sell everything on a planet scale, but we don’t have a payment solution that would be better than ApplePay, so we just pay for rising in the clients’ esteem”. So I made a conclusion: don’t look at the figures (they’ll come), look at the people, their vision, and their product. If they are unique, you should invest in them and hold on to them”.
Classic examples of how banks react to fintech are the examples of the American Goldman Sachs and Spanish BBVA. These companies’ CEOs claim that there is no point in waiting until new players disrupt your market – you should disrupt yourself with the help of communication, partnership, investments or acquisition of new technology startups: not only they bring new ideas and technologies, but change the way of thinking for the whole company. You should think less “like on Wall Street and more like at Silicon Valley”. These companies buy “the sense of future”, not the cash flows. As Yuri Milner says, invest in attention. Once he was asked how he ended up investing in companies that were very unprofitable, but are now big revenue earners. He answered that there are more and more money in the world, its value gets lower, and in this setting, attention becomes the most expensive thing. If a startup can draw attention, you should invest in it, and the ways to monetize it will eventually turn up.