Serguei Netessine is Timken Chaired Professor of Global Technology and Innovation at INSEAD (Singapore campus), and Research Director of INSEAD-Wharton Alliance. He is angel investor, startup advisor, industry consultant and speaker on entrepreneurship and innovation. His recent book “The Risk-Driven Business Model: Four Questions that will Define your Company” was published by Harvard Business Press in 2014.
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Business models of traditional financial companies are increasingly comping under pressure. There are more than 5000 fintech startups in the world now. Fintech, the home of the fabled unicorn, is hot. Already in May 2015 were 36 fintech-unicorns (plus 25 in comparison with 2014 year) and 34 more closing in.
There are now about 50 fintech-unicorns in the wild. Along with many established players becoming larger, new startups are launched monthly, if not weekly. While some have expanded quickly, others have taken longer to evolve—much to the disappointment of their backers and potential partners.
This staggering growth is a reflection of the hype around fintech, where a plethora of startups are using technology to compete against or collaborate with established financial players. The result is a dramatic increase in company valuations as investors look to get in on the ground floor of the next big thing. However, there is an enormous difference between being valued at $1 billion-plus and realising that exit. Vast potential seems to be sacrificed too early. Young unicorns are culled. Why is that? The fintech scene isn’t set to create a wave of financial technology giants hell bent on world domination. Too many are built to exit, rather than to compete.
The magical combination of geeks in T-shirts and venture capital that has disrupted other industries has put financial services in its sights. From payments to wealth management, from peer-to-peer lending to crowdfunding, a new generation of startups is taking aim at the heart of the industry—and a pot of revenues that Goldman Sachs estimates is worth $4.7 trillion. Like other disrupters from Silicon Valley, “fintech” firms are growing fast by questioning status quo of the very traditional and highly regulated industry.
The fintech firms are not about to kill off traditional banks. Nonetheless, the fintech revolution will reshape finance—and improve it—in three fundamental ways. First, the fintech disrupters will cut costs and improve the quality of financial services. Second, the insurgents have clever new ways of assessing and innovating around risks. Third, the fintech newcomers will create a more diverse, and hence stable, credit landscape.
If fintech platforms were ever to become the main sources of capital for households and firms, the established industry would be transformed into something akin to “narrow banking”. Traditional banks would take deposits and hold only safe, liquid assets, while fintech platforms would match borrowers and savers. Economies would operate with much less leverage than today. But long before then, upstarts will force banks to accept lower margins. Conventional lenders will charge more for the services that the newcomers cannot easily replicate, including the payments infrastructure and the provision of an insured current account. The bigger effect from the fintech revolution will be to force flabby incumbents to cut costs and improve the quality of their service. That will change finance as profoundly as any regulator has.
The banks are doing what the old adage tells them: keeping friends close but enemies closer. BBVA, Santander, HSBC and Citi are among those that have set up fully fledged venture-capital-like arms to deploy hundreds of millions on such enterprises. Others, including DBS in Singapore, run their own startup-mentoring programmes, exchanging cash and staff time for a small stake in a budding enterprise.
Most fintechers do not feel half as warmly towards their incumbent rivals. One dismisses them as “the Kodaks of the 21st century”, another as “financial vacuum-tube makers in the age of the transistor”. They see banks as tomorrow’s telephone copper wires, vestiges of an earlier age, and believe that in essence banks cannot adapt. “How often have you seen an incumbent really reinvent themselves?” a startup founder asks. The best thing anyone can say about banks is that they will always be around. “People like to whine about them but they will never leave,” says Neil Rimer of Index Ventures, a fintech investor.
Bankers are well aware of this. They are keeping a close eye on how their products compare with those of the newcomers, and many of them understand their limitations when it comes to innovating. “If you want to come up with a new product in a bank, any one of 50 people internally can shoot it down. If you’re a startup, you can go visit 50 venture capitalists and you only need one of them to give it a green light,” says Tonny Thierry Andersen, head of retail at Danske Bank.
Even so, the startup ethos is changing the way bankers think about their profession. One common refrain among incumbents is that they need to become less product-focused and more customer-focused, which is true but easier said than done. They also note that customers value transparency. And all of this requires new business models.
Fintech faces many challenges. A lot of startups will fade away when venture capital stops flowing quite so abundantly, as one day it undoubtedly will. Even before that, they will have to prove they can be sustainably profitable, even when credit conditions are less benign. Some services may falter, some may continue to thrive, others will no doubt evolve to work in different conditions. Never mind if fintech fails to take over the world, or even the current account: its emergence is changing the face of finance.
There’s perhaps no bank more controversial than the investment firm Goldman Sachs, for its role in the financial crisis of 2008. So there’s probably some small irony in Goldman’s latest area of focus: financial startups. Over the past few years, Goldman has invested hundreds of millions of dollars in far-flung assortment of payments and alternative finance companies.
In a March investment note, Goldman said that old-guard financial firms, like itself, are in danger of losing $4.7 trillion to new financial technology startups, and suggested partnerships and acquisitions were an important way for such companies to gain a foothold. The same ideas are advanced in the recent report that I co-authored with 500 Startups: “500# Corporations: How do the World’s Biggest Companies deal with the Startup Revolution”.
2016 will be a pivotal year for the future of fintech. What happens in 2016 will determine longer-term valuations of the new fintech business models. Over the next 12 to 15 months, as recent and upcoming exits play out, we’ll likely get better insights into which new business models are overvalued, poised to grow into their valuations over time or prepped for mass-market disruption. The new wave of fintech models is only in the early stage, but it carries the potential to redefine the entire ecosystem of global financial services, creating new technology solutions that might forever change the financial services landscape.
2015 was still the best year for venture investment in U.S. fintech since 2000, with $21.6 billion invested in the subsector, according to VentureSource. About $4.9 billion of that came in the fourth quarter. The number of deals for the year, however, declined for the first time since 2009. The initial public offering market has also been unwelcoming lately. Elevate Credit Inc., an online subprime consumer lender, delayed an IPO scheduled for this week, citing difficult market conditions. That follows an indefinite postponement of an IPO by online mortgage and consumer lender LoanDepot Inc. late last year. Nevertheless, investors, analysts and banks themselves still see a big future for financial innovation.
Autonomous Research in a new report estimated that digital lenders would collectively triple to roughly $100 billion in loans globally by 2020, roughly 10% of the total market for small business and consumer loans. Banks “left the door wide open” to upstarts by cutting back on lending after the crisis. The report also noted, however, that there were more than 2,000 firms globally now competing in digital lending, with “low barriers” for even more new firms to enter. “We expect some businesses will succeed, others will fail, and some lenders will be acquired by more traditional financial services firms,” they wrote. Partnering with big banks is increasingly seen as a good outcome for many upstart firms.
A mass of FinTech enthusiasts managed to score significant funding in December 2015, while others were already looking at 2016 opportunity, crossing December from financial calendars. In total, about 81 FinTech companies raised close to $944.5 million in December. US, UK and Australian FinTech are the most represented ones, while China`s FinTech outpaces Australia and UK by the amount raised.
Almost 1000 distinct venture capital investors have participated in the fintech feeding frenzy that has gripped the financial services sector over the past three years. Fintech deals with VC participation have seen a median post-money valuation of more than $71 million, with much of the investment ploughed into high-growth areas like mobile payments, personal wealth management, and marketplace lenders.
Whether the sector can continue to thrive throughout 2016 is open to debate. Speaking recently to Inc. magazine, fintech enthusiast Max Levchin cast a cloud over funding prospects heading in to the next year. “My general view of the world is that raising money for series B will be harder in 2016 than it was in 2015 in fintech,” he told the mag. “There’s a perception of oversaturation or at least significant overinvestment in too many small bets being taken by venture capital.” “My guess is that you will see a lot of M&A and failure activity.”
Less than half (40%) of companies that raised a Seed or Seed VC round in 2009-2010 raised a second round of funding. 225 (22%) of companies that raised a Seed in 2009-2010 exited through M&A or IPO within 6 rounds of funding (1 exited after the 6th round of funding, for a total of 226 companies). 9 companies (0.9%) that raised a Seed round in 2009-2010 reached a value of $1B+ (either via exit or funding round). 77% of companies are either dead or dormant. 56% of companies that raise a follow-on round after their Seed are then able to raise a second follow-on round after that.
In other words, it’s easier to raise a second post-Seed financing than the first post-Seed financing (as noted, only 40% of companies are able to raise a post-Seed round). In the later follow-on rounds, the gap between the average amount raised and median amount raised becomes much higher, indicating the presence of mega-rounds.
Series B is hard for a simple reason: suspension of disbelief fades and is replaced by an increasingly cold, hard look at milestones and progress. Series B is the round where the rubber meets the road, where the promise has to be met with numbers and projections. Series B is the round where hard nosed investors drive ownership up before your company really starts to scale. Series B is the unloved valley of slow progress that precedes scaling. It’s the no-man’s land of the startup build phase. Series B is raised on mostly one thing: your ability to instill confidence.
When you to go raise your Series B, you’ve driven burn up as you needed to fully staff engineering (these damned “enterprise” features…), start hiring a commercial team that takes its time scaling, get a few hires wrong usually to top it off and have hired a full layer of VP’s to show that you have the basis for scale. This makes the company particularly fragile.
Investment into VC-backed fin tech companies has skyrocketed over the past four quarters. While North America continues to account for the bulk of the funding to VC-backed fin tech companies, 2015 will be the first year where three continents will see $1B+ in total funding in the space. Asia, Europe, and North America have all surpassed 2014′s totals with over a month left in 2015.
Asia has seen the largest explosion in funding with nearly $3.5B in funding thus far this year across 102 deals, the first time another continent besides North America will see 100+ deals in a single year. 2015 saw the rise of fintech, with investments in Asia Pacific growing from $880 million in 2014 to nearly $3.5 billion in the first nine months of 2015, according to a recent Accenture report. And everyone wants a piece of that fintech pie, from banks organizing hackathons for fintech solutions in-company and going fully-digital, to launches and expansions of fintech-centric incubators and accelerators.
List of 2015 fintech unicorns and semi-unicorns by sectors indicated that 29% of them are from the Lending sector and 27% are from Payments. The next biggest, interestingly, are Real Estate with 8% and Other with 8%. Insurance and Investing focused fintech startups represent 6% of unicorns and semi-unicorns each.
It is no secret, that innovation momentum is not spread equally around the world. There are certainly well-known hubs where innovative solutions are being born the most and find their way up. Barriers to innovation across the world are coming down. Some of the reasons for that are related to the nature of technological innovation itself, which is quickly adoptable. APIs offered by fintechs can allow businesses to jump to another level of efficiency and experience relatively easily.
Moreover, since technological advancements allow companies to operate globally even while being physically located in one country, it increases competition for local companies that did not achieve that stage of technological improvement. However, the concept is true for a startup that has already reached a certain level and has resources and network to go borderless. For those who seek to fly or fail quickly, there are certain places in the world that will foster the process.
It would be almost a crime not to mention Asian region as emerging at outstanding speed innovation hub. China, India, Singapore and Hong Kong are fueling Asian fintech and emerging as significant competition globally. As one more interesting trend, Fintech startups also have attracted investment from a variety of corporations globally. Of the 72 corporate deals since 2012, the US has accounted for just under half with 35. Asian corporates were quite active, with China and Japan ranking second and third in deal terms. Besides the usual US suspects like GV and American Express Ventures, Chinese internet heavyweights such as Renren, Alibaba, and Tencent also had a strong presence in deals.
Many big banks, which are embracing tech to reduce costs and attract new kinds of customers, look at startups as future partners or acquisition targets, rather than as lucrative investments. Barclays, Wells Fargo, and Bank of America host or sponsor finance-tech accelerators, awarding cash and guidance in exchange for a small stake in the companies and an ongoing relationship. Banks may be feeling a newfound sense of urgency.
According to a September report by McKinsey & Co., tech companies could wipe out as much as 60 percent of profits on some of banks’ financial products. That would come from a mix of decreasing margins and increasing competition. Banks are already seeing a drop in margins, the report said. Truly, if traditional banks don’t reinvent their own business models then other players will do it for them, and it will not be pretty.
Fintech was one of the most promising industries of 2015. Long seen as a highly technical, highly regulated industry dominated by giant banks that resist disruption – other than the occasional global meltdown – finance is now riding an entrepreneurial wave. Demand for upstarts’ services is strong, piqued by widespread frustration with big banks; supply is growing, fueled in part by financial types itching to do something other than toil inside those same megacorporations. And low interest rates have made capital, the raw material for many money-related startups, cheap and plentiful. In some respects fintech is being revolutionized by entrepreneurs for entrepreneurs.
You may get your next business loan from Lending Club, OnDeck, or Kabbage, instead of a it-takes-forever bank; rather than scrambling to interest venture capital firms or other traditional investors, you can now look to Kickstarter, Indie-gogo, or CircleUp. Your company’s transactions could be processed with fewer headaches by Square, Stripe, or WePay. And you can manage your money automatically at Betterment or Wealthfront and not pay for investment advice that may or may not outperform the market. You can even start replacing money itself using Coinbase, Circle, and other digital-currency options. The future of financial industry is here: are you ready?
Life.SREDA VC is a global fintech-focused Venture Capital fund with HQ in Singapore