By Chris Myers for Forbes
I’m of the belief that the financial technology sector is failing to live up to its considerable hype due to the fundamental disconnect between the finance and technology industries.
This argument has caused quite the stir in the fintech community, and the personal response I’ve received from readers has been extraordinary. It seems as though the euphoria that once gripped the space has been replaced by a general uneasiness about the future.
No one said that surviving, let alone winning in fintech would be easy. While my initial assessment of the sector may have seemed overly negative, there are still plenty of reasons for hope.
As one Twitter commenter pointed out, the hurdles I mentioned will “ filter out useless, cosmetic fintech” solutions, and I think this is an excellent point. There will likely be a great thinning of the herd in the coming months and years.
I believe that only those who follow three specifics steps will emerge from the cull, stronger than before and ready to make an impact on the industry.
Step One: Ensure you have the right investors
The first and arguably most important step to finding success in fintech is to make sure that you have the right investors in your corner.
As I mentioned in my earlier article, many investors, both institutional and private, have a three to five-year investment horizon in mind when evaluating a company. This means that when these investors inject capital into a business, they do so with the expectation of realizing a return on that capital within that investment horizon.
However, the finance industry is inherently conservative and slow-moving. Only in the rarest of cases will a technology company be able to responsibly gain enough traction in the typical three to five-year investment horizon.
As a result, pressure tends to mount, and fintech companies make compromises—some big, some small—to drive rapid growth. Unfortunately, such compromises typically lead to short-sighted and irresponsible decisions that result in failure.
Fintech companies that have reasonable and patient investors with a longer investment horizon will be able to drive responsible and sustainable growth. Finding these investors, however, is easier said than done.
This investment strategy is usually at odds with the modus operandi of traditional venture firms, so fintech investors will have to look to high net worth individuals and other angel investors for support.
Private investors tend to be more patient, but they also invest less than institutional investors. As a result, fintech companies that go this route won’t have huge capital reserves at their disposal, which brings us to our second step.
Step Two: Stay lean and don’t act like a tech startup
Fintech companies that want to survive in the long-run will need to embrace a new philosophy of frugality. Gone are the days of unlimited ad spend, direct-to-consumer channels, and fancy offices.
In addition to adopting a more frugal approach to business, fintech companies must learn to balance innovation and conservatism. There are no quick fixes in finance, but that doesn’t mean that technology can’t change things for the better.
Fintech companies that try to storm into a partnership or industry with flashy, fast-paced solutions and expectations won’t be able to forge lasting partnerships with incumbents or drive necessary institutional change.
Instead, fintech companies must abandon the arrogance that often typifies startups and commit instead to driving incremental change.
Financial constraints can, somewhat counter-intuitively, help in this regard. As James Altucher once told me, “View funding challenges as a creative constraint, which often creates the best creativity.”
That is precisely what we have done at BodeTree. Rather than spend excessively on a direct-to-small business approach, we were forced to get creative and find ways to partner with incumbents. The strategy has, in turn, helped to drive our scale and reach in the space.
This strategy, of course, brings us to our third and final step.
Step Three: Show respect for the incumbents, but hedge your bets
While working with incumbent players in the financial technology space can lead to cost-effective and sustainable scale, it isn’t always easy.
The current regulatory environment makes it difficult for startups looking to partner with traditional financial institutions when it comes to vendor management and internal deployment. As a result, the sales cycle can often take a year or longer.
Successful fintech companies will find ways to muscle through this arduous process, respecting the regulatory burden that these players are forced to endure. However, they’ll also find a way to “hedge their bets,” so to speak.
At BodeTree, we’ve managed to hedge against the difficult bank sales cycle by diversifying our channels. While financial institutions represent our core client base, we also focus on insurance companies, alternative lenders, community development funds, and franchisors.
This enables us to continue to play the long game when it comes to established financial institutions, while still growing our business at a reasonable clip in the near-term. All-in-all, it is a balanced approach to growth that other fintech companies would be wise to follow.
The euphoria around fintech that has taken root over the past few years is beginning to fade. However, smart firms can still find success by taking the path less traveled in the startup space; the path of conservatism.
At the end of the day, success comes down to three simple things: finding patient investors, understanding the friction between finance and technology, and successfully hedging your bets.
If more fintech companies follow this path, the future might not be so bleak after all.
First appeared at Forbes