November 19, 2015
Charles Moldow
People just hearing about FinTech for the first time could be forgiven if they mistook it for a trendy new club, since commenters these days have been so eager to describe it as “hot,” “sexy,” and “wildly exciting.”
While I certainly agree with those assessments, it’s also necessary to recognize that there needs to be a balance between starry-eyed and clear-eyed when it comes to the financial technology space. This is because while there are factors that make FinTech more exciting than other tech investments, there are also factors that make growing successful companies in this space more grueling.
There should be a rule in FinTech: if you lose your patience, you risk losing your shirt.
Unlike in a typical startup, emerging FinTech companies have unique sensitivities that make it even more challenging to acquire customers, generate revenue, and grow.
Some of these challenges will be temporary, such as those tied to generational shifts. Millennials, as any big bank will tell you, have much less wealth to spend, save, and invest than their elders – for now. But they do account for most early adopters of new technology.
Mobile payments apps provide a telling example. Millennials prize them because they simplify transactions – making it easy to send and receive money by removing steps from the process. But wealthier generations, who have long relied on traditional institutions, have yet to fully embrace them. They’ve built their wealth over decades, and exposing their savings or nest eggs to any new technology would seem to introduce a degree of risk.
FinTech companies will count this among one of a number of more persistent challenges – among them reputation, security, and regulation. Fall short on any one, and what took years to build can disappear in hours.
1. Reputation: Traditionally, your parents’ bank would almost certainly become your bank. The same goes for their car insurer, their realtor, their financial advisor. FinTech companies must work harder than others to overcome such long-standing cultural inclinations, in large part because they work with other people’s money. The software and services they offer are not simply purchased with funds, but often serve to hold, transfer, or invest those funds.
2. Security: Now that vaults are digital, they can be attacked from anywhere. Recently, the world learned of a multi-year hack that forced ATMs in 30 countries to dispense $1 billion in cash, straight into the hands of criminals. And that example (one of many) speaks merely to the theft of financial assets. Considering threats to customers’ personal information, the challenge gets even more complex and consequential.
3. Regulation: FinTech startups must pick their way through a thicket of regulation to figure out which agencies have jurisdiction and which laws apply – and how. A non-exhaustive list of U.S. financial regulatory bodies includes the SEC, the Fed, FINRA, OCC, FDIC, NCUA, CFPB, FTC, FSOC, CFTC, and FHFA. I’ve omitted state regulators, but startup CEOs won’t be able to.
Navigating these complexities alone will take time, but also consider the fact that FinTech companies face off against incumbents who have had a presence for perpetuity – banks especially. They benefit from these barriers to entry and have spent centuries erecting them.
But none of this in any way diminishes the potential of this sector in the long term. And that’s in large part because of the banks themselves.
As I discussed in my whitepaper on marketplace lending, banks have failed to innovate. They’ve failed to significantly improve user experience and transparency. And they’ve failed with millennials (and most people, for that matter), who strongly dislike them. The only thing they’ve succeeded in doing is increasing their margins. For a telling look at the long-term future of bricks-and-mortar banks, take a look at Viacom’s Millennial Disruption Index: “banking is at the highest risk of disruption… nearly half are counting on tech startups to overhaul the way banks work… 33% believe they won’t need a bank at all.”
This is one reason why the financial technology space is getting dramatically more crowded. By Accenture’s count, U.S. FinTech investment nearly tripled in the last year alone. But if the new money is going to become smart money, it must first come to appreciate that it takes longer – as many as five to fifteen years longer – to firmly establish a brand and build significant value.
The most successful FinTech companies will be what my colleague Steve Vassallo would call “two-marshmallow companies,” in that they will ultimately grant the largest rewards to investors who are willing to delay gratification.
What we’ve seen so far is that, on the other side of those years spent laying the foundation, navigating the regulations, and proving the business model, enduring businesses emerge.
I believe that, in time, these businesses will come to dominate the financial landscape.
But no one should be surprised if it takes longer than what we’re used to seeing in other sectors. Building the companies that will supplant today’s financial services incumbents requires a certain aggressive patience, but it will be worth the effort and the wait.
Charles Moldow is a General Partner at Foundation Capital.