Fintech startups: risk and reward

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Antoine Baschiera
CEO and co-founder
Early Metrics
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Investors, media and the start-up sphere are all going mad over fintech start-ups. In Q1 2016 alone, fintech benefited from $4.9bn VC-backed investment.

VCs like Philippe Collombel from Partech Ventures, corporate funds like Santander InnoVentures, and Lloyds Banking Group focus their investments and innovation strategy on the sector.

Fintech start-ups are certainly exciting: when the idea is innovative enough, and the execution seamless, they disrupt, and generate big cash. But counter-intuitively to the general frenzy, fintech are actually not the most opportunity-generating start-ups to invest in; it is therefore important to assess them well.

Out of the 700 start-ups rated by Early Metrics, strong trends are appearing amongst our pool of rated fintech start-ups, and as it turns out, they are not the best-rated early stage ventures.

They actually present one of the riskiest investment opportunities on the market. Indeed, if we assess the team, the product and the market, fintech start-ups generally score high on the first pillar, but substantially lower than Early Metrics’ average rating on the two latter criteria.

Fintech start-ups usually build dream teams who score high. Indeed, whilst some are composed of first time entrepreneurs, most fintech team have strong financial industry practice.

In fact, our rating trends show that most fintech start-ups’ management have between 5 to 15 years experience in the banking industry. It is common to see bankers start their fintech after having identified a pain point – whether in process or service – in their former corporation.

The combo between reformed bank executive and entrepreneurs is proving very successful and is an essential part of the scaling success of companies such as Lendinvest or Funding Circle.

In addition to the level of seniority and financial technical knowledge, the management’s ability to draw from its previous network to engage in strategic partnerships with incumbent players explains why fintech start-ups’ team usually get high rating on the Early Metrics matrix.

The lack of innovation and product dependency can however bring the score down. This is essentially due to the inherent technical complexity all fintech start-ups must face compared to early stage ventures in other industries.

Fintech start-ups’ technologies hardly ever operate alone and are highly dependent on third parties integration.  More than 75% of fintech start-ups rated by Early Metrics rely on external technology (API or others) to integrate payment solutions or draw market information for instance.

Another source of complexity (mainly for B2C fintech) is the necessity to convince large audiences to use their product. The cost of customer acquisition (up to $200 for a company like TransferWise) explains why B2C fintech need to raise a substantial amount of initial capital to go to market.

Thus, fintech start-ups are not only reliant on external technology to operate, but also on external investment to even get started. No fintech start-up in our rated pool actually started operating – let alone trading - on sole revenue generation.

While other companies with the right business plan can quickly become financially self-reliant, our data shows that more than 50% of fintech start-ups started generating revenues after two years of operations. 

A market filled with pitfalls but also opportunities. While the dependence on service providers and investors is high, the dependence on clients is also very constraining, especially for companies selling to banks or large financial organisations.

Fintech start-ups have little initial bargaining power with the incumbent financial services actors who can be their primary customers. The traditional sales as well as integration cycles, which average between 18 to 24 months, can be incredibly painful, if not lethal for an early stage venture.

Regulation represents another challenge: regulators, used to interact with whole compliance departments, need to adapt to smaller structures with less manpower and legal resource.

In the UK, the FCA has managed to adapt fast with the creation of a “sandbox” but some legislations forbid trading unless regulations are adopted. While no fintech start-up has so far faced any compliance issues, the risks around private data are real, and remain a concern.

On the bright side, however, the size of the market fintech start-ups are targeting – as well as its growth potential - is substantial, which contributes to elevate the rating score. Indeed, most fintech start-ups address a universal need, and capital flow can quickly amount to billions. 

Fintech start-ups are difficult ventures to start and grow without the right combination of skills, support and careful deployment strategy. For the assessed start-ups scoring high on Early Metrics matrix, it means that they managed to overcome some of the major pain points that can break a business at an early stage, and have strong potential to scale. If you have invested in a fintech company, you will certainly have taken a risk, but if you’ve assessed your start-up well, it may be one well worth it!

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