I’ve spent the better part of my career investing in technology companies involved in financial services. Given that, it’s a bit surprising how much I hate the term FinTech.
Historically, FinTech has defined the technology vendor community selling into banks and broker/dealers. Until 2008, this was a reasonably good business. Since then, there has been increasing consolidation, both on the financial institution side and on the vendor side. As a result, while ostensibly there are still thousands of banks in the US, the vast majority of the budget is tied up by 20 FIs, and the vast majority of the revenue goes to the large, incumbent vendors. It is a classic logjam, and woe betide any small firm looking to selling into that mess.
The much more interesting opportunity in financial services isn’t selling to financial institutions, it is competing with them. As I have written elsewhere, banks in general are retreating from customer-facing activities, not vigorously defending their turf. This happened in merchant payments, for example, even in advance of the financial crisis. In 1988, banks had 62% market share in the acquiring industry; now they have 38% and shrinking. Currently, banks are losing share in the DDA market, the lending market and the personal finance market, among others. I anticipate that the corporate treasury services market will be next, hence my current obsession with b2b payments.
As you might expect, entrepreneurs figured out this new reality far more rapidly than venture capitalists. One example from my experience is OnDeck, a small business lending company, and a ridiculously fun and exciting company to be involved with. I invested in their first round of capital and have been on the board since 2006. From the time of that initial investment until I finally came to my senses, I was one of several investor directors urging the company to offer their underwriting and processing platform to banks as a vendor, in addition to (or instead of) being a direct lender to small businesses. Thankfully, the entrepreneur (Mitch Jacobs) and the CEO (Noah Breslow) kept their eyes on the prize, and while the company has several very productive referral relationships with financial institutions, OnDeck has continued to originate loans directly. As a result, it has grown like topsy and will soon pass the $1B mark in terms of capital lent to small businesses.
To paraphrase the pushback of the management team, their basic argument went like this, “Do we really want to put our destiny in the hands of bankers?” That argument, in brief, explains why every time someone asks me if I invest in “FinTech companies”, I respond that actually I invest in financial services companies. Given that this distinction, while meaningful to me, is always met with blank stares, I’ve now tried to put some analysis around it, which you can see here:
My colleagues and I (thanks to Jordan Bettman and Matt Brennan for their help with this) defined three universes of companies: Banks, Bank Vendors and (for lack of a better term) Finsurgents, ie, companies providing functionality that had historically been the province of banks. The results are clear. The bank vendors’ market capitalization relative to banks’ market cap remains relative constant, with a slight premium reflecting the fact that technology spending at banks is growing faster than bank revenue. But the Finsurgents’ market cap relative to banks grows at twice the rate, which is quite logical in that these players are taking an increasing share of profit pools that would otherwise belong to banks, not depending on banks for their revenue.
In defining these groups, we had the requirement that the companies be public for the whole period 2003-2013. As such, while the bank and bank vendor universes contain all the logical players (vendors include Fiserv, Deluxe, D+H, TSYS, Diebold, ACI, etc), the Finsurgent group misses key players who have either gone public post 2003 (Visa, Mastercard, Fleetcor, Wright Express, Cardtronics, Vantiv, Higher One, Greendot, Netspend), plus companies who are still private or are subsidiaries (Square, Paypal/Braintree, Stripe, Lending Club, OnDeck), not to mention the entire Bitcoin universe, etc. In 10 years, I suspect that these lines will have entirely diverged, as the banks become relatively stable financial utilities, their vendors settle into a symbiotic but unexciting and slow upgrade and refresh cycle and the Finsurgents complete their takeover of customer facing applications and innovation in the sector.