Thanks to the influx of disruptive startups, the financial industry has been privy to more changes (and dramatic ones, at that) in the past few years than it has in the past 50 or so years, perhaps more. There are so many exciting developments and opportunities that it’s hard not to notice the level of activity and potential the fintech world is enjoying right now. Throughout 2019, fintech startup funding grew to $34.5 billion. 2020 continued strong too until the coronavirus came in and laid a wrench in the gears.
As the industry matures and more companies pour into it, the temptation to take the plunge and dive in with your investing money becomes too strong to resist. That’s what I did and, as both investor and entrepreneur, I think I have a solid vantage point to share some potentially useful insights for those interested in how to invest in fintech startups and what to avoid.
First – decide between real or virtual finance
Fintech is a huge space but there are two distinct segments within it. At least that’s how I see them, even though the industry is selling it as one. On one side, you have financial technology concerning real money while on the other, there is financial technology relating to blockchain and virtual currencies.
Why the division? Those are two totally different kinds of business models and I feel blockchain and virtual currencies are making a bad name for fintech. Blockchain is an amazing technology that, if harnessed properly, has countless practical applications and could rewire the Internet as we know it. A decentralized blockchain financial system could be much simpler because, in theory, it removes layers of intermediation.
However, amidst all the ”threats” to side-step old(er) legacy structures, there was very little impact. Way too many projects put the technology front and center, trying to figure out how to make money from it, instead of focusing on the present challenges and discerning if blockchain can solve them. Add in the incredible volatility of cryptocurrencies and the hype dies down quickly.
Outside of blockchain, the broader fintech space has impacted the financial sector, forcing historically key players like banks to adopt fintech and the new standard of user experience. I’m not saying there aren’t signs of blockchain’s promise to transform financial services processes – there are, it’s just that there are far more difficulties right now, from scaling the technology for commercial application to fragmented landscape to regulatory uncertainty. If you fancy a blockchain-based fintech startup investment, make sure you understand 101% the problems that need to be solved and the technology that aims to do the solving.
Focus on the key challenge: regulation
This is a heavily regulated industry, which sometimes makes sense (e.g. KYC, AML) and other times can be frustrating. Sometimes, it can be both so your key focus should be on your investment target’s understanding of regulatory laws and licensing requirements as one of fintech’s primary challenges.
Regulators tend to obsess about the privacy and use of data. It’s important to note that the laws of scaling a business don’t apply the exact same way here as they do in any other tech industry. People lose jobs over these issues but also harm fintech startup investors who put up their cash, which could be you. Doing homework upfront will save you time and money, and just might help you make smarter decisions within your investment plan.
Look for total process automation
When talking about fintech, it has to be something that is fully automated. This is one of the key fintech metrics for me and an important thing, important enough to say that you should invest in such a startup because it’s the easiest way the solution will sell itself. The industry revolves around the interplay between risk and return. You’re either checking out if it’s a good investment or not or if there are good loan terms or not. The risk and return due diligence has to be done manually as it’s the only way you can do it a lot faster than a bank or anybody else you’re trying to scale against.
Hence, there has to be something fully automated – something easy, where you have access to information. I’ve seen a lot of fintech companies with great ideas but storing their data in the bank, and you just know the bank won’t give you the information. This is why most of the P2P lending processes always do small scale loans because it’s the only way they can process information efficiently.
Changing the face of the business quickly
The fun part of fintech is that there are a lot of opportunities of the more immediate variety. The industry’s biggest problem (and consequently, the biggest opportunity) is that a fair share of financial processes today still works very slowly, mimicking the offline world of bureaucracy. Because the banks process a new customer the way they do, it takes them a while to do due diligence and understand where the money is coming from, how you get it, and so on.
As you know, the Internet doesn’t play by those rules, which is why traditional, legacy systems can’t keep up with the online world. That’s why every other bank today is calling itself a neobank. It’s like a USP – by admitting they have a strong tech culture, they accentuate innovative banking solutions that provide a streamlined process.
You may actually miss out because a fintech startup basically became a unicorn in two or three years. The cases where companies start small and end up with market capitalizations in billions are increasing: Upgrade has raised a $40 million Series D round en route to a $1 billion valuation by the company’s estimation. Whether its fintech valuation methods are proper is another story: the point is that there are interesting startup stories if you know where to look.
My final advice is to not aim for flashiness when deciding how to invest in fintech startups. The solution doesn’t have to be amazing and eye-popping (this is hardly such an industry) but it has to make the process a lot more approachable. Think about the simplicity and doing things with one, two, or three clicks or taps compared to all the hassle users go through today. In my book, those are great investment ideas.