Sectors once dominated by traditional providers have become hotbeds of startup activity, with most of the action occurring in payments, foreign exchange, short-term lending and, more recently, current accounts. As is often the case, where entrepreneurs have led, money has followed. This has led to success stories such as Funding Circle, Transferwise, Wonga, Zopa, GoCardless, and Revolut – full disclosure, we invested in the latter four.
As innovation in these sectors continues, it is becoming difficult to see where the next momentous innovation will come from. I am always willing to be surprised by great entrepreneurs but, at present, it feels very much like these industries are quickly reaching saturation point.
Perhaps most critically, the majority of this activity represents startups picking the financial industry’s lower hanging fruit. Entrepreneurs should refocus their efforts onto what I am going to dub “long-term fintech”.
In this category I include long-term assets such as pensions, investments, and life assurance; and liabilities such as mortgages and student loans. It is hard to define what constitutes long term, but for the sake of argument, I will say a period of more than five years.
These markets are comparatively huge. The combined revenue of short-term credit, personal loans, and business-to-business payments businesses in the UK is approximately £20bn a year. The revenue of the UK consumer pensions market alone is the same. Revenues of UK consumer investment also total around £20bn, and mortgages is £15bn. It becomes clear, then, that both startups and venture investors stand to benefit if the tide of innovation turns toward these industries.
These waters are not completely uncharted. Companies such as SoFi and Commonbond offer innovative student loan consolidation opportunities. At Balderton, we have invested in Prodigy Finance, which pioneers cross-border student lending. Balderton has also invested in Nutmeg, a company that is innovating in wealth management and pensions, as are Betterment and Wealthfront. Property Partner, Lendinvest and Exporo are focused on real estate investing, while companies like Habito and Trussle are aiming to transform the mortgage application process.
There is a reason that startups have tended to steer clear of long-term fintech. Areas such as pensions, mortgages, and investment are highly regulated and capital intensive. If an entrepreneur develops the right model, however, startups can become hugely profitable due to the sheer size of the addressable market.
The characteristics of this industry and the companies within it alter how a technology investor analyses a potential investment, as applying the same rules would lead to bad decisions.
For example, I would usually expect a business to have covered the cost of acquiring a customer within 12 months of that customer’s first transaction. But if I were looking at a “long-term fintech” company, I would be quite comfortable going far beyond this. This is because changing a pension or mortgage provider is a big decision for a customer, and therefore these industries have long purchase cycles. Also, incumbents are able to fund expensive marketing campaigns to defend their position. As a result, it is not uncommon to spend $1,000 or more to acquire one customer. The upside is that customer lifetimes in these industries are reliably five, 10 or even 30 years and, in the case of investments and pensions, revenues increase over time.
A second area of difference is that these companies will often require long-term debt capital early on. Peer-to-peer financing is rarely a viable strategy given the timeframe and sums of money involved: they need to raise large amounts, and offer a return over a long period of time. A prerequisite of success is a deep knowledge of the industry, and the regulatory expertise to navigate protracted legal processes and to pass strenuous due diligence. The ability to secure quality capital at a comparatively low cost allows insurgents such as SoFi to build a strong “moat” around them.
Third, “long-term fintech” startups are regularly aiming to replace brokers and advisers. Banks and financial institutions are currently hamstrung by their obligation to use these expensive channels despite the high costs. Startups, on the other hand, can take full advantage of artificial intelligence-driven financial advice, which is already starting to offer a superior service. It is also more transparent to regulators, and comes at a far lower cost.
The biggest challenge facing new entrants is building trust with clients. The majority of these companies play a major role in taking complex financial decisions, and they do so without offering the face-to-face reassurance with which the status quo has grown familiar. Building a strong brand and a flawless online user experience is vital to overcoming this potential stumbling block.
Companies chasing shorter-term opportunities have done London proud: it is now time for long-term fintech.