Talking about Fintech: Industry drivers, investment landscape and a word of recommendation..

I recently gave a talk to a crowd of entrepreneurs embarking on their fintech venture, and shared our perspective on the industry and Fintech investment.

We at DTCP are long on fintech. The fintech industry has quadrupled over the past 3 years and we believe that it will continue to thrive, and that there are exciting times ahead.

A quick snapshot in numbers: Over the past three years, global venture capital investment into Fintech has risen by 4.7x to $13.6 billion in 2016. These companies are now creating significant shareholder value: there are 39 Fintech companies valued at over a billion dollars. According to Geektime’s Israel Annual Report 2016, Fintech was one of the leading sectors in 2016 in terms of VC financing. There was an enormous 434% jump in the amount invested, and a 200% increase in the number of investments. Fintech was the most frequently funded vertical in 2016 and Q1 2017, with 178 investments and 62 investments, respectively. Israel is a hotbed for many successful companies in fintech, and is well positioned to remain a leading destination for fintech innovation.

What is driving the industry?

The development of the fintech industry has been driven by three key forces:

First, the rise of Fintech has been driven by the notion that the consumer demand for on-demand services is not limited to leisure, travel or retail like Uber, Deliveroo etc. Consumers are expecting the same kind of instantaneous, efficient experience from their banks and lenders.

Second, technology advancements have accelerated the innovation in the industry. Here are just a few examples of key technology innovations:

Big Data into Artificial Intelligence: With the explosion of consumer data and the use of AI and machine learning applications, we will expect increased personalization around customer interaction and engagement and product development. The sources of data are ample, so now the key is to successfully filter and clean the data and make use of it. The gigantic, traditional financial institutions will have a much harder time gathering the data and making sense of it than digital-native players. We recently invested in Dynamic Yield following the same logic: the consumer experience is becoming increasingly personalized.

APIs: Standardized interfaces allow for seamless integration and partnerships between established banks and FinTech platforms. This creates an enhanced user experience, with more intuitive user interfaces and assisted customer interactions.

Agile, decentralized business model: Innovative technologies allow for a decentralized and digital business model which allows many companies to operate cost effectively and transparently. Take for example Blockchain. Even though blockchain is not limited to the financial technology sector, it makes perfect sense here. It lowers the cost and time of transacting, increases transparency and enhances transaction security. While it initially catered mainly to bitcoin and cryptocurrencies, the investments and focus have shifted to blockchain as a platform for financial services.

Security: With the increasing trend towards mobile, IoT and contactless transactions, stricter security measures need to be adopted. Authentication will become biometric in nature, which in turn will make consumer data infinitely more precious. While once (not too long ago) fingerprints were enough to secure consumer assets, transactions now involve multi-step security, including face or voice recognition.

Last, the development in fintech was shaped by the notion that fintech companies are no longer the “enemies of banks”. Fintech is now well established in the mainstream of financial services market. Now, the industry speaks much more about a partnership or collaboration than on an attempt to disrupt the banking industry. This trend has been driven also by regulatory shifts and legislation such as the Payment Service Directive 2 (PSD2) in Europe, and the commitment to open banking by other governments and regulators. Collaboration has taken many forms, including the development of accelerators, partnerships, acquisition of promising companies and direct investment in fintech companies.

A look on the fintech investment landscape:

We at DTCP as a growth stage investor seek B2B companies that use the vast amount of data to create solutions with higher efficiency and transparency, security and lower costs. While I can’t speak for all VCs, the industry seems to be going in that path: while 90% of fintech companies were focused on consumers, there is now generally an increasing shift to B2B investments.

There are mature fintech areas which have already seen a significant number of investments. In fact, out of the global 39 unicorns mentioned above, 16 are in the alternative finance space (includes: digital payment, marketplace lending, P2P payments etc.). Then there are the emerging sectors that have vast market opportunities and growth, such as the Insurance, Investment Advisory, B2B (SMB and Supply Chain Financing) and Regtech.

· Insurance: The traditional broker model is getting disrupted and insurance will be moving more online. There are disruptive insurance companies (who issue their own license and underwrite policies) and there are enabling insurance companies that work in conjunction with legacy insurance companies to optimize the operations.

· Investment advisory / wealth management: According to Business Insider, robo-advisors are expected to manage $8 trillion in global assets by 2020. These platforms often eliminate the middle man by using data and algorithms to recommend and manage portfolios. By doing this, the consumer can enjoy lower fees, enhanced consumer experience and more transparency.

· B2B: While most of the fintech investments has been focusing on B2C, there is an increasing shift to financial disruption of traditional B2B businesses, in particular SMB and supply chain financing.

· RegTech: This has been becoming a category by itself and a huge market opportunity. For banks, the cost of managing the regulatory risk is more than 10% of all operational spending. Hence, solutions that provide costs savings and higher transparency will disrupt the industry.

While there are naturally more earlier stage companies in fintech, Israel has already produced a number of late stage companies that are valued at a couple of hundred million dollars and upwards. What’s important to note is that investment in fintech can’t be generalized. Every sub-sector has its own characteristics and metrics. The definition of later stage is also different across areas.

Lastly, a recommendation: Build SMART — with a focus on the letter “R” in the word:

With every company, it is important to build the right business Strategy, know the Market really well, pitch the company with the right Attitude and build a strong Team around you. In addition, fintech is one of the sectors that is highly regulated. When embarking on a fintech venture, it is important to know the regulatory framework really well and build a strong regulatory roadmap. While regulation might not be a bad thing (it creates opportunities and barriers to entry), it requires capital and resources to cope with the regulatory demands. One more thing on the regulation. Typically heavily regulated sectors are not going to be winner takes it all market as the regulator will simply not allow a monopoly to be created. We believe that we will see fewer players taking greater market share and acquiring smaller competitors.

Feel free to reach out to irit.kahan@telekom-capital.com.