TADAM! What’s Really Driving Fintech Trends

By Tyler Griffin and Ryan Falvey

Fintech continues to generate an astonishing number of new companies. Earlier this year, our firm, the Financial Venture Studio — which invests primarily in early stage fintech startups — completed its first call for startups, and received an overwhelming number of applicants.

This application process can be a lot of work, but we like it for two big reasons:

It’s a great way to find companies we might otherwise overlook or never see if we were to rely solely on our existing networks, and
It provides an insightful look at what’s happening in the market — and the process reveals emerging trends that are driving innovation

Through this process, we’re able to see a broader geographic mix of startups from across the country, with less Bay Area concentration among founders and more exposure to broader market dynamics, founder sentiment and financing trends.

Trying to draw trends from this mix is always a bit like reading tea leaves — after all, sometimes it’s not even clear what a startup actually does. But, after the internal arguments, trends start to emerge. So what did we see? TADAM!

What is TADAM?

Ok, bad acronym: Transaction Accounts, Debt and Management.

Transaction Accounts. The first trend is this “Cambrian Explosion” of new design innovations on the transaction account — especially with respect to consumer transaction accounts — created by the existence of relatively easy to implement APIs. (h/t to Ethan Bloch of Digit for that one.)

Debt. We’re also seeing a lot of credit-oriented businesses that are either being built at exactly the wrong time, or we’re exactly wrong. More on that below.

And…Management. Finally, we’re seeing a really exciting trend starting to surface in Real Estate and Education driven by disaggregation of credit management from the underlying credit asset (the consumer’s debt). Historically, most consumers interacted with credit (their loans) via a servicer that existed principally to collect payments on behalf of the creditor. Arguably this trend started with Tally, which works to help consumers optimize credit card spend and debt, but it’s now firmly taking root in real estate and education with potential long-term impacts on each of those industries.

A Cambrian Explosion?… But didn’t all the dinosaurs die?

Yes. Yes, they did. However, the Cambrian period — way before the dinos started their slow transformation into cheap plastic toys — was marked by an explosion of new life and ecological diversity. We think a version of that is happening right now in fintech, and it’s driven by the increasing reliability and number of fintech API providers.

Data providers like Plaid/Quovo and bank service providers like Synapse and Cambr/Q2 are making it easier than ever for developers to integrate their offerings with legacy banks. This is dramatically shrinking the go-to-market period for highly specialized consumer banking apps. This shift could be massive. Think of it as the fintech equivalent of the emergence of cloud computing: it dramatically reduces startup costs at the earliest phases.

However, as with many technologies, the initial use-cases tend to be derivative and feature-heavy: products that exist because they can instead of because they are needed. The features are largely identical, defined by the API providers, while the products differ mainly in how they are marketed and to whom. Our view is that this lack of differentiation is likely to be short-lived, and is instead a harbinger of a new phase of hyper-innovation in what has been a pretty stodgy, slow and anti-consumer product set. As the basic features of banking become fully commoditized, entrepreneurs will have a free hand to develop genuinely useful user experiences that leverage broader trends in technology.

One example of this is Joust, a company in our first Studio class, which is creating a bank for independent contractors. The company’s differentiation, however, is in its ability to create a credit score for the contractors’ customers, predicting how likely it is that Joust’s customers’ customers will pay, and providing insurance against the risk of non-payment. This is just one example of how the explosion of banking functionality to be built upon these data providers is just beginning, and we remain excited about the products to come.

It’s probably not the time to learn to lend

Not all trends are trends we like, but this is the one we found most concerning: too many entrepreneurs are launching long-tenor or untested debt products at a very late stage in the credit cycle. While we’re naturally skeptical of startups with credit-based business models — though we’re not saying we don’t ever do them — we’re especially concerned when we see companies selling relatively low-margin credit products behind a thin veil of software. In our experience, that veil is often ripped away by the first flutters of turbulence in the credit markets. Further complicating these business models is the fact that very few lenders will lend to very early stage companies, so most of these companies need to use expensive equity capital to fund debt lines when they are least capitalized. This, unfortunately, means that these firms then lack the financial resources to grow at a sufficient rate to attract additional equity capital. This dynamic can be especially pronounced in markets where longer loan tenors are common or as less sophisticated firms move (perhaps unknowingly) into higher risk parts of the credit market.

Again, not saying all credit businesses are bad — lots of good firms make lots of money lending — but our investment bar in this corner of the market remains very high. (Also, we found that most credit investors are way sharper with their command of the numbers than most venture investors. That scares us.)

It’s a management problem

We like this trend: the disaggregation of credit from the management of credit in long-life, long-term credit assets like student loans and real estate. In each of these sectors, we’re seeing a new category of consumer-oriented service and management products which exist only to help the consumer manage their life around this credit product. These products essentially treat real estate and education debt as near-permanent debt, and they’re betting that consumers are willing to pay for a new service to help them manage that debt.

For example, student debt is both a capital problem and a management problem. While we do not expect fintech startups to do much in the way of managing the $1.5 trillion capital problem, we’re seeing some cool innovations to address the management problem. Specifically, the challenge of managing the overlapping issues of individual student debt, multiple servicers (and their abysmal user experiences), and the complex set of federal and state rules around extension and forbearance provide an ideal target for a startup. We expect to see continued innovation in improving user experiences and automating decision-making in this sector.

Similarly, the complexity of real estate transactions and the subsequent complications around owning, managing, and insuring structures provide myriad opportunities for software to improve the experience of preparing for — and managing — home ownership. Think about it: How many homebuyers aren’t stressed when they suddenly need a reliable repair person, are faced with unfamiliar yet routine preventative maintenance on their home, or must grapple with unforeseen home-related emergencies, or have to quickly sell a home in order to finance a new purchase, move for a job, or save for a down payment? There’s plenty of opportunities to address the key pain points of homeownership, precisely because there are so many pain points.

While we are enthusiastic about real estate-related solutions, we remain mindful of the fact that most of these solutions are based in high-priced coastal real estate markets — and that they are addressing the specific challenges associated with these markets. While not necessarily unique, the challenges posed to buyers in these regions are not representative of the entire country. In order to scale nationally, these startups will have to respond to the varied demands of a fragmented national real estate market.

We are seeing a demographic shift in home ownership (in large part driven by the student debt crisis), which provides a market opportunity to address a different kind of first-time home buyer: older, well-educated, but with fewer social resources to manage the process. Some of these challenges are financial, but many relate to information accessibility, transparency, and marketplace inefficiencies. Such areas have all proved fruitful for disruption by software in the past, and we’re excited to see what solutions emerge here in the future.

After reviewing all the applications, as a team we are more enthusiastic about the potential of fintech than we’ve ever been — the quality of the applicant pool was very high, and the creativity that founders are bringing to address these problems is encouraging.

To learn more about our companies and our investing approach, visit www.finventurestudio.com, or sign up for our newsletter for regular updates. And stay tuned — we’ll be announcing our next class of Studio companies in the coming weeks!

Authors Tyler Griffin and Ryan Falvey are managing partners at the Financial Venture Studio, a seed stage fintech venture firm based in San Francisco. Have a promising fintech startup we should know about? Reach out to info@finventurestudio.com.