5 Red Flags of Startup Development in FinTech
* The article was initially published on our blog.
Description: Armada Labs took on a survey to detect the main reasons for Fintech startups failure. Unlike the vast swaths of similar listings compounded of unorganized random points, we undertake a scientific approach tying failures to imbalances of a startup living cycle. In conclusion, we provide you with some meaningful insights on how to avoid the same mistakes that another FinTech entrepreneur has already felt.
More than almost any other industry, FinTech strives for an experience. Recent research by Small Biz Trends defines FinTech as one of the most troublesome industries accumulating as much as 60% of startups failed to transform their bright ideas into valuable business models.
The figures show that up to 30–40% of emerging FinTech startups do not gain from an investment as they are accounted for collateral damage to their VCs ledger with the rest of 10–20% are getting to the startup “limbo” hardly providing any return on capital.
The problem these FinTech entrepreneurs encounter is not a shortage of big ideas or bad luck, but an inability to bring them to live in a valuable way. Steve Jobs once said that there is a tremendous amount of craftsmanship in between a great idea and a great product. All unsuccessful FinTechs, in some way, fail to master the craft of 5 core startup dimensions: Customer, Market, Team, Product, and Financials — that is why they burn out.
Trap 1: Rapidly Scaling Customer Base
According to the Startup Genome Report, 74% of startups fail because of not being prepared to scale or scaling prematurely. FinTech space is no exception.
What looks like a blue dream for many startups, a rapidly scaling customer dimension, which fall out of tune with the others, can turn into a complete disaster as neither a team nor a product itself is ready for it.
The problem of premature scaling occurs due to poor planning and management inefficiency. When a user base starts to spike, a development team needs to be on 24/7 firefighting mode to respond to any glitches or outages at the speed of light.
However, a team of early-stage FinTech startup usually lacks this capacity to maintain 100% uptime of a core system. As a result, a project is posed to the risk of potential long-term clients losing interest and disappearing into the sunset forever.
Michael Allen, serial FinTech entrepreneur, and investor said:
“Having been both an entrepreneur and investor I’ve seen many entrepreneurs including myself try to scale blindly. No one takes venture money to stay a small business and scaling successfully is what separates eventual industry leaders from long-forgotten startups in the deadpool. Far too often though entrepreneurs start scaling before they know what is going to work.”
Trap 2: Poor Market Knowledge
Building an in-depth market understanding is the first line of defense to make sure that your endeavor does not succumb due to a foray of entrenched competitors or a lack of customers. FinTech expertise is something very different. Being forged through years of meticulous market research it requires not only an understanding of consumer behavior but solid financial literacy — something an early-stage FinTech startup is direly missing.
With no access to this pool of vital industry information, FinTech founders are unable to make successful strategic decisions about technology and business trends — as a result, their startups are getting sunk. The industry knowledge, on the other hand, helps them take a more systematic and structured approach to tackle the opportunities and challenges that their future growth will bring.
Accurate market data together with the experiences of early FinTech adopters help them prevent top reasons why startups fail, suggesting a strategy for deriving tangible performance improvements and achieving long-term impact with a modest investment in the development of software tools.
Describing his failure, the former CEO of an e-commerce startup Adam Scott said:
“I think my most obvious mistake was the lack of realization that my experience making good software would not translate well to investing into a team that made good software. Having such FinTech companies was better left to experienced team and investors. We grew too fast, too quickly. We did not stay lean.”
Trap 3: Poor Team
Research from venture capital database CBInsights broke down the Top 20 Reasons Why Startups Fail and listed “Not the Right Team” as the third leading cause of startup failure. The rapid developments of startups imply relatively quick shifts in the demand for skills. Considering that FinTech space is short of talents, it might be a problem.
At this point, when a startup is the most vulnerable, any people problems such as mismatched skill sets, interpersonal conflict or a poorly-chosen team can easily lead to a lack of synergy between data, systems, and processes.
However, many entrepreneurs are obsessed with product engineering and business strategy with no time left to focus on human resource management. Over time they fall prey to common mistakes like hiring too fast and firing too slow.
The team ends up with a glowing skills gap hindering not only an ability to streamline consistent processes execution but the future of a startup itself. It is good when the founders timely recognize that they are dangerously amateur at dealing with these situations, but usually, they do not, and a startup fails.
In their post-mortem interviews, many FinTech startups’ founders cited a coherent team with diverse skill sets as being a crucial factor in the success of a company. David Kramaley, the former CEO of Sharkius said:
“Running a team has so much more complexities than a single person project. I made numerous mistakes in people management, some of the guys I worked with were great people and great developers, but we were extremely opposite characters and at times there was a great synergy but more and more often this led to a lot of friction. As a result, our project stumbled.”
Trap 4: Non-Compliant Products
As an idea becomes a product, many startups find themselves consistently on the high end of the regulatory risk spectrum where they need to comply with any federal and state laws applicable to their businesses. In FinTech space, where new stringent legislations come into force daily, regulatory compliance is a pain point — one needs to be alert and act quickly in order to mediate the risk of mislaying a product.
FinTech founders should deeply research the rules of anti-money laundering (AML), know-your-customer policy (KYC), anti-terrorist funding (AML/CLF) and data protection regulations.
Even more legal challenges occur when a startup is operating from multiple locations or it considers going globally since the laws, which apply to a business, will vary depending on a range of different factors, such as what type of business entity a startup is and what region a startup does business in.
A bulk of startups unwilling to hire an expert consultant who suggests proactive and tangible steps they can take to help ensure their businesses are set up to succeed in security and compliance usually ends up heavily fined if not behind bars.
As a part of their post-mortem call Decide.com said:
“We received a notice from the regulatory authorities informing us we weren’t compliant and unless we removed our product, they’d suspend our affiliate account. We weren’t making a lot of money, but that account probably represented more than 80% our revenue.”
Trap 5: Lack of Financing
Obviously, when an early-stage FinTech startup launches a fundraising campaign, this whole spectrum of challenges we have mentioned before is yet to come. Venture capital firms to whom it came for money perform investment due diligence to decide whether a project is worth being funded but, in the earliest days metrics lack the cumulative data and nobody, not even savvy venture investors can know for certain, which startup is going to become a unicorn.
Only 1% of roughly 70,000 startups that managed to raise at least some money in a seed round from outside angel investors, go on to raise a Series A. The rest is unable to handle an onslaught of entrepreneurial challenges such as team building, acquiring customers, leveraging partners to scale and raising capital. As soon as they are running out of initial venture investment, their ideas dry up and a startup dies.
The team of an unsuccessful news reader startup described his concept more broadly, testifying that a lack of financing goes in a package with other top 5 reasons for startup failure including the inability to find a product-market fit and failed pivots:
“In fact, what eventually killed Flud was that the company wasn’t able to raise this additional funding. Despite multiple approaches and incarnations in pursuit of the ever-elusive product market fit (and monetization), Flud eventually ran out of money — and a runway.”
Key Findings
Despite differences in their geography or sector, every CEO of every startup in their pursuit of solutions that will transform the sector faces common pitfalls including insufficient capacity, poor industry knowledge, disharmony among team members, strict regulatory environment, and limited cash flow.
As a part of our research, we found out that FinTech startups who learn from Startup Thought Leaders have greater chances for success. They raise 7x more money and have 3.5x better user growth. Meanwhile, hands-on help from investors has little or no effect on the startup’s operational performance whereas the right mentors significantly influence their ability to raise money and grow exponentially.
Deep understanding of finance and the concept of money is also vital for every FinTech founder. Many startups fail because they don’t understand psychological behaviors around money, credit, savings, payments, etc. They do not envision the needs of their target audience and, as a result, they’re unable to find a smart way to do marketing for their FinTech product.
Knowing FinTech industry challenges firsthand, Armada Labs comes as a valuable mentor for new or would-be FinTechs who encounter similar obstacles. Our team has committed to bringing its experience and focus to help ready early-stage FinTechs to build resiliency, networkability and product vision needed to untap their potential fully.
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