Unlocking the future of finance: why we are all-in on fintech.
Despite pervasive fear, uncertainty and doubt, and rumors of fintech’s demise, we believe that the fintech venture opportunity has never been stronger. It’s a space we know well and as our thesis continues to evolve, we wanted to share our thinking, to make it clear where we are most interested in investing. This post will set out our high-level point of view, but you can expect a series of follow-up posts where we will dive deeper into these areas of interest.
It’s true, segments that caught investors’ attention in the last few years — such as traditional B2C products with digital go-to-market (GTM) and high customer acquisition costs, or companies that rely on balance sheet strength to scale, are losing investment luster — and in our view this is a good thing. These are not long-term sustainable business models, but business models that rely on venture capital to grow.
True fintech (more on what we believe that is, in a minute) continues to run hot — with the global fintech market expected to reach $324B by 2026 The influx of ‘tourist investors’ brought on by the incredibly frothy market of the past few years is waning significantly, leaving greater opportunity for those with capital to deploy. More importantly, recent market activity has contributed to our strong thesis about the future. The starting point for our continuing interest in the sector is this:
- Financial services are high value, high distribution, and represent approximately a quarter of the world’s GDP.
- The pandemic was a massive acceleration for many industries and resulted in significant adoption of digital money movement and financial applications.
- The transaction volume of digital payments continues to rise.
- The long-term intrinsic margins on fintech products are extremely high due to high switching costs and an ability to own and expand within a technology stack.
- When we analyze our own portfolio, in the most mature businesses like Hopper, TouchBistro, Shopify (exited), and Jobber, fintech services within these businesses have proven to be the most scalable.
Our fintech knowledge is based both on the market, and our direct experience backing companies in the space. Fintech ‘first’ companies in our portfolio include ClearEstate, Clearcover, Flagstone, Fonoa, Joyn, Moves, Onevest, PrimaryBid, Wave and Wefox. Fintech ‘adjacent’ businesses include Bold, Deliverect, Hopper, Jobber, League, Manifest Climate, Touchbistro, and Qui to name a few.
There are many different definitions of fintech. Like Angela Strange at Andreessen Horowitz wrote a few years ago “every company will be a fintech company”. For our own investment focus, we define fintech as:
1. Movement and management of financial assets
2. Movement and management of financial data
3. Software purpose built for a financial institution (FI)
4. Software for a non-FI to offer financial products.
Market tailwinds
Fintech adoption is at an all-time high. COVID advanced adoption by 3–5 years, moving from a face-to-face model to remote-first, coupled with a global push towards cashless transactions. In short, people are more comfortable with technology as part of their banking experience than they ever have been. According to McKinsey (2020), 75% of people who used digital payment methods for the first time during the pandemic said that they will continue to use these modes even after the situation normalizes.
And globally there are 2 billion people who still don’t have access to a bank account. Fintech is bringing financial services to those people who previously could not access them, giving them a chance to save and a chance to borrow without having to meet the lengthy requirements of the traditional banks.
Open Banking, while well on its way in the UK, continues to be a promise on the horizon in the US and Canada. Despite policy delay, it remains high on the radar of the largest public companies, with 55 public filings referencing Open Banking in the most recent quarter. In the US, FedNow, introduced in July 2023, provides near-instant access to payments and money movement between financial accounts for a variety of use cases, including: payroll, consumer purchases, recuring bills, P2P, loan payments, execute trades, and insurance payouts.
Digital wealth has hit a 94% CAGR and the world of financial planning is moving to a new paradigm, replacing financial savviness with automation.
The market is sending big signals that it is readying itself for a major shift in how we move money.
Regulatory complexities
We can’t write a post about our fintech thesis without addressing the regulatory environment. There is no denying its complexity, and the heavily regulated nature of the financial services industry can make it challenging for startups to navigate. Complying with regulations can be time-consuming and costly, and failure to comply can result in significant penalties and fines.
The barriers to entry are high — the industry is highly competitive, with established players having significant brand recognition, customer loyalty, and resources. This can make it challenging for startups to enter the market and gain traction.
And the development cycles are long — developing and launching financial services products can take longer than other industries due to the need for regulatory approval, testing, and compliance. This can increase costs and delay time-to-market for startups.
But for the right startups, these same challenges can be positive — regulatory oversight in financial services helps to ensure that investors and customers are protected from fraud, mismanagement, and other unethical practices. This can help to build trust and confidence in the industry, even though a player might be new.
Regulatory oversight can also help to promote transparency in the industry by requiring companies to disclose relevant information to investors and customers. This gives us comfort as investors that we will be making informed decisions. This oversight also adds an element of stability and predictability.
Fintech features to frontline focus
Over the years, OV has invested in numerous companies with both fintech-first focus along with many who have fintech adjacencies and features. This isn’t a new strategic priority for us, but it is one that has moved to the top of the list. Why? Because we believe in a future where there are infinite financial components, services, or processes but they can all be centrally coordinated to work together seamlessly. It’s like a conductor leading an orchestra; every instrument (or component) has its role, but the magic happens when they’re all coordinated to create a symphony.
Part of this future will be that real-time financial services become the norm. If you think about it, why on earth are customers prepared to wait days for money to hit their bank account following a transfer? Or even satisfied with being paid only once a month? The urgency to digitize and move away from legacy banking structures will only increase and with the increasing democratization of financial products, financial literacy and self-enablement for all customers become critical.
We believe embedded finance enables every company to become a financial company. This idea really started to take off in 2017 with payments — ‘SaaS plus payments’ business models leveraging Stripe and Square. This combination helped companies increase their annual contract values and likely, increase retention as they provide an integrated solution to customers. But what was once a high bar for market entry is now simply an exercise of supply and demand and selecting the right embedded finance third party. Payments was just the beginning of embedded finance. Now there are commercial opportunities in lending, investment management, insurance, F/X, payroll, and accounting.
However, just because you can become a bank doesn’t mean you should. Would I want to get my mortgage from Starbucks? Probably not. But would I be interested in a Starbucks credit card that rewards me with free coffee far beyond what my loyalty card offers? Well, I just might consider it. And thinking about mortgages — maybe I’d be open to seeking my first mortgage from my university alma mater, where there is a strong element of trust already established.
Embedded finance has the potential to be a win:win. The service provider offers customers a convenient, easy-access solution, and vendors get access to step function distribution. The ones who potentially lose in this scenario are the banks. For those who choose not to innovate, we see core banking systems becoming further commoditized as highly complicated transactional systems (once a technology moat) are replaced by APIs and “in-a-box” solutions.
We believe the level of personalization we see today is just a fraction of what’s to come. Orchestrated and composable products will become the norm, for example, enabling an individual’s investment account to auto-rebalance in coordination with their employer RRSP.
We believe real-time and automated financial services will be the rule, not the exception. Notoriously slow financial transactions will struggle to keep up and those processing them do so at their peril. Gone are the days of waiting for a bank transfer to clear, or of calculating equity portfolio values with a newspaper and prior day’s closing prices. Robo trading, leveraged ETFs and high beta commodities, currencies and crypto have changed the game — timing can dramatically impact returns.
Traditional mechanisms for payment, such as cash and check are on their last breath as payments made outside the banking system clear and are visible instantly (credit cards, Paypal, Venmo, crypto, etc.) We believe demands for liquidity and transparency in valuation (mark to market) will grow. The banking system is moving to digital — but is the industry prepared for this fundamental shift? The world banking system just witnessed its first digital bank run with the fall of SVB earlier this year. It took less than two business days to unfold — compare this to the bank run on Washington Mutual in 2008 that took 10 days.
Increasingly we see financial services being abstracted away from the end customer. Both B2B and B2C users seek seamless software solutions to problems they face day to day. No one ever seeks a checking account, they seek a low-cost bank account that allows them to spend freely.
The end of traditional banks?
Well, not quite. Incumbents have traditionally hidden behind the safety of legacy systems and the fintech features arms-race has caught many flat-footed. The rush to digitization has begun.
Once deemed the safest and most secure, monolithic banking systems are in transition to microservices and modules, now called “composable” architectures. Initial implementations of composable products were in non-core use cases, such as Twilio for communication or Plaid for data exchange. Now, demands for new products are pushing core features, like KYC/AML, asset management, customer service, etc. to further adopt composable architectures. It’s coming. Fast.
As banking IT teams (are forced to) become more comfortable with the safety and scalability of these applications, and monoliths become harder to support, more of the core system is distributed. Incumbents realize that a key requirement for staying competitive will be adopting new features earlier in the cycle. For those that move fast, there is significant advantage to be had.
We believe that digitization of financial services creates democratization, for those that are financially literate. Which means, those who are financially illiterate are being left behind — accumulating unsustainable debt burdens, poor credit rating, bankruptcy, housing foreclosure, or other negative consequences.
There is a public policy effort to educate consumers on financial literacy — the topic has been added to primary and secondary school curriculum in Canada and adopted by 7 states in US so far. In addition, there’s public policy efforts to improve retirement for Americans through the new Secure Act 2.0 regulation.
The possibility of unlocking financial literacy and the ability to create compelling ethical products for those who have traditionally been underserved is vast. And just because a product is ethical and not predatory doesn’t mean it can’t be profitable. We like products that are emerging to prevent people with low incomes from getting trapped in endless debt cycles.
We think the conversations being had in the Senate right now to cap credit card interest rates are harbingers of change. Its movements like this that will prompt real innovation in financial services, focusing on giving customers products that add real value rather than simply relying on interest rates to generate revenue.
These tailwinds should combine to create shifts in user expectations/desires, especially when coupled with technology developments such as open banking and generative AI, and data protection.
Placing our bets
Based on all our research, we have identified and been focused on a few areas for investment. These include:
- The data layer — data operations and infrastructure for a variety of use cases, including sharing account information on partner sites, reducing fraud, and improving underwriting data sets and models.
- Orchestration — orchestration layer platforms or completely new infrastructure supporting composable financial services.
- Insurance — we wrote about it here, and invested in Joyn
- Wealth management — we wrote about it here, and invested in OneVest
- Banking and treasury — full-service platforms that are digitizing incumbent banks and credit unions financial products and services.
- Financial wellness — financial planning and wellness offered by third parties such as employee benefit providers or those for whom it makes sense as a value-add, like banks or insurers.
If you believe our vision of the future to be true, these are the areas we believe will see the greatest opportunity.
So how does AI change the game?
As challengers continue to rush in, does AI prove to be the great equalizer or the knife in the heart of incumbents? There is a world in which AI dramatically simplifies legacy transformations.
Imagine a world where a CTO of a regional bank prompts AI with: “Convert my monolithic architecture into composable, modern stack. Next, build a data migration tools to move my DB2 database to the new environment.”
This raises the additional question of whether the large customer base of incumbents becomes the defensible moat. Some might argue that for the innovative-minded traditional financial institutions, it’s all there to play for. And we wouldn’t disagree. But partnering with the right startups will make that shift a lot faster, in our view. Imagine this:
“AI, analyze data on my three million customers and determine the demographics of the highest LTV quartile. Once completed, please determine the 3 most cost-effective acquisition strategies to acquire. “
Or maybe extremely complicated planning could become trivial?
“AI, build me a trading strategy that has a 20% probability of 100% growth in one month a maximum downside of 20% loss of principal.”
And the tedious could become simple:
“AI, get me insurance quotes from 10 carriers for my home — both replacement value and ACV based on age, roof materials and my claims history.”
The beauty of generative AI today is that nobody really knows what its impact will be. We can’t imagine looking at a company in one of our top three interest areas that doesn’t rely on generative AI in some way.
Making moves
Our team is actively meeting with companies building in all these mentioned areas, across North America. Stay tuned for upcoming primers on each of our interest areas. If you are building in the space, we’d like to hear from you. We’ll be at Money2020 if anybody wants to meet face to face .Equally, if you want to challenge the conclusions we’ve come to, bring it on!
We remain in learning mode in this space. Don’t hesitate to reach out to Laura, Charlie or Dave if you want to talk.
