Many financial businesses aspire to be a fintech. It is a bit like the old days when adding “.com” to your brand name boosted your share price and caused investors to form an orderly queue. But some “fintechs” are losing their way? Is it because they aren’t fintechs really?
There are three defining characteristics, amongst a number, that make an early stage company super-valuable rather than just merely valuable.
First, revenues can scale much faster than costs. This is a defining characteristic of technology companies where services are provided by computers without significant labour involved. Revenues can flood in as customers take up the service, but costs barely move; the only real cost involved in delivering the service is maybe adding another server here or there. The payments sector and payment card sector are clearly spaces where this can be done – companies like Transferwise and Revolut for example. Customers keep signing up, and the computers just have to run fast enough to keep up.
Second, they do something difficult whilst making it look easy. This is, again, a natural feature of technology businesses that are well-executed. For example, whatever we think about Uber and its clones, they have made the task of calling a taxi, tracking where it is, and paying for the ride much more intuitive than before. There are many examples and every valuable company has some ingredient in its core business model that involves doing something difficult but making it look easy.
In the fintech space, this is something that we expect to see. The customer service provided by banks has been going backwards as they deal with legacy computer systems, mis-selling and other scandals, increasing regulation and tougher compliance. On the flip side, delivering the same services wrapped in an app can offer a compelling user experience and high levels of convenience. This conjunction of forces makes fintech businesses stand out in a banking world that faces significant challenges. The new wave of challenger banks springs to mind – packaging conventional but simple banking products like current accounts in easy-to-use wrappers.
Third, they have sufficient lifetime customer value. Lifetime customer value measures the difference between the revenue generated from a typical customer over its life versus the cost of acquiring that customer in the first place.
This is a most difficult element to deliver – and it is where many early stage businesses fall over on their path to potential unicorn status. Whilst a financial business may have brilliant automation – for example in underwriting and processing – they fall over when it comes to the cost of sale, the stickiness of the client base and the addressable market space. In other words, they have to spend a lot to win customers, but customers hard to retain and the addressable market is not big enough to get a sufficient number. Sufficient lifetime customer value is a simple proposition – a business has to make enough money from each customer and have enough customers.
So what is a fintech then – and what makes a fintech “super-valuable”?
In our view, a fintech should embody all three characteristics – and very few companies that claim to be fintechs actually have all three. In the main, the issue is the third element: an absence of sufficient lifetime customer value. This is where technology vision meets the reality of the marketplace. Typically, companies that are not making it big are running into trouble because (a) the cost of sale is too high, and (b) the addressable market space is not big enough. In other words, whilst the company is great at what it does, there is simply not enough bang for the buck available in the segment where the fintech operates.
Whether or not you are a fintech matters a lot.
A financial business, with or without great technology, is typically valued on a multiple of book value, which is the money that has been put up by shareholders plus its retained earnings. A good exit for a financial business might be at 2x or 3x book value, and, let’s note that traditional banks are trading at 0.5x or even 0.1x book. This means that such banks are worth less than the money that shareholders have tied up in them. Really not good news for an investor. But a “fintech” can often be valued at a multiple of sales. This can be 20x book value or even 100x book value …. So that means every $ invested by shareholders is being valued at $20 or $100. So being a fintech and making the label stick is worth a fortune to the investing shareholders.
Reflecting on the various IPOs, triumphs and failures of the marketplace, we can see clearly where the immediate winners are using these three principles – and the disappointments can usually be laid at the door of “sufficient lifetime customer value”. A case in point, and close to home, is Funding Circle. Revenues can scale faster than costs (tick), they do SME credit well (tick) but they fall down with insufficient lifetime customer value. Their cost of sale is too high relative to the value that their customers generate for them - and they are fishing in a pond that is too small.
So whether you are an investor or an entrepreneur, it is important to walk the walk as well as talk the talk. Delivering a fintech business model to the marketplace is difficult.
The author is Founder and CEO, PrimaDollar