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Where funding for financial technology is going, in five charts

The appetite for fintech investment in Europe and Asia is growing, according to the latest numbers.

CB Insights’ Global Fintech Report reported Wednesday that investment in financial startups soared 222 percent quarter over quarter in Europe and 89 percent in Asia, while North American investment took a small dip.

Those numbers look big, but the U.S. has the largest financial services market and other regions have generally played catch up to it for years, said Eric Byunn, a partner at Centana Growth Partners, a Palo Alto-based growth equity firm focused on investments in the financial services industry.

“The overall message across all of this is financial services affect the global population and there are a lot of companies with incredibly varied business models and levels of sophistication,” Byunn said. “The opportunity for innovation in the sector is huge and the numbers here all in all only confirm that.”

Here are five charts from the report.

Funding is down, but it’s not a cause for concern

In the first quarter, fintech startups raised $2.7 billion across 226 deals. That’s a 33 percent rise in funding on a quarterly basis but down 47 percent from the same quarter last year. Deal activity increased 12 percent from the fourth quarter of 2016.

At this rate, U.S. deals could fall below 2016 figures
U.S. fintech could see a drop in funding of about 18 percent from 2016, going by the first quarter rate of activity. Startups raised $13.1 billion across 889 deals in 2016. U.S. startups’ first quarter funding activity is just below total funding for 2013. Global activity, however, could surpass 2016 records if the rest of the year keeps with its current pace.

The recent numbers viewed in a long term historical context are very strong, Byunn said, reflecting the recognition by the investment community that innovations have changed and the industry is ripe for opportunity. Quarter to quarter variation is typical.

Insurtech funding has dropped, but recent activity has been consistent
Funding to insurance technology companies — those creating new underwriting, claims, distribution and brokerage platforms, to help insurers deal with legacy IT issues — fell 25 percent from the previous quarter to $194 million, while deal activity fell 30 percent to 23 deals. This time last year, appetite for insurtech firms was much larger, at $770 million across 38 deals.

Payments and billing companies — payments processing companies, payment card developers and subscription billing software tools — took a slight dip from last year with $304 million in funding from $311 million, although total deals rose from 38 to 50 on a year over year basis. The biggest funding activity took place in the fourth quarter, with $495 million in funding for payments over 44 deals.

Bitcoin and blockchain startups rebounded in the first quarter to $113 million from $77 million in the fourth quarter — in large part because of BitFury’s $30 million Series C round and Veem’s $24 million Series B.

For the past four quarters payments and insurtech have had high investment, with blockchain investment hovering in the 100s, which may be partly to do with hype around the emerging technology that doesn’t match up.

That drop in insurtech probably not as alarming as it seems, Byunn said, noting there were some large investment deals that took place just before the first quarter of 2016, like Lemonade’s $13 million investment in December 2015.

Asia and Europe are catching up to North America
At the current rate, Europe fintech deal activity could top 2016’s total by 57 percent, according to CB.

UK fintech companies raised $328 million in the first quarter, including more that $200 million invested in Atom Bank and Funding Circle.

German deals rose 143 percent on a quarterly basis, while funding grew 341 percent, which was largely driven by investments to Raisin and solarisBank.

North America has had and will continue to have the largest amount of investment activity in this financial services startups, Byunn said. Quarter one showed there’s some recognition by global players that they have been slow to invest in financial startups.

“The U.S. has the largest financial services market pretty much any way you cut it,” he said. “You will continue to see increased levels of investment outside North America – not necessarily taking away from North America, but just showing good health outside of it.”

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Ask a VC: How startups are turning away traffic from payday lenders

This is Ask a VC, where we quiz venture capitalists on the latest trends in the finance space.

The name of the game in the financial industry right now is simplification. But the growing plethora of apps and startups claiming to simplify people’s money game has created a crowded market.

Core Innovation Capital is a San Francisco and Los Angeles-based venture capital firm that invests in companies that figure out how to cut down the red tape around personal finance. It’s invested in companies including NerdWallet, Trim and CoverHound and a recent exit from the portfolio is bill payment company TIO Networks that was acquired by PayPal last month.

Tearsheet spoke to managing partner Kathleen Utecht about the problems innovators are working to solve, what she looks for when deciding to invest in a company and what’s coming next in the financial inclusion space.

How can investors tell the difference between the next big fad versus the next big thing?
Sometimes people say it [financial technology] is a fad, but it’s not. There’s major structural inefficiencies in financial services as a whole. For example, if I hand you a check and it takes three days to cash and if you don’t have enough money in your bank account, it costs you money. It’s based on ACH technology which is really old, and in between banking systems that’s based on Swift technology and again that hasn’t been slowly updated. They’re not just fad businesses. There’s normally real unit economics and people are solving a need. We avoid things that are only small incremental improvements. We’re looking at things that are really going to cut costs, save time or create upward mobility for people and are not incremental — a significant value proposition to their lives.

Core Innovation Capital supports ideas that generate an attractive return on investment and aim for upward mobility for Americans — can you do both of these, from day one?
Our whole thesis is that you can do well and good at the same time. We’re on track for that. We also want to have a major impact on people’s lives. When you think about it, the best companies are the ones that bring true value to the end consumer. We look at how much money our companies put in people’s pockets or make them upwardly mobile, and we look at the revenues and what their profitability is — those two things go hand in hand.

What financial technology trend is most exciting to you right now?
There are so many, but we love the stuff going on in the future of work and fintech. When you’re a W2 [full-time] worker, you get taxes taken out and you can save for your 401(k), but for part-time workers or 1099 workers, this isn’t done. A lot of companies are trying to get to this base — it’s a third of the country right now. These startups can insert themselves in the payroll system and do what an employer would do for you — they can take out money for your taxes, they can take out money for your savings and for your insurance.

The second trend we see a ton of is insurance. We’ve made three investments in insurance and we expect to do more. Tech is hitting insurance and every insurance company is creating their own venture capital arm. Insurance companies see all these new startups coming to disrupt them and they want to be part of it. They want to partner with the [startup] companies rather than let new startups eat their lunch.

Is there a trend that’s particularly overhyped to you or has lost your attention?
It will be interesting to see if [financial technology] will be successful in the life insurance space. I like the concept of it, but it’s something the insurance companies might be able to just do themselves and copy. The economics are going to be hard to prove out.

There are many funds that aim to help people who can’t access financial services, in the U.S. and in the developing world. Can startups offer something different than the banks?
Banks have so much legacy infrastructure and so much overhead they can’t serve these smaller dollar accounts — whether it’s investing, saving or lending — as as much as startup can. They don’t have the technology or efficiency. Banks don’t want a lot of the less affluent customers, they don’t treat those customers well, and there’s all sorts of fees.

So what can startups do to add value to the underserved market?
When serving the underbanked, you just need to do better than the payday lender. Do you know how awful payday lenders are? These are terrible experiences. The places are dimly lit, and you wait in a really long line to spend 10 dollars to cash a fifty dollar check. I would be glad to see the payday lenders and check cashers go away. They’re awful. Startups can create a better experience and responsibly underwrite people.

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The state of fintech funding, in five charts

Investment in financial technology may have fallen a spectacular 47 percent last year but it is perhaps just an indication of the maturation of the industry.

Total global funding to fintech companies fell to 47.2 percent to $24.7 billion in 2016 from $46.7 billion the year before, according to KPMG’s quarterly fintech funding report, The Pulse of Fintech, which came out in February 23. Deal activity dropped to 1,076 from 1,255 the year before.

“The appetite for fintech investment is strong and will remain so for the foreseeable future,” said Steven Ehrlich, lead analyst for emerging technologies at Spitzberg Partners. “However, things are certainly not as frothy as they used to be, especially for the early stage companies.”

That’s largely due to investors’ renewed focus on business models and plans for profitability, Ehrlich said. And as always, regulation. “Startups are realizing that they cannot skirt those requirements and financial institutions are working to make sure that everyone is playing by the same set of rules.”

Below is a breakdown of who’s funding fintech activity on a global level today.

VC deal volume is down, but dollar value keeps growing
The number of venture capital deals fell to 1,436 last year from 1,617 in 2015. However, those deals continued to increase in value, rising to $17.35 billion globally in VC investment from $15.64 billion the year before.

Chris Hughes, vice president at Revolution Growth, the growth-stage investment arm of venture capital firm Revolution, said growth slowed following 2014 and 2015 markets, two fast growing years for fintech VC funding, when the industry’s most exciting companies, marketplace lenders Lending Club and OnDeck, had trouble growing and reaching profitability. As a result, “public market investors started to reprice these companies based on their performance relative to their traditional peers and monitor metrics like net interest margin, return on equity and profitability,” he said.

Ehrlich said after getting early returns from the Lending Clubs of the industry, many began realizing how difficult it really is to unseat legacy financial companies.

“In the lending space it may have been easier to offer attractive returns on products when rates were at historical lows, but now that they are rising again it the burden is being placed on them to demonstrate significant value over the incumbents, which is difficult to do,” he said.

Early stage deals are down, late stage deals are up
According to CB Insights, seed investments fell to 29 percent at the end of 2016 from 35 percent the year before, while Series D investments rose to 7 percent, showing that while investment volume is still larger among younger companies, interest in those startups slipped over the last year while interest in more established, developed companies grew.

Private equity is emerging as an additional source of fintech investment
The value of private equity deals in fintech fell by about $7 billion between 2015 and 2016, but deal volume rose to 112 from 99. PE firms have been investing in technology in general, according to KPMG, “so it comes as little surprise that many are targeting businesses within the fintech space.” These companies have been hard-pressed to find worthwhile investment opportunities and as they broaden their deal-sourcing strategies, “those with financial services and technology portfolios may be dialing up activity,” according to the report.

Corporates and startups are more open to working together
Banks and startups are starting to work together more aggressively this year, as evidenced by JPMorgan Chase’s partnership with OnDeck Capital or the Wells Fargo partnership with robo-advisory SigFig. The venture arms of financial institutions increased their participation in fintech startup investment to $8.5 billion (17 percent of deals) in 2016 from $4.9 billion (14 percent of deals) the year before.

Corporates backed 29 percent of VC-backed fintech companies last year, up from 23 percent in the previous year.

“There is a shift where the fintech startups and established firms are realizing that they can have symbiotic relationship,” Ehrlich said. “It is challenging for [banks] to innovate themselves because it requires beating back entrenched and established processes that often times have their own internal challenges.”

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‘Both vision and data’: Why mobile phones are giving millions access to financial services

This is Ask a VC, where we quiz venture capitalists on the latest trends in the finance space.

While billions across the world have limited access to financial services, that number is quickly falling. The World Bank reported that between 2011 and 2014, 700 million people became account holders at banks and mobile money service providers. At least part of this can be attributed to technological advances that give people new ways to manage their money. It’s the kind of progress that inspires Monica Brand Engel, a partner at Quona Capital, a venture capital firm that specializes in early-stage financial technology companies in emerging markets.

Quona manages the Accion Frontier Inclusion Fund, a $141 million pool that invests in products for the underserved, including alternative credit, payments and business-to-business financial tools. Investors include Accion International, JPMorgan Chase, Mastercard, Metlife and Prudential Financial. Its portfolio includes the South Africa-based mobile payments provider Yoco, CreditMantri (the ‘Credit Karma of India’) and Konfio, a Mexican online lending platform.

For this edition of Ask a VC, we spoke to Engel about what’s driving innovation in the financial inclusion space. Answers have been edited for clarity.

How can investors tell the difference between the next big fad versus the next big thing?
Financial technology has seen a resurgence in emerging markets since the financial crisis. I wouldn’t call it a fad but a convergence of trends, including the proliferation of mobile phones in parts of the world where access was limited as well as internet connectivity. Similarly, another trend is mobility. Borders are becoming less relevant and people are seamlessly moving from country to to country, and also economic mobility is fueling an emerging middle class.

Quona supports ideas that generate an attractive return on investment and promise to change the world for the better — can you do both of these, from day one?
We expect that the portfolio companies will incur a loss for the next two or even three years. At some point in the short to medium term they will earn a profit, they’ll get acquired or go public. When the liquidity event will happen, that’s when we the investors and Quona will get our money back as a return. When we invest in them there’s a clear path to profitability.

What financial technology trend is most exciting to you right now?
That’s like saying to a mom which child do you love best! There’s so many trends out there. I’d say the proliferation of mobile phones. It means you have a digital identity for people who were previously invisible. A mobile phone in their hand that doesn’t mean just connectivity — it means you can see them. A phone number becomes like a social security number, and that’s powerful because you have an identity that can be geolocated.

Is there one that’s particularly overhyped to you or has lost your attention?
What’s overhyped is the notion that the old financial system is going to disappear. In the new world order, banks will have different roles.

There are many funds that aim to help people who can’t access financial services, in the U.S. and in the developing world. Can startups offer something different than the banks?
Startups are nimble. They can take risks that a deposit-taking institution just can’t take, particularly in product design, user experience and breadth of access. Banks are interested in the inclusionary space. For example, Mastercard is an investor in us. They’re interested in how they’re going to get new clients. They struggle because they see things through their lens and it can be a blinder sometimes, but the banks are trying to see if they can extend what they do today and want to push their boundaries.

What’s the greatest lesson you’ve learned from a failed venture?
Both vision and data are important to get to success. And just because everyone is doing it doesn’t mean you should do it.

What’s the biggest mistake that entrepreneurs make when pitching you?
Thinking that your investors want to hear that there are no problems. When you say there’s no problem, it means you’re not sure how to manage your business. I like bad news early and often.

 

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Ask a VC: Why Andrew Parker thinks blockchain is past its prime

Blockchain is going to revolutionize financial services. Unless it won’t.

Too often, blockchain solutions for financial services are square pegs trying to fit in round holes, according to Andrew Parker, a partner at Spark Capital. While bitcoin and its underlying blockchain technology are interesting and maybe even revolutionary inventions, they don’t have a significant place in the industry.

Spark has placed some pretty good bets in fintech, having invested in some of the most successful startups across different sections of the ecosystem, including financial API provider Plaid, marketplace lender Orchard, installment payments company Affirm and robo-adviser Wealthfront.

Parker, who has been with Spark, spoke to us about where his attention is in fintech and why it’s important to focus on innovating for the customers’ sake and not for the sake of technological innovation.

Investors know not every idea out there will survive. What makes you want to invest in the next big fad versus the next big thing?
I strive to invest in enduring companies with big ideas that will thrive for many years to come. A common feature I see in fads is that, in hindsight, they look like technology for technology’s sake, as opposed to solving a pressing customer need. So, in evaluating an investment opportunity, I focus on the customer need first and then analyze technology solutions to address that need. I hope that approach keeps my focus on the next big thing.

What consumer-facing fintech trend is most exciting to you right now?
My favorite trend is the continued rise of the robo-advisers. It’s not new (in fact, it’s a decade old), but the evidence is overwhelmingly strong that retail investors are best off focusing on indexing, and I think robo-advisers offer an excellent product to help retail investors into the ideal indexing balance to meet their needs. The benefits that robo-advisers offer in automated rebalancing and tax-loss harvesting provide surplus gains that exceed the fees that they charge, and they save consumers the cognitive load of trying to pick the best index funds from the deluge of options Wall Street has created.

Is there one that’s particularly overhyped to you or has lost your attention?
I find the blockchain to be one of the most interesting inventions of the past few decades. It’s an incredibly elegant way for a group of counterparties who inherently do not trust each other to be able to collaborate and agree on a commonly accepted ledger of transactions together. And, Satoshi Nakamoto’s original bitcoin whitepaper that outlines the blockchain is delightfully readable and wonderful in its simplicity. But the trend that I find overhyped is using the blockchain to solve problems that don’t fit this general use case of a group of untrusting counterparties. The trend that has passed its prime is using the blockchain to solve problems that are more easily and efficiently solved using boring old open-source database software (often run and owned by a single party).

How has activity in the fintech ecosystem changed over the couple years, and how has that affected your work as an investor?
The past couple years have been pretty even in demand for investment in new fintech companies in my experience. Some subsets of the broader fintech market have had more highs and lows. For example, the scandals that led to the firing of LendingClub’s CEO last spring had ripple effects in the funding market for online alternative lending companies for a few months. But for the most part, I’d categorize the market over the past couple years as active, and investors are showing continued healthy interest in new fintech startups.

What’s the greatest lesson you’ve learned from a failed venture?
The greatest lesson I have learned, which has now affected my behavior as an investor going forward, is a need to hire proactively ahead of issues in the senior leadership team. I never have had the experience of saying, “Wow, I think we hired that finance or engineering lead too early.” But, I’ve found myself on the opposite end of that spectrum too many times. This lesson has led me to encourage senior hiring earlier than were previously my instincts.

What is the biggest mistake entrepreneurs make when pitching you?
The biggest mistake is failing to convey a really ambitious vision for the future. No company is ever perfect at the outset; they all have significant issues that must be overcome to become valuable. The big ambitious vision is how investors fall in love with a company in order to embrace the significant issues, overcome their doubts, and get on the train. The big ambitious vision is also the opportunity for a founder to show their passion for their mission, which can be very persuasive when done well.

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WTF is the JOBS Act?

WTF is fintech

When equity-based crowdfunding platforms emerged around 2011, they, unlike their donation or rewards-based cousins, were restricted by law to accredited investors. The crowd, as it were, was quite selective. And while exclusivity has always played a major role in the finance industry, limiting equity-based crowdfunding to accredited investors meant that these platforms were exacerbating a funding gap for entrepreneurs who needed much less funding to get their businesses off the ground.

“Since 2008, it’s been so hard to get a bank loan,” said Tess Hottenroth, chief executive officer of BankRoll Women. “The venture capitalists have moved up in the amount that they are generally giving to companies, and as a result the angel investors have also moved up to a level where VCs used to be.”

Signed into law by President Barack Obama in 2012, the Jumpstart Our Business Startups Act sought to enable a greater number of entrepreneurs and investors to benefit from equity crowdfunding. The bill passed with bipartisan support; after all, Hottenroth noted, “Who’s going to vote against JOBS?”

Tell me what I need to know about the JOBS Act titles.

Title II: Makes it possible for small businesses and entrepreneurs to advertise their businesses or products and solicit investments on equity crowdfunding platforms. As Title II is a private offering, companies that choose to fundraise under this title can only accept investments from accredited investors.

Title III: Is for all of the little guys and gals out there who want to raise up to $1 million. This title is often likened to an equity version of Kickstarter, but with a system in place to make sure the general public doesn’t invest more than they can afford to in startups that might not make it. As David M. Freedman and Matthew R. Nutting wrote in A Brief History of Crowdfunding, Title III was considered particularly risky, because “it opened the riskiest area of alternative investing to tens of millions of investors who, because they were not wealthy, were presumed to be less sophisticated investors.”

Title IV: There are two types of Title IV, Tiers 1 and 2. Tier 2, which allows entrepreneurs to raise up to $50 million, is pretty exciting, because it basically allows companies to form mini IPOs funded by the general public. These offerings are liquid, and can be traded if listed on a stock exchange. Mini IPOs are much, much less expensive and complex to set up than actual IPOs.

Who can benefit most from the JOBS Act?

On the investor side, the average Joe and Joanna Public could potentially win big with the JOBS Act. Unaccredited investors can’t invest in Title II of the act, but they can invest in Titles III and IV. In other words, the crowd went from a complete shutout to be able to invest in nearly every type of equity crowdfunding, much as they can in mutual funds and other types of stock.

On the entrepreneur side, any entrepreneur that fell outside the funding scope of VCs and angel investors are now able to use crowdfunding platforms to raise equity. Crowdfunding equity has joined a growing number of fintech financing solutions for entrepreneurs looking for funding outside the traditional bank channels.

Of course, these are the people who can in theory benefit from the JOBS Act. In reality, very few startups have applied for this type of funding so far.

So you’re saying that from 2012 the JOBS Act has completely changed equity-based crowdfunding?

Not exactly. The SEC has been slow to implement the rules, much to the chagrin of professionals in the equity crowdfunding business. While Title II has been legal since 2013, Title IV wasn’t legal until 2015, and Title III until 2016. Not all of the blame lies with the SEC, though. Many entrepreneurs and investors probably just aren’t aware that the JOBS Act happened.