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- As fintechs cope with a tightened funding environment, it’s likely the industry will see some startups fail while others will excel.
- Business Insider spoke to six investors and dealmakers about the types of startups that are in the best, or worst, positions.
- Most warned that lenders and those in the payment space might be the most susceptible to the market downturn.
- Meanwhile, trading-related startups have opportunities to grow their business thanks to market volatility.
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The coronavirus crisis is providing the first big test for many young fintechs, which benefitted from rising stock markets and ample funding for years.
Now, the spread of the coronavirus is taking a huge economic toll worldwide, and fintech startups are being forced to reckon with a new reality. Still, while this could hurt some startups that bet on transforming the world of finance, it could also be a boost to newer players.
To put it more bluntly: There will be winners and losers.
While many lending and payments businesses aren’t well-positioned to weather the financial storm, startups focused on trading and market structure are in good shape to benefit from the increased volatility.
Wall Street execs have already told us how the coronavirus is in many ways a watershed moment for the adoption of tech, as people’s behaviors change to adapt to things like social distancing and remote work.
Business Insider spoke to investors and dealmakers about the startups best positioned to succeed, and those that will likely struggle, in the new environment.
Some of these answers came as part of a broader survey of 11 backers, who laid out how fintechs should be looking to conserve capital, weighing opportunities against risks, and keeping the human toll of the coronavirus crisis in mind when making decisions.
Retail trading platforms and financial software were mentioned as among the possible winners.
On the losers side, the backers and bankers identified point-of-sale systems — which are a feature of the retail and hospitality industries that have been forced to temporarily shutter physical locations — as well as fintech services for small businesses and freelancers, as areas that could hurt.
Merritt Hummer, partner at Bain Capital Ventures
Notable investments:Ribbon, Finix, SmartRent
Winners and losers:So far, we are seeing COVID-19 beneficiaries emerge in areas including mobile banking, accounts payable and accounts receivable automation, fraud detection, and online brokerages.
Mobile banking:COVID-19 is a catalyst for the already rapid migration from offline to online banking. Even before coronavirus hit, retail bank branches were disappearing at a rapid clip; from June 2018 to June 2019, the number of total branches in the US fell by 7%, the biggest yearly decline on record. And that was before coronavirus shut down the retail sector.
Digital payments:Over the past several years, there has been a gradual transition from checks to digital forms of payment in B2B commerce. Few would have predicted a global pandemic to disrupt this inexorable march, yet for the first time, we may see a step change increase in the digital penetration of B2B payments.
Fraud detection:For many who have been distracted by other headlines, it may have been easy to miss that the FBI released a public service announcement a couple of weeks ago notifying the public about a surge in fraudulent online schemes during the pandemic.
Online brokerages:Volatility is a brokerage’s best friend. Digital brokerages can advantage of unprecedented market volatility to acquire (and likely retain) new customers during this period.
Fintech companies that are likely to face headwinds in this environment include pay day advance apps, POS systems for retail businesses, home/mortgage financing platforms, fintech services for freelancers and SMBs, and lending businesses in general, particularly those serving consumers and SMBs
There are obvious segments that will produce winners and losers in this environment. I think we are all tired of hearing about Zoom as the Nasdaq golden child. The more interesting question is how businesses will fare that have both positive and negative exposure to the current environment.
For example, a company like Affirm should benefit from rising e-commerce penetration and the fact that consumers are probably more inclined to “buy now, pay later” in this economic environment. At the same time, Affirm may extend credit to consumers who have less ability to pay back their loans than they did a month ago.
How forces like these offset each other, and how companies like Affirm adapt and respond to rapidly changing economic parameters, will be fascinating to watch.
Kim Trautmann, head of DRW Venture Capital
Notable investments:Digital Asset, ErisX, OpenFin
Winners and losers:
Retail trading platforms and trading tools (e.g, charts, data and analytics) that provide transparency to the markets will benefit in this period of uncertainty as consumers look for answers.
These platforms will likely see record volumes and record account sign ups, and successfully navigating their busiest days will be their greatest challenge.
Conversely, fintech companies offering a “nice to have” product in this environment are likely to struggle as consumers and businesses make decisions about where to curtail their spending. For companies with strong balance sheets, this will create some opportunities for M&A, and I expect we’ll see consolidation in the space.
Jennifer Lee, principal at Edison Partners
Notable investments:MoneyLion, Yieldstreet, Clearpool
Winners:There’s a lot of companies, for example, talking about financial inclusion and their job is to actually cater to these underserved financial communities, which comes into play now more than ever.
Where a lot of different segments of the consumer side is getting hit, that could actually be a perfect opportunity for all of us in that community to help each other out and continues to provide solutions that are now more important for them.
Peter Johnson, principal and head of fintech investing at Jump Capital
Notable investments:M1 Finance, Personal Capital, TradingView
Winners and losers:Winners in today’s environment seem to be the trading-related companies. Someone told me — “with sports shut down, financial markets are the new sports,” as in that is what everyone is paying attention to now.
Surprisingly, the fintech wealth management companies seem to be winner … Assets took a big whack, but lot of customer signups.
Losers have to be payments companies and lenders. Although there does seem to be some bright spots within lending — we’re investors in an auto loan refinancing company, and their volumes are through the roof due to low rates and people looking to save money. So for lending it probably depends on who you are lending to, and if you are holding the risk of the loans.
Jason Gurandiano, global head of financial technology investment banking at RBC
Notable deals advised on:$1.5 billion sale of Intralinks to SS&C, £3 billion sale of Paysafe to CVC and Blackstone, Francisco Partners $3.4 billion take private of Verifone
Winners and losers:I think the ones that are going to have the toughest time are the lenders. I think you’re going to see very large increases in default rates, which are going to call into question the profitability and sustainability of those models. So I think the lenders are probably the ones that are going to face the roughest ride.
I think next on the list would be the digital banks. The one question/issue I always had with digital banks was it’s all well and good to have your money in “pick your digital bank.” However, in times of crisis, people all of a sudden want the comfort of a JPMorgan, BofA or RBC or whatever the big brand is in their respective geographies. So I’ll be interested to see whether there are outflows from those types of models.
I think traditional payments, depending upon the focus area, is going to go through some pain, obviously, because a large portion of what’s happening with a large portion of their customer portfolio — bars, restaurants, various SMBs. So I think that’s challenging.
I think one of the strongest areas in fintech will be the financial software space. I think there’s a perception that in a reduced-revenue environment people will continue to leverage software and technology as a means to drive better efficiency. So I feel quite bullish about financial software.
I think B2B payments is also an area where it may be a little more insulated from the economic downturn.
Then I guess the one thing that doesn’t get talked a lot about in fintech is market structure. If you look at the names that are levered to volatility (exchanges or the high-frequency guys) those firms are just minting money right now. They don’t care what direction the market goes. If there’s vol then that is the way they make money. It’s a perfect storm for those guys.
Vikas Shah, managing director for investment banking at Rosenblatt Securities
Notable deals advised on:Exablaze on its sale to Cisco, Euronext on its acquisition of Fastmatch, Visible Alpha’s Series B round led by Goldman Sachs
Winners and losers:
Challenger Banks: Declining consumer activity, a weakening economy, and tight funding conditions will hurt Challenger banks. With the Fed reducing the benchmark interest rate to zero, Net Interest Margins (NIM) for challenger banks will get more compressed than traditional banks as they rely heavily on transaction revenues, which will decline amidst the COVID-19 lockdown.
Making matters worse, the cost of funding for challenger banks may not reduce proportionately to lower Fed rates, and less than that for incumbent banks, weakening their competitive position. The only positive trend for Challenger banks in the current climate will be a higher demand for digital interactions as customers have restricted mobility and can’t access traditional bank branches.
The question remains whether additional transaction volumes from the new account sign-ups offset the secular volume declines.
Online Lending:Digital lenders could be entering into a perfect storm of lower net interest margins, falling loan growth in a bid to avoid adverse customer selection, rising delinquencies, and defaults.
The algorithms of digital lenders using alternative data to underwrite risk and make loans will be severely tested for the first time. Plans of newer online lenders like LendInvest and Zopa, who were hoping to exit via an IPO, will be delayed indefinitely while the first generation of fintech lenders (Lending Club, OnDeck) come under pressure once more, especially as they see quick downgrades from the rating agencies of the securitizations that they have undertaken over the past few years and the corresponding equity losses from the first loss tranches.
However, if digital lenders can persuade the SBA to let them disburse at least part of the over $350 billion of loans that the federal government has approved via the Cares Act, it may provide the much-needed boost to the otherwise distressed sector.
Robo advisors/digital wealth managers: Severe volatility and the lack of recovery in public stocks may scare away all investors, especially millennials, who are the biggest customer segment for robo advisors.
Self-directed investors using robo advisors and online trading platforms may gravitate away towards established wealth management shops (Charles Schwab, Fidelity Investments, Morgan Stanley) who have matched the “zero commission” model of e-brokers and also offer the comfort of human advice.
Over time, robo advisors have shifted business models from earning revenue from transactions to AUM-based fee models that will suffer as markets remain volatile in the short term. Robinhood’s technical problems last month have dented investor confidence at the most ill-opportune time and will shake the trust of customers in all robo advisors.
Payments/transaction processing:Payment and transaction processing fintechs will face a mixed picture, with B2B payments faring better than B2C and C2C, and the subsector doing better than other fintech subsectors.
A paralyzed global economy with consumers and corporations curtailing travel and entertainment will have a profound impact on consumption in the short term. This will result in a fall-off in transactions, which are the lifeblood for payment fintechs.
Visa and MasterCard’s warning that sales will fall short of expectations in the current quarter by 2-4% and a sharp contraction in cross-border flows will hit money transfer fintechs and other payment providers, especially hard.
Institutional capital markets:Traditional capital markets firms (institutional brokers, exchanges, clearing firms) are benefiting from the current elevated volatility, though runaway volatility for an extended period could have the opposite effect of freezing up trading.
Fintechs providing trading infrastructure may benefit from this short-term volatility-driven euphoria, but their future depends on how their institutional clients fare as the market downturn continues.
RegTech and compliance fintechs will remain popular as a market dislocation doesn’t impact demand for their services. Investors may double down on these investments boosting their valuations. They may be one of the few bright spots in an otherwise tough fintech market
InsurTechs:Usually, massive calamities spell bad news for insurance carriers. But we don’t expect large claims from COVID-19 as most insurers most often exclude pandemics or infectious diseases from their coverage.
But the virus could boost demand for certain types of insurance by increasing awareness and demand for a greater life, health, and business disruption coverage. The P&C sector insurtechs should not see much difference as an event like COVID-19 doesn’t impact that sector.
In other insurance segments that address unconventional risks (cybersecurity, climate change, social disruption), investors have been keenly funding InsurTechs, so the demand for startups in these segments will continue to attract investor interest.