Robinhood, the commission-free brokerage famous as the pump through which day traders inflated the meme-stock bubble earlier this year, enjoyed a turbulent start to its own life as a public company.
By the time it listed on Nasdaq on July 29, the company’s free trading app with no minimum account size had attracted 18 million customers, many new to the stock market. Few understood that Robinhood monetizes their activity through payment for order flow from the big market makers, almost guaranteeing that they don’t get the best price.
Neither did the company.
It priced its own IPO at $38, achieving a market capitalization of $32 billion. Within minutes, its shares fell and ended the first day down 8%, tarring the deal as the most disappointing large IPO of recent times.
Capital One was the first real fintech disruptor of our era
Nigel Morris, QED Investors
No matter. In the first week of August, Robinhood itself became a meme stock. Its shares shot up to $70 on August 4 then fell back to $50 a day later and closed the first full week at $55. That implied a market cap of $46 billion for the eight-year-old company – so just a bit more than Barclays, which traces its history back to 1736.
Valuations for fintechs coming onto the stock markets and being acquired are extraordinary.
In the first week of July, shares in Wise, the remittance company formerly known as TransferWise, began trading on the London Stock Exchange following a direct listing.
From an initial price of 800p, the shares finished their first day at 880p and one month later were trading at 974p, valuing the company at £9.74 billion ($13.55 billion).
One year before listing, in July 2020, a private secondary share sale had given it a $5 billion valuation.
We were pleased that we were able to reduce pricing by 2bps to 0.67%
Kristo Käärmann, Wise
Wise has grown revenue fast. In July, it announced its first quarterly results as a public company for the three months to the end of June, with Kristo Käärmann, co-founder and chief executive, stating: “We were pleased that we were able to reduce pricing by 2bps to 0.67%, dropping prices for 19 currencies while also delivering 38% of all transfers instantly.” Rising customer numbers and volumes enabled it to increase revenues to £123.5 million, 43% ahead on the same quarter a year ago.
Wise began by serving immigrant workers that were being fleeced sending money home to their families. It has since attracted more business customers looking for a better way to pay employees, freelancers and suppliers from overseas.
Attention will soon focus on Seattle-based Remitly, another global remittance company which back in June confidentially submitted to the SEC a draft registration statement for an IPO that is expected in the fourth quarter.
This follows an equity investment in May 2021 from Visa amid talk of a possible $5 billion valuation, up from the $1.5 billion implied by its $85 million series F venture funding round in July 2020.
The future of remittances has always been digital, but that shift has accelerated rapidly
Matthew Oppenheimer, Remitly
Founded in 2011, Remitly has grown customers rapidly in the last year. On the series F funding a year ago, Matthew Oppenheimer, co-founder and chief executive, stated: “The future of remittances has always been digital, but that shift has accelerated rapidly over the past few months with the demand for safe and convenient solutions to send money.”
Immigrant workers and their families back at home are much less keen to stand in line at Western Union these days.
One of the early backers of Remitly is QED Investors, the specialist fintech venture capital firm co-founded 14 years ago by Nigel Morris. The British consultant had proved himself by founding Capital One, a sub-prime credit card provider, in Virginia in 1994 and then growing it into a top 10 US bank, taking it public and expanding overseas.
“Capital One was the first real fintech disruptor of our era, focusing on credit cards and consumer loans and leveraging advanced marketing and analytics,” Morris tells Euromoney. “That became the platform on which we started QED back in 2007 when nobody even used the word fintech and we were simply looking to take the Capital One paradigms and apply them to disruptive new start-ups.”
In 14 years, QED has invested in over 150 companies. More than one in eight – 20 in total – have become unicorns, valued at over $1 billion, with several worth many times that.
There are 750 unicorns across the world in all industries, according to cbinsights.com. Money.co.uk has tracked these by country of origin and by industry sector and finds 131 fintech unicorns, the most of any sector, even ahead of e-commerce and direct to consumer.
QED has backed 15% of them.
These include SoFi, which began as a specialist in student loan refinancing and went public through a Spac deal at the start of this year that valued it at $8.65 billion post-money.
The next decade will be a golden era for digital financial service
Anthony Noto, SoFi
Anthony Noto, chief executive of SoFi, told investors: “We believe the next decade will be a golden era for digital financial services, where three to five fintech companies will emerge as leaders, and one will emerge as a ‘winner takes most’.”
QED led a $2.5 million series A venture round for Credit Karma, a free credit score tracking company, back in 2009.
In December 2020, Intuit, the tax and accounting software company, paid $8.1 billion for it, attracted by its 110 million members, or customers. These track their credit scores for free and learn how to improve them, and Credit Karma derives revenue from lenders and credit card companies that want to sell to them.
Nubank may have been QED’s best bet. Euromoney named the digital disruptor Latin America’s best bank in 2021, months after it achieved a $25 billion valuation in a series G funding round.
Morris says: “I remember David [Vélez, chief executive of Nubank] telling me: ‘Nigel, there’s an opportunity to create a Capital One in Brazil.’ I wasn’t sure myself, but lo and behold, he builds this extraordinary juggernaut that may be the best and biggest neobank in the world.”
Vélez acknowledged that inspiration when he told Euromoney earlier this year: “A lot of our credit DNA is from Capital One. We used a lot of their techniques with the sub-prime [segment]. We start customers with low limits and credit cards are a great product for capturing a lot of data quickly – we’re effectively dynamically underwriting the customer every single day.”
What has Morris learned in 14 years of backing fintech start-ups, helping them grow and then partially or fully exiting?
“Growth is not linear. The rate of evolution changes, sometimes dramatically, as it has in the last 15 months, in large part thanks to Covid. Before the pandemic, there were still plenty of digital deniers, for example among the top executives of regional and smaller US banks who reasoned they had their branches and that customers would continue to stick with them.”
Advantages and disadvantages
Banks have considerable advantages. They are trusted; they comply with a complex regulatory system; they have access to funding and balance sheet for lending; they have plenty of proprietary data on large customer bases, and often deep pockets to invest.
But they tend to be distribution-led and not, for all their claims to the contrary, customer-centric. They distribute a set range of banking products and services but are often tied to local economies. They can often find that they are simply in the wrong places, without the technology skills to quickly build apps to deliver what customers actually want to wherever they are located.
“There are fewer digital deniers now,” says Morris. “Something very tangible has been happening. If you look across the fintech universe broadly defined it is now worth somewhere around $1 trillion out of a total market capitalization for banking and payments companies of $10 trillion. So, fintechs are already 10% of the market and growing rapidly.”
Not all of them are taking business away from banks. Many are building new businesses serving banks.
What happens with the overwhelming majority of fintechs that don’t ever make it to unicorn status and that either muddle along, fade away or blow up?
Morris suggests that many become blinded by rapidly acquiring large numbers of customers at low cost and gaining enviably high net promoter scores without working out how to generate revenue and profit.
“We see a lot of companies who say they will figure that out down the road,” says Morris. “But if you don’t have line of sight to profitability at the customer level –which may come with the initial core product or with an added product – it will all end in tears, I’m afraid. The key is always unit economics.”
As the digital deniers are drummed out and banks awaken to the technology, they don’t have to buy fintechs. They can partner with them
Nigel Morris
Most fintechs try to build renown in one business and then expand. Robinhood no longer depends just on stock trading. It moved into options early on, then crypto, from which it now makes a lot of money. It also offers debit cards.
SoFi began with student loan refinancing, then built a multi-product offering across insurance, savings, investments and crypto, making big play of the zero cost of customer acquisition for each new line. It aims to be the Amazon of banking. So, it comes as a surprise to hear Morris express doubts about the broad applicability of this approach.
“So many banking acquisitions have been justified on the altar of cross-selling, but I believe it can be a canard,” he says. “At Capital One we had millions of credit card customers. But when we tried to sell them deposits or wealth management, very few were interested. Even with consumer loans you have to do all the segmentation upfront and offer pre-approved products that customers just click to get.”
He continues: “Digitalization and smart phones are encouraging customers to unbundle and to go and get the best credit card or the best mutual fund from different providers. One day there may be a superapp to connect them all.”
Revolut is trying to build that.
“But today,” Morris says, “customers would need to be strongly incentivized to bundle it all back together.”
Large banks in the US, as well as some in Europe and many in Asia, have begun to invest heavily in fintech, seeking to disrupt themselves from within before someone else does, or to acquire the best start-ups before they become threats.
JPMorgan has been buying fintechs hand over fist this year.
There’s a double challenge for smaller regional and local banks seeking to do the same: how to spot the most promising disruptors and the best time to buy them.
Pile in too early, before new businesses are proven, and a bank could lose a lot of money on a series of small acquisitions that fail. Wait until it has reached industrial strength and even a small fintech could be valued on far higher revenue multiples than any would-be acquirer and be very expensive.
And it is even harder to absorb a group of fintech companies, many of which might fail, and put them to work on a bank’s own customers and balance sheet assets at scale.
Partnerships
Morris suggests there is another way. “As the digital deniers are drummed out and banks awaken to the technology, they don’t have to buy fintechs. They can partner with them.”
Chicago-based Avant, for example, is a digital consumer lending platform focused on loans of between $2,000 and $35,000 over two to five years to near-prime retail.
Founded in 2012, it had already delivered $6.5 billion of loans to 1.5 million customers by the start of 2020. In the process, it had built a software as a service business for other banks to digitalize their own lending and omnichannel banking operations. It separated this out as a new company, Amount, in February of last year.
Amount lists TD Bank, HSBC and BBVA as customers. In April, Barclays in the US partnered with it for buy-now-pay-later loans extended to customers at the point of sale. This old product is the new big thing in fintech. It is the business Afterpay built, starting in Australia and ending up being bought by Square this month for A$39 billion ($29 billion), in Australia’s biggest ever M&A deal
“There’s been an explosion in buy-now-pay-later,” says Morris. “The banks should have owned those smaller-ticket, riskier, point-of-sale loans paid back in instalments, but they completely missed out.”
QED is an investor in both Avant and Amount.
Morris says: “We are at a point where regional banks, if they wake up and partner with fintechs, might, by leveraging their technology against the banks’ own assets, make two plus two equal five. But if they carry on in the old way, buying small banks and smushing them together, they will start to lose ground significantly.”
Many fintechs start with debit, subsidized interchange, payments transfers and savings accounts before venturing into the riskier business of making loans to customers to make money off them.
A few start with the harder business of lending, which exposes them both to the credit cycle and to the funding cycle. Even if it remains available, funding can cost far more than for banks.
QED has invested in plenty of both kinds. Morris highlights the capacity of new technology to bring financial services to underserved segments of the population by improving credit underwriting for those on low incomes.
Across the US population, the average Fico score for credit was 711 the last time it reported, in 2020. The average score for home buyers was then 731; and the average score for those on low income was 658.
Morris says: “In the US, if you have a Fico score much under 650, banks don’t want to lend to you and they figure you don’t have a lot of money so they can’t generate much revenue. That’s why neobanks are crowding into that space.”
It’s not just banks. Mission Lane, for example, provides credit cards to sub-prime customers in mobile-first form. These are a vastly lower-cost alternative to harvester cards, often described as ‘payday on plastic’. Mission Lane grew out of LendUp, an alternative credit scoring and credit education platform that shows customers options for credit from various third parties.
QED has invested in both. What does Morris see as the cutting edge, the next buy-now-pay-later?
He says: “We are seeing more in revenue-based lending, that is against revenue that has been earned already but will be received later. So Wayflyer in the UK makes working capital loans to small e-commerce businesses. Rain, based in Los Angeles, lends to people who earn by the hour but get paid by their employers at the end of the month. Wagestream in the UK is very similar.”
This is often called income-streaming.
“It’s a type of business that could kill off the payday lenders,” Morris says.
Wouldn’t that be a very good thing?
