Fintech: throwing down the gauntlet to financial services

Given the sprinting pace of change in today's society, the continued use of paper money may strike some as anachronistic. Innovation in the financial sector is there for the taking and the sector attracted VCs from all over Europe in 2013.

Though Sweden boasts payment solutions firm Klarna, and Germany is home to credit analytics firm Kreditech, the rapid growth of UK-based companies such as money transfer firm TransferWise – owned by VCs including Index and Valar Ventures – and payday lender Wonga – backed by investors including Balderton and Accel – suggest the UK is steaming ahead in the global fintech space.

"There was about $11bn invested in fintech businesses globally last year, of which the US accounted for 61% and the UK 30%," says Alex McCracken, director of venture services and origination at Silicon Valley Bank's UK branch. "The UK accounted for half of the US, but given that our population is one fifth of the US, pro-rata the UK is two times ahead of the US, with most of that in London."

Career opportunities
After the swathe of redundancies in the UK financial sector, few of those clutching a P45 would have seen the recession as a chance for career development. But in the fintech space, that's exactly what happened. Says McCracken: "I think the City of London has a large part to play in the UK's dominance in fintech. Banks were shedding staff during the recession, but we're seeing people who were experts in a big bank and had nice bonuses, some savings and strong expertise. They've come out with interesting plays that leverage cloud infrastructure and their own knowledge. They've become experts to the sector, rather than one particular bank. It's the best type of spinout really."

From payments software, behavioural analytics and security and fraud prevention technology, these point solutions firms are focusing on one function that had erstwhile been a very small component of the services offered by behemoth banks. Leveraging cloud infrastructure and focusing on technology, overheads are low for niche providers. But scalability is tough.

"The amount of money you need to actually get big is a challenge," explains Paul Jozefak, managing director of fintech accelerator Liquid Labs. "You can start a business very cheaply, and it's an area where investors can find a product or service that can start generating revenues very quickly so you can very concretely measure whether something you're working on has a chance in the market or not. But, fintech is one of the areas that if you really want to compete and go global, you have to raise a significant amount of money... millions upon millions from multiple financing rounds. Because once you get to a certain size the big players start competing against you, and they have tons of cash to compete. You have to build up a war chest."

Indeed, funding rounds have been frequent. Take Wonga; the headline-grabbing poster child of the fintech space has raised around $145m across several funding rounds since inception in 2007, beginning its lifespan with Balderton Capital among its shareholders and concluding 2013 with the unwitting support from the Church of England...

Klarna's total funding stands at around $150m across five funding rounds. The Currency Cloud, a cloud-based currency conversion and international payments service, completed three funding rounds in just six months in 2012.

International scalability is another issue altogether and one that holds back many start-ups from true disruption in an institutionalised market. The tomes of regulation a fintech start-up must comply with is enough to deter even the most bright-eyed and bushy-tailed of founders.

Says Jozefak: "Regulation is one of the greatest hindrances in the fintech sector. The regulations that are in place are obviously there to protect the consumer, but a lot of them are protecting the incumbents more than anything." And the regulatory burden increases as the start-up targets new international markets for expansion.

Despite the challenges, traditional financial institutions are increasingly drawn to innovation in fintech start-ups. In December 2013, for example, Barclays partnered with Techstars to launch a London-based fintech accelerator. But Russian bank Sberbank took a bolder stride towards innovation with the launch of SBT Venture Capital, a new venture fund focused exclusively on investments in the fitnech space. The vehicle will invest $2-10m per deal, primarily in series-A rounds.

Venture forth
"Our first main objective is obviously economic," explains Matteo Rizzi, SBT partner. "But the second is to help the bank to study and get close to fintech disruption and innovation, avoiding any surprises. Like every leader, Sberbank has the luxury problem of maintaining its very big market share. And one way of doing that is to make sure it is at the cutting edge of technology, customer services and new ideas, and cross-selling opportunities and so on. Investing in a start-up is probably one of the smartest ways to do that." 

And the bank is dedicated to wooing the most promising start-ups before others get a look in. "We will soon announce a couple of investments in fintech incubators," says Rizzi, highlighting the fund's strategy to ensure dealflow. "One of the reasons we decided to put some money in a couple of them is to have the chance to be in the first draw for the best start-ups, but it's also so that when we see a company that is too young for us, we have a place to put them," he adds.

The sector has certainly caught the eye of the big banks. But will this translate into a welcoming exit route for VCs? Says Rizzi: "Large financial institutions might look like a logical exit opportunity, but tech and services companies, as well as alternative financial players, are probably better prospects."

Whoever the buyer, the opportunities are rich. McCracken recalls the case of Tradeshift, an e-invoicing cloud software provider backed by Notion Capital and Kite Ventures. The business worked with a number of large corporates, such as the NHS for example, which received invoices from a huge number of suppliers, all of which invoiced in a different way. Trade Shift standardised the invoicing process through a cloud-based solution. "They had thousands of suppliers sign up," says McCracken. "They then went and signed a deal with CapitalAid to provide up to $3bn of working capital to all those suppliers, saying if you need working capital or invoice financing, here it is. They went from a standard invoice solution provider to an invoice financing provider in the space of a few months – that's how fast things can happen in fintech."

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