The seismic shifts caused by the financial crisis led many industry commentators to believe that the industry would experience a new wave of innovation borne out of pure necessity.
This has not happened. Instead, the FinTech sector has steadily grown to fill the gap. In the past year alone, over $1 billion has been raised in FinTech focused VC funds.
Nimble start-ups easily outperforming banks in terms of speed, agility, and attracting the best talent. While legacy institutions have missed opportunities or been constrained by a culture of ‘decisions made by committee’, FinTech start-ups have pressed on with creating exciting products or services that have the potential to disrupt major areas of the financial services industry.
Services like Stripe which is disrupting online payment, SumUp which is tackling mobile card payment and Digital Insight which is leading the way in providing online banking solutions to middle market banks, are cases in point.
It is the FinTech sector’s capacity to disrupt, coupled with the sheer breadth of opportunity within financial services, which make it a sector that is so interesting for investors.
This is underlined by the fact that, according to Financial Technology Partners, 74 deals have taken place in the FinTech sector in the last month alone (4th November – 4th December).
Crucially, the products that FinTech companies create have the capacity to become profitable rapidly. This is in part due to the amount of revenue these companies can generate, which is usually significantly higher than in other market segments.
Braintree, for example, which allows merchants to accept card payments online, was founded in 2007 and has already been acquired by PayPal in an all cash deal for $800 million. This is more than eleven times the $69 million in funding that Braintree received prior to the acquisition.
An oft-cited problem attributed to the FinTech sector is the inordinate number of regulations that companies need to navigate to launch a product. While regulation is obviously a burden on the sector, it has the advantage of weeding out inferior start-ups and providing a level of protection for successful products.
As a result, the general quality of start-ups and the potential for profit is much higher in FinTech than in other technology segments, such as digital marketing or ecommerce. For example, according to NVCA data, between 2008-2012 in the US, there was over $4 billion invested in consumer products and services.
FinTech accounted for almost $2 billion of this figure. In that same period, exits in consumer products and services amounted to around $2 billion and FinTech approximately $750 million. This is a very effective use of invested capital.
Looking at the European FinTech sector as a whole, London is leading the way. A glance at the FinTech 50 will show a majority of activity taking place in London.
The flourishing tech scene around Old Street is in close proximity to one of the world’s leading financial centres. This has created an environment that no European city can yet match.
Europe’s other leading tech centre, Berlin, is constrained by the lack of large financial firms based there. Culturally, consumers in the UK currently have a much greater appetite for innovative FinTech products or services than in other European jurisdictions.
This can be seen in the number of accounts per person. In the UK, there are approximately 2.5 payment cards per person, in Germany 1.6. Investors also have less experience of the FinTech sector than their London-based counterparts. This means that UK-based start-ups can scale faster than their European competitors.
While the potential for a good investment in FinTech companies is readily apparent, would-be investors need to caution their approach by being aware of the risks that are unique to this tech segment.
For many start-ups, the youth of the CEO or management team is a unique selling point. However, in a FinTech company, a fresh-faced graduate – no matter how talented – will lack the required level of financial experience.
Observation of regulatory issues is essential. If a company breaks compliance rules in the financial sector, it will get caught by the regulator and will probably be shut down.
Most FinTech start-ups also require much more capital to launch and run than companies in sectors such as consumer or mobile. International expansion must also be on the agenda in the very early stages of the process, as the majority of FinTech opportunities need to be global to be worth investing in.
The potential for FinTech companies to earn substantial returns, coupled with the breadth of opportunities to disrupt the financial industry, marks this space out as one of the most eye-catching investment opportunities currently available.
Michael Backes is a co-founder of Liquid Labs
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