The Solution To The Fintech IPO Shortage



A Seeking Alpha article titled Why Fintech May Not Be Fit For Public Consumption states:

The year 2019 seems set to be a record-setting one for venture capitalist exit value capture by means of tech IPOs. But fintech doesn't seem to be a part of this picture. VCs are certainly putting money into fintech startups. There were 170 financings in the US in the first quarter of 2019. But, as Pitchbook says, 'not one of the most valuable fintech companies in the world seems particularly close to an offering.' "

The article chalks this up to three primary causes:

1. Poor IPO performance in 2018. According to the article, "One reason nobody is in a hurry to go public is that the results of the last crop of fintech concerns that did go public have been unimpressive. Adyen and IntegraFin are prospering, but neither GreenSky nor EverQuote is "lighting up the heavens" according to Seeking Alpha.

2. Mega-round financing. Seeking Alpha postulates that investor interest in mega-rounds--e.g., Qatar Investment Authority's investment of $500 million in SoFi and Tiger Capital leading a round that raised $300 million for Coinbase--is another factor dampening interest in IPOs. According to Jim Marous, publisher of the Digital Banking Report:

With all of the mega-round investment in fintech firms, you would think more fintech players would cash out and go the IPO route. But why would successful fintechs, who appear to have a bottomless pit of funding at their disposal, subject themselves to the massive scrutiny that comes from going public? Fintech firms don't see a slowdown of the funding fire hose and have no desire to lose control of their vision."

3. Lack of scale. Seeking Alpha asserts that fintech "doesn't scale as easily as other sorts of tech," making fintech startups less likely to be IPO candidates. According to one veteran of the fintech startup scene (a founder and angel investor who now heads up technology innovation at a large bank, which is why he prefers to remain anonymous):

People underestimate the scale dynamics of financial services. You need a lot more maturity across all measurable KPIs before you can be successful in the long-term. In an ecosystem with these scale dynamics, if a fintech startup can use private capital at favorable costs to grow operations and monetize employee equity, and avoid the distracting microscope of quarterly filings, it's going to do so."

Pascal Bouvier, Managing Partner of Middlegame Ventures echoes this sentiment, but points out that there are startups who have achieved scale and still not gone public:

Stripe is an example of a fintech that should already be public--they've achieved scale. But for others, operational readiness at massive scale is key in order to go public. If you do not achieve repeatability in your core business you end up suffering post-IPO.”

The Business Model Factor

Scale is certainly a big part of the equation--but why aren't many fintech startups able to achieve scale? The answer may be their lack of a sustainable, viable business model. According to Brad Leimer, co-founder of Unconventional Ventures:

It's much easier for companies like Ayden and Klarna to go public because they have a profitable model out of the gate--they only need to achieve market share to achieve escape velocity. Fintechs have to figure out that there are alternative business models to the ones banks leverage today. The path toward more IPOs in fintech is to think differently about where the industry derives value in exchange for what they create for the consumer of business."

Interestingly, Leimer's two examples are B2B--not B2C--companies, and that might hold a clue to the dearth of fintech IPOs.

Many Fintech Startups Aren't Meeting The Criteria For Sustainable Growth

What must a fintech (or any) startup do to succeed for the long-term? To oversimplify matters, it must first either offer a new product or service to fulfill unmet needs or provide an existing product or service with innovations to marketing, distribution, service, and/or product and service features that enable it to compete with incumbents. And then second, it must either expand the market size and/or its set of offerings to sustain growth.

Too many B2C-focused fintech startups have come to market with existing products or services whose "innovation" is digital distribution and service. That's not enough of an innovation to thrive. The world of B2C fintech in the US is characterized by:

  • Digital tunnel vision. Too many fintech startups suffer from Bank Displacement Syndrome--the belief that traditional banks can be displaced with nothing more than a digital product offering. Consumers who opened accounts with digital banks have done so because they want rewards, better interest rates, and/or better PFM tools--not because they want a "branchless" bank.
  • Featurization. A number of fintech startups have hung their point of differentiation on capabilities like providing a "safe to spend" feature or getting one's paycheck a day early. Savings tools like Digit and Qapital do a great job of helping people save, but the service is tied to some larger solution (i.e., checking account) that they don't provide. This "featurization" of fintech is creating firms with business models that won't provide sustainable growth--and the market is not ready to believe that these firms can expand product-wise.
  • High-risk lending strategies. After hitting a high of $25 per share in December 2014, Lending Club's stock price has been trading for less than $10 since the beginning of 2016. It shouldn't be a surprise. According to Pascal Bouvier, "Lending Club is an example of a fintech that should not have gone public--its credit portfolio wasn't mature enough." That's being generous. The firm's portfolio has been heavily weighted to credit card consolidation from sub-prime borrowers, and it hasn't successfully expanded market size or its offerings to create and sustain growth. The same can be said for some digital-only small business lenders.

Is there hope for the fintech IPO shortage?

B2B Fintech

A Harvard Business review article claims that "disruption starts with unhappy customers, not technology."

On the B2C side, there is no huge mass of disgruntled bank customers waiting for something new to come along. In fact, JD Power found that Millennials' satisfaction with large banks is on par with their satisfaction with smaller institutions.

On the B2B side, however, US banks--who will spend $67 billion on IT this year--are hardly very satisfied with many of their IT vendors.

Digital marketplaces like LendKey and OnDeck have learned that the bigger opportunity in the market is to help improve the effectiveness and efficiency of existing financial institutions--not to displace or replace them.

This, by the way, is why I'm convinced Amazon will not directly offer financial services and compete with the banks--there's too much money to be made there by having banks as customers, not competitors.

The bigger opportunity in the world of banking--right now at least--is in changing the economics of the banks' cost structure, not the consumers'.

There are few--if any--fintech startups who are changing the economics of financial services the way Google and Facebook changed advertising, the way Uber changed transportation, or the way AirBnB changed lodging.

As more fintech startups address this opportunity, expect to see more fintech IPOs.

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