Financial technology (fintech) startups are trending topic in recent years. The financial industry can be a sloth-like creature, with banks just recently adding support for decent mobile apps and more advanced capabilities such as spending trackers and remote deposit support. There are still many gaps left between what consumers want and what banks provide. This gap is currently being filled by fintech startups.
As I see it, there are currently three major categories of fintech: Payments & Money Transfer, Spending Trackers, and Investments. The order in which these categories are listed is not random: each category becomes easier to enter, in terms of the capital (human and financial) and barriers to entry. To be abundantly clear, let me further define the first category. The Payments & Money Transfer encompasses companies that allow you to pay for goods and services through them, or transfer money to anyone you wish. I lumped payments and money transfer together because the distinction between the two is not always clear (are you transferring money to pay someone?). This category includes companies like Venmo, Square, TransferWise, Stripe, and PayPal. It also includes Apple Pay and Google Wallet, but these services are provided by established companies and do not fit the bill for this analysis, which focuses on smaller companies. To be comprehensive, however, I have added them to the graphics below. You may even argue that Square and PayPal are too large to include here, but I feel they are not large enough to eschew.
1) Payments & Money Transfer
As I briefly mentioned earlier, the Payments & Money Transfer category is most difficult to enter. It is extremely expensive to process payments due to the risks involved for each transaction, fraud, required security measures, governmental requirements, and a slew of other difficult problems that need solving. It’s not impossible, and we’ve seen some startups attempt to solve these problems, but on the whole, these startups are much larger in size and rarer in quantity. While I think a few may thrive on their own and even become public (Square, Stripe), the most likely scenario is for them to be purchased by the tech giants (Apple, Google, or Microsoft). For this scenario to be avoided, this category of services must find new ways and markets to monetize - an extremely hard proposition (Square is currently paying users $1 - $5 to use their Square Cash app!).
2) Spending Trackers
The Spending Tracker category is exactly what it sounds like. It is a service provided by startups that allows you to monitor your income, expenses, bills, and everything else that measures your cash flows. This category includes startups like Mint, Mint Bills (formerly Check and Pageonce before that), Level Money (as if to prove my point, acquired by Capital One at the time of this writing), and a few others. Unlike Payments & Money Transfer, the barriers to entry here are lower. However, it is costly to partner with banks to allow for a historical list of your transactions. The very same risks are present here as for Payments & Money Transfer, but they aren’t as demanding. The reason we see relatively few companies compete in this category is because there is very little money to be made. Spending tracking apps and services provide a value-add, but most consumers are not willing to pay additionally for it. Consequently, these types of apps are best when used as gateways to other products, or when they are bundled with an existing product.
To illustrate, let’s look at Mint, which is the largest and most popular Spending Tracker. The company began as a startup, and was soon purchased by Inuit, which sells personal finance and small business software. Although Intuit could have certainly charged users to use Mint, they smartly did not, because Mint is a gateway product to other Intuit software, most of which is not free.
Just this week, Capital One purchased Level Money, a spending and budget tracking app. The reasoning behind this purchase is likely to acquire Level’s infrastructure, team, and technology. I expect to see Capital One’s apps to improve in the next year as a result of this acquisition, either by incorporating Level into its existing apps or keeping it standalone and adding features.
It’s becoming increasingly difficult for banks to compete solely on savings and checking accounts, so they began to compete in mobile and online services. If Capital One’s mobile app are superior, for example, to Chase’s mobile app, it is more likely that a consumer will open an account with Capital One. Spending Tracking startups, of which not many remain private, will not survive on their own. They will either close shop or be acquired by larger financial companies.
Investment startups (aka Robo Advisors) are the final major category of fintech companies which I have identified. They are also the most common. This includes huge startups like Wealthfront and Betterment, in addition to smaller companies like Acorns and Robinhood. They are all companies which aim to help you invest (long or short term). These startups compete with the established financial advisory and investment firms (Vangaurd, Schwab, TD Ameritrade). I listed this category last because I believe the barriers to entry are lower than for the above two categories, but I’m not against rearranging this category with Spending Trackers either. They have very different barriers to entry, and it is difficult to say which is harder to break into. Do not get too preoccupied with the order of the categories, as the order is more for academic than hierarchical purposes.
This category of startups may actually succeed on its own, because they take a percentage fee or a flat cut of your investment. As I have written previously, these Robo Advisors face the majority of their challenges from huge traditional institutions, which have a lot more capital and consumer trust. The startups, however, have vastly better apps and sometimes provide more features than the traditional firms.
I see this category playing out in one of three ways. First, the less disruptive startups will simply flounder, since they won’t be able to get consumers to invest with then.
The second scenario concerns the innovative, but smaller startups like Acorns and Robinhood. They do not have the resources to compete effectively on their own, since investing is a capital intensive business. Consequently, most of these startups will go the way of Spending Trackers, and will be acquired by larger financial institutions for the same reasons: infrastructure, team, and technology.
The last scenario involves the larger Investing startups, such as Wealthfront and Betterment. They have much more capital to work with, and can hire the best people. Additionally, the more assets under management (AUM) they have, the more consumer confidence they will get, which will result in even more signups. It will become a virtuous cycle, to the point where these companies become large enough to stand on their own or otherwise go public. Not all of the larger firms will succeed, however, since there is a limited market for such services. The unsuccessful ones (success is measured by profitability) will either close shop or also be purchased, at a bargain, by the larger institutions.
In summary, due to the current unprofitability of fintech startups and the psychological aversion to risk that most consumers hold, most fintech startups will not succeed on their own. I see two emerging trends that effect the three fintech categories.
The first is for larger, established and traditional financial institutions to purchase fintech startups (i.e. Simple was acquired by BBVA, Mint by Intuit, Level Money by Capital One). This is a win for both parties; the startup gets the capital to create disrupting technologies, and the banks get the best technology, infrastructure, and human capital. Finally, consumers trust their money to the banks, and are more likely to make use of new technologies.
Second, fintech companies can go public to raise capital. We’ve seen this most recently with LendingClub, but this will become a trend in the future. For example, Square and Stripe seem ripe for an IPO (unless they get acquired). If Wealthfront continues to grow and steal market share from Vanguard, it too can look into an IPO. Again, this will provide them with the additional capital needed to succeed in the financial industry, and it will reinforce consumer beliefs in the long-term health of the company.
Not a trend but a reality of business, the unsuccessful startups will fail. This is a sad, but true reality of any business. Most businesses fail, and startups are businesses. Not all fintech startups will be able to become profitable businesses, and some will inevitably lose funding and exit the market.
Postface: This analysis did not include every startup in the fintech industry - there are simply too many to include. For this reason, I have chose to include only the largest and most well-known fintech startups.