J.P. Morgan Private Bank Publication

Mark Munoz, Managing Director for Contineo & Venture Partner at Vectr Ventures

Financial Technology – or FinTech as it is commonly known – is riding a wave of unabated enthusiasm. The industry attracted US$12.2 billion of capital in 2014 alone1, with new players looking to replace or enhance traditional banking services – from smartphones offering contact‐free payments to artificial intelligence services providing investment advice. Banks are realizing that the days of incrementally updating legacy systems and patching solutions when possible are ending. In turn, there is a shift from the “run versus change” mentality toward a “run versus innovate” model.

FinTech startups are gaining recognition from banks and investors alike, albeit for different reasons. Whereas banks are keen on partnering with those who can offer them an edge in this digital shift (whether by cost streamlining, providing greater transparency for regulators, increasing their service distribution range or revamping outdate processes), investors should instead be looking at how sustainable their business model is, or whether they have a competitive advantage to endure a financing crisis during their early growth phase; when their brand is not yet well established. In either case, investing in FinTech is not a short term trade, it should be done by those who are prepared to be long term partners. Given the importance of longer term sustainability, below are a few aspects investors need to consider:

The strength of the team is the top criteria. Unsurprisingly it is among the first things experienced VCs look at when making an investment. Having the right team can make or break the company, more so than the idea behind it. Investors will want to look at the right level of expertise and experience of the founders, the right background/academics, past track record and reputation in the sector.

Investors should be familiar with the startup’s niche sector and business model. Although often used as a generic term, FinTech tends to be quite specialized across a wide range functions, from data analytics companies that establish a borrower’s loan risk to blockchain solutions for derivatives trading and the record‐keeping of complex products. This means keeping up‐to‐date with market developments and becoming comfortable with the nuances of the sector. It’s important to note, most FinTech startups won’t survive the first years; so if investors do not understand bitcoin, or payments, or lending, it may be best to invest elsewhere. Understanding the competitive landscape is necessary, as the companies that lack competitive advantage will be quick to fall behind the pack.

Keeping close checks on market changes and emerging trends is especially relevant. In this sector there are many fast moving parts. A new technology, a newly accessed market or changing regulation can quickly blindside someone looking to make an investment without the proper due diligence. The emergence of RegTech (technology focused on supporting banks in meeting their strict and ever‐ changingregulatory requirements), for instance, is a testament to how new entrants are creatingsolutions for an evolvingindustry demand. Fintech can be a catalyst for innovation, benefitting banks and regulators alike and create key opportunities.

The potential market size is big, there is a sound strategy to win customers; but how well can a small company take advantage of this opportunity? Having a scalable business model is imperative for success. Scalability and an appropriate pricing model makes a notable difference from leveraging distribution networks, engaging in trusted partnerships and cost advantages. Scale ensures the business can grow up to a level where investors will get their money back.

Whether a startup, a home or an asset, an investor needs to trust what he is buying and to be convinced that this business addresses a real concern or problem in the marketplace. The founders’ vision needs to solve a problem and do so in a simple and innovative way. If the supply chain is too complex, or the value proposition is not clear, the investor might need to rethink.

The FinTech space is quickly becoming a crowded one. The added choice is great for consumers and market participants, but what does it mean for the sector? The FinTech world also has its fair share of challenges and shortcomings compared to leading banks. These include questions around client trust, a lack of long‐term credibility and the absence of an existing client base. Another difficulty is the culture clash that potentially exists between the tech and banking world. Successful startups will need to adapt to the inner workings of banks and gain credibility for delivering trustworthy solutions for consumers.

Out of expediency, banks have typically had a culture of quick fixes and improvised patches, mixed with long approval processes and committee sign‐offs. As with any investment, understanding the risks is imperative.

It should be apparent by this point that FinTech will soon be facing a big rationalization. Does it mean that now is not the time to look at investment opportunities? Of course not, the potential opportunities are too great to ignore. It does mean, however, that this is the time to be selective and discern which will be the startups that will define the future of the sector. Investors must look past the noise and hype surrounding FinTech and choose the right founders, with innovative ideas, who are well placed to capitalize on emerging technologies in this new market.