Updated: Sep 9, 2022
Fintech is a catch-all term for anything related to finance and technology. This moniker was suitable for so long because banks were so slow to adopt technology. But fintech is no longer a niche arena as the space has attracted 20% of all VC dollars in recent years.
Now that the space has grown, companies have matured, and the cycle is turning, we need to start defining these “fintech” companies with more accurate descriptors. It’s important for partners, regulators, investors, and the founders themselves to understand that not all fintechs are treated equally. Though the market may tell you that you are one thing during a delirious period, you will eventually be forced to deal with the reality of your company’s identity. Being clear-eyed from the get-go mitigates future pain and increases the likelihood of positive outcomes.
The Fintech Spectrum
Fintech so cleverly comes from combining the words “finance” and “technology”. The spectrum between finance and technology is what we’ll call the Fintech Spectrum. On one extreme you have pure finance companies and on the other hand pure tech companies. Everything in between is fintech! This includes neobanks, alternative lenders, compliance solutions, roboadvisors, fraud monitoring, digital onboarding companies, BI reporting solutions, investment platforms, payment companies, bank core providers, and so on.
You know who else is a fintech? JPMorgan, the biggest bank in the world. How can we not call them fintech? They spend billions of dollars per year in R&D, employ more developers than Paypal has employees, manage their own blockchain, and regularly acquire fintechs.
How can we look at JPMorgan and definitively say “that’s finance” and then look at Square and say “that’s tech”? Jamie Dimon’s suit and Jack Dorsey’s beard don’t define their businesses. We need better ways to do so.
Let’s start with the ends of the spectrum: finance and technology.
What is a finance company? A finance company is one that makes money from money. Money is lent out and repaid with interest. The finance company “lends” cash to its customers and “borrows” money from its suppliers. Its good sold is cash and COGS is their cost of capital.
What is a tech company? A technology company is one that makes money from information. Tech companies mine data, organize data, process data, and produce answers using data. They create efficiency, capacity, capabilities, and reach.
Finance companies offer liquidity and leverage. Software companies offer automation and insights.
Within this spectrum, we can define three categories of fintech companies that account for the majority of the industry. I’ll touch on the companies that don’t fit the categorizations later.
#1 Tech-Driven Financing Company: A company that leverages and solely relies on technology in its information gathering, processing, and decisioning for the purpose of extending financing products to customers. These TDFCs assume the risk of their loan book, issue funds from their balance sheet, and likely raise debt from investors, generating most of their revenue from interest spread.
#2 Software Companies in Finance: A company that enables their clients in the finance space to better manage and utilize their data, process information, or service customers. This label can also be applied to B2C companies that do not move or manage their customers’ money.
#3 Digitized* Finance Company: A company that utilizes technology to execute transactions, move money, facilitate investments, manage portfolios, and even prevent customer losses. These companies make money from their active participation in the customer economic activity built atop their services.
Digitized Finance Companies are what we think of as the traditional epicenter of fintech. PayPal made it possible to send money online. Stripe and Braintree made it easy to accept credit cards through websites.
As the space has grown, the opportunities and investor appetites have expanded. Successful fintechs grew so large that fintech-specific SCFs were built just to service them. Alternative lenders that looked like tech companies, have attracted venture capital to disrupt the old guard or deliver new forms of customer value.
These companies all fall within Fintech Spectrum but are very different. Even if they each start out acting like a fintech, the market will eventually correct them. Founders that don’t fully understand what they are building and their future operational, regulatory, or capital markets challenges are guaranteed to be blindsided. Investors that gloss over the differences may overpay and help set the entrepreneur down a rocky path with a low likelihood of success.
Every startup is hard to build. Not knowing what type of fintech you are guarantees it will be harder.
*A Quick Note on the use of “Digitized”: I subscribe to the notion, pointed out by Simon Taylor in this Brain Food blog post, that nearly all of fintech is still Digitized Financial Services because they are built atop very non-digital banking infrastructure. True “digital” services, from a first principles standpoint, are being built across the Web3/crypto world. This same, 3-category framework could be extended from the current generation, digitized paradigm to the digital versions built in web3. Services would look the same but would be measured differently, because the open nature of web3 creates much larger opportunity and risk.
“But I Don’t Fit”
I predict that most founders reading this will think that their company doesn’t fit neatly into any of these boxes. For their sakes, I hope that is true . Innovation doesn’t result from fitting into the existing paradigms and the most exciting opportunities are combing elements from across the fintech spectrum to deliver their unique customer value.
However, the founder should be able to look at their business and determine which category fits best. If they earn multiple forms of revenue, how is their revenue distributed? What is the primary job to be done for your customer? What are your bottlenecks to scale? What is your critical path to success?
If you can’t answer these questions, especially at an early stage, you may not be focusing on what drives your company’s success.
Companies that successfully grow beyond a single category transcend into industry giants. These companies create new products that build atop and adjacent to their initial solution, creating new acquisition vectors and engagement drivers. These expanded solutions often reinforce the primary value driver for the business and in many cases, have additional revenue streams (born out of these overlaps) that surpass the original source of revenue. The fintech giants became multi-category fintechs over long periods of growth and success with their primary solution. Even when the companies reach that multi-category point, they are forever known by the initial product hat drove their success.
Early-stage founders hoping to join the titans should remember that, as they position themselves to customers and investors. Be clear about what business you are building from the start so that you raise, hire, build, partner, and grow in the manner that gives you the greatest chance of success.