Month: January 2020

Solving for Company/Investor Fit

Early stage financing options have evolved radically, giving founders more choices to optimize for company/investor fit.

Early stage financing has evolved radically, everything from the amount of capital available to the types of funds and their return targets.

It’s critical that founders think about company/investor fit as they choose financing partners, particularly in the earliest stages.

Why?

Choosing for company/investor fit enable founders to authentically build the company they envision. It also avoids misalignment between founders and investors along the way as critical decisions are made.

Early Stage Capital Explosion

A few trends have converged, creating an explosion of both capital (3x as more in the last 10 years) and types of funds managing that capital focused on early stage.

  • Yield Chasing – We’ve lived in a zero and negative interest rate environment for years now. 15+ countries offer negative returns on their sovereign debt. Capital managers are chasing yield in riskier sectors and stages.
  • Software Ate the World – The importance of tech in our lives grow and their market cap dominance does also. Early stage tech is a good place to chase yield.
  • Software is Cheaper to Build – AWS has made software 10x cheaper to build, meaning companies can do more with less capital.

Funding Landscape

The amount of capital focused on the seed stage from traditional venture capitalists has exploded, ~500 firms at last count. These are “traditional” in that their goal is to return 3x+ of funds invested (net of fees) to deliver top decile results to their LPs.

The growth in number of firms and capital gives founders options of personalities and operating styles to choose from, if they believe their business has the potential to fit their return profile.

Let’s focus instead on the emerging class of alternative capital sources for early stage tech that offer founders other options.

  • Shared Earnings – (Indie.vc, Earnest Capital) These firms invest provide between $75K to $1M to companies on a shared earnings model. This is a novel approach for software business that aligns the returns the fund targets (~6%) with revenue generated by the company over a given time period.
  • Non-Dilutive Working/Growth Capital – (ClearBanc, Lighter Capital, Capital, RevUp) These firms offer capital to grow and run your business with fixed terms (~1%-20%), no equity warrants or conversions. These models are more efficient today via real-time data the company can provide the lender. For example, ClearBanc can inspect your ad spend and conversions to asses the health of your marketing spend to base a loan decision.

These alternative funding sources have vastly different return needs than traditional venture capital. They provide new, and in some cases more efficient path, for founders building businesses that fit the profile.

Why Company/Investor Fit Matters

Imagine you’re running a business that is doing $5M in ARR and growing steadily with healthy margins. You can either pocket the free cash flow or reinvest for growth. Odds are you’re probably happy.

Except…if you’ve taken early investment from a fund that needs you to hit $100M in revenue in the next 3 years to meet their return expectations. Oops, instant misalignment in the decisions to be made about how to grow the business.

Raise another round, build a risky new product line with 10x possibilities or incrementally grow your existing one? Easy decisions when the company and investor share the same expectations. Nightmares when they don’t.

Pick the investment source that aligns most closely with the business you plan to build. Then adjust on the fly because nobody’s business goes according to plan!

One Way to Improve Open Finance Apps

Banks need a regulatory push to make our data more accessible and transportable.

Regulation could help here…gulp.

Particularly in the US, our financial data should be more easily accessible and transportable. This would make it simpler for more applications to be built to give us views into our financial life (bank account, brokerage, etc…). That in turn would allow different segments of the population to be better served for their needs. Worried about overdrafts? Remittance fees? There’s an app for that.

Wait. Doesn’t Plaid make financial data easy for developers to access $5.3B different ways? And didn’t Mint begin this trend over a decade ago? Yes and yes.

Notice I said improve in the title though, not enable.

First a quick background on how Plaid, Yodlee, and others work today. Primarily they compile your financial data via screen scraping. They access your account using the credentials you provide and parse the interesting data (account balance, tx dates, etc…) to share through a formal API to an app developer. For the app developer it saves time and allows them to focus on their unique business value rather than plumbing.

To be clear, I’m not condemning screen scraping. I’ve used it in multiple companies to structure data that resides in unstructured formats on websites or PDFs.

It does have serious problems though. For one, it’s brittle. The underlying site changes often and when it does your scraper breaks. So access to some banks is constantly under repair and there is no way to know when. Also, it can break completely when the provider of the website wants to break your scraper. And they have multiple reasons to want to do this.

So what can be done? Why don’t banks adhere to a standard format of making data available? It is your data in the first place. Unfortunately, they have no motivation to do so. They prefer you live within their universe of products and not easily manage finances across banks or have simple access to products elsewhere that would compress their margins.

Europe offers a roadmap to solve this with their PSD2 initiative. Among others things, PSD2 requires banks to adhere to a standard API for data access. Unfortunately, there probably isn’t another way to make this happen among banks that aren’t motivated to do it on their own. More unfortunately, we probably won’t see a similar rule in the US.

This wouldn’t negate the value of Plaid and similar services (see Tink for proof). It would serve to make their APIs more robust and reliable. The winners would be end users benefiting from more ways to manage their financial health. And we should all want that outcome.

Visa, Plaid & Networks

Plaid’s acquisition is a tailwind for the next wave of fintech infrastructure networks.

Big news, $5.3B big. Everybody has takes, including Visa themselves, on why fintech infrastructure is more important than DTC fintech. We’re all geniuses in hindsight.

Unsurprisingly, Ben Thompson has one of the best explanations of the rationale [paywall]. It ties back to the power of a network that can not only provide read-only access to your money, which is what Plaid offers. The future is programmatic read and write access.

Visa today sits in the middle of a 3 sided network.

  • Merchants – who offer products and benefit from a network that extends credit and fixed payment terms
  • Consumers – who need credit and convenience
  • Banks – who have money to extend credit

Plaid today sits in the middle of a read-only 3 sided network, a threat and opportunity to Visa’s business

  • Consumers – who want modern access to their finances
  • Banks – where money resides and earns interest, is lent/borrowed/etc…
  • Developers – building new financial products

Today, Plaid dominates in the read-only use case for developers. Tomorrow, and what drove the acquisition premium is a read+write network that Visa can operate alongside it’s current one. Ben Thompson’s explanation:

More importantly, though, is the power of inertia: as long as it is hard to move money around, the more likely it is that that money will stay in the bank, collecting minuscule interest; or, if customers need value-added services, the path of lowest resistance will be simply getting them from their bank.

An API-based world could change this dramatically: suddenly consumers could commission robo-advisors to move their cash to whoever is offering the best rates, or to automatically refinance debt. Value-added services from multiple vendors would be equally easy to access, meaning they would have to compete on price or terms. In other words, much like the open Internet, banks fear that profits will be rapidly transformed into consumer benefit.

Ben Thompson

Plaid’s founders, team and investors are huge winners obviously. The secondary effect is the rising tide this will provide to the next wave of fintech infrastructure players like Astra, Alpaca & SynapseFi.

Innovator’s Dilemma at Coinbase

Coinbase faces a dilemma in the battle to own the emerging brokerage layer in crypto.

This quote from Brian Armstrong holds the clue to an underappreciated threat to Coinbase.

…many of the companies we think of as cryptocurrency exchanges were actually brokerages, exchanges, custodians, and clearing houses bundled into one….I think we’ll see the cryptocurrency market structure evolve to more closely resemble the traditional financial world, with these functions being separated out…

Brian Armstrong

TL;DR

  • Brokerages are an inevitable evolution of crypto-finance, abstracting investors from exchanges.
  • This is the new battleground in crypto and the winner holds the key to serving users with a full suite of financial products.
  • Coinbase faces a classic innovator’s dilemma. Their exchange business is a cash cow today, but a liability in the battle to own the brokerage layer and winning the next phase in crypto.

The Opportunity

The $100B opportunity over the next decade is to own the brokerage layer in crypto.

Let’s assume Brian is right and crypto-brokerages emerge. The key to appreciating the importance of this trend is that brokerages, not exchanges, own the end user relationship. And owning that relationship is critical.

That relationship is the key to cross-selling banking, savings, borrowing and investing products, crypto or otherwise. Winners in finance offset high CAC by serving all your finance needs. The brokerage has the customer touch points to understand their needs and market other products.

This is why every fintech company follows a land and expand strategy and why Coinbase is expanding from their core exchange business.

The Dilemma

Brokerages own the customer relationship

Coinbase’s strength today, their exchange, may be severely impacted in the battle to own the brokerage layer.

Brokerages execute customer orders at the best price, thus they operate across exchanges tied to no single source of liquidity. A healthy market for crypto-brokerage products would deteriorate Coinbase’s pricing power and volume.

Today all Coinbase retail orders are funneled directly to their exchange. Competing with other high-quality brokerage products would require Coinbase to provide best execution for customers, distributing their order flow across competing exchanges.

This begs the question, will they sacrifice short term revenue for the longer term prize. It’s easy to say yes in theory but hard to do in practice, even for a private company.

Consider that they just raised trading fees! It’s less expensive for them to offer this service over time, but they chose to offset declining volumes by raising fees. Does that sounds like a company ready to sacrifice short term revenue?

Brokerages make the market more efficient in general which reduces cost. So even if Coinbase doesn’t compete directly with other brokerages, they will feel their emergence via reduced margin.

Are you thinking that Coinbase is the 100 lb. gorilla of crypto and will naturally dominate every layer in the stack? Consider though that only ~50M people hold crypto today. A rounding error. The billions of new users will choose their onboarding path via crypto-native brokerages and banks, not directly with exchanges. So Coinbase’s dominance is far from certain.

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