14
Feb
2016
1

Ten Reasons why Fintech firms fail

This post originally appeared on the CB Insights blog, and was republished on American Banker.

 

You have a great fintech business plan. You assemble your team and create your startup. Here are seven common mistakes you can avoid if you want to have a chance to live another day.

1. Not thinking about proper licensing
You think you are a tech company. You think you are only building software. If you are focusing on b2c model, chances are you may require some type fo license. At the very least you may need to talk to your local regulator. Many a startup has tripped up by forgetting that the financial services industry is heavily regulated – sometimes maddeningly so, sometimes rightly so, sometimes both. Make sure you understand the regulatory laws and licensing requirements. Do not be shy, ask a law firm specialized in regulatory work. Heck, upfront homework may actually save you time and money later on and may help you be smarter with your business plan.

2. Not thinking about what it takes to raise money from strategic investors
You have decided to raise money from a bank or an insurance company. Financial services incumbents are regulated entities. They need, they must, they have to abide by very tight rules. If you are raising money from a finserv incumbent, do your homework, ask if regulatory approval is needed and plan accordingly. Prior to closing an investment from a finserv incumbents, ask what type of reporting they will need, what type of governance, what type of information they will require. Finserv incumbents work under different rules than a startup. Be aware of the culture difference and fine tune how you interact with your future shareholder.

3. Disregarding compliance as a pesky annoyance
This may actually be your death sentence. If you do not comply, if you cannot prove that you intend to comply. If you are late hiring a compliance officer and/or develop a compliance rule book that you abide and operate by, you may end up dead meat. Be smart, realize compliance can be your friend – this includes anything that has to do with AML/KYC.

4. Not choosing a VC with fintech experience
If there is one industry where experience matters, deep experience, granular experience… it is the financial services industry. VCs with an understanding of the space are invaluable. Shun them at your peril.

5. Thinking that the general laws of growing a startup apply uniformly in fintech
Wrong. Money is a weird concept. Individuals care about their money and at the same time they are not engaged with it as they are with their social networks, friends or the passionate causes they care about. Finserv incumbents care very much about money and are risk averse, their and their clients. Regulators obsessively care about individuals’ money and the health of the enterprises they regulate. In other words, if you think the laws of growth hacking, of scaling a business apply in exactly the same way in any given tech industry as they do in fintech and finserv… think again. Understand psychological behaviors around money, credit, savings, payments, both at retail and institutional levels, and you will be better off. Most startups that do not study these behaviors closely end up being surprised by how slowly they gain traction either because growing a retail customer base is much more expensive than they originally thought, or selling to finserv incumbents is taking much longer than they thought.

6. Thinking that competing on cost will win the day
Many startups come up with business plans that provide financial service or products at a cheaper price with the application of better technology. Payments startups, roboadvisors are prime examples of such hubris. If you fail to understand that incumbents have massive scale advantages you will be wiped out when said incumbents finally move into action and race you to the bottom while undercutting you on cost. Be smart, find a real differentiator, one other than just cost enabled by “better” technology.

7. Thinking that IP is easily defensible
There are two lessons worth noting here. If you have come up with some technology you think is defensible, chances are a) a finserv incumbent already has something similar in its IP portfolio and b) your tech can be tweaked easily by anyone without much effort. I bet this holds true for other industries. In fintech it holds especially true and if you base you business model on your IP alone, then you will run into trouble.

8. Payments is easy – a false positive
Payments is the easiest of financial services sectors to enter. It is the most difficult to succeed in. Many startups mistake ease of entrance for ease of success, and as a result many startups fail. Think of how difficult it is to sell to customers in any industry. Now, multiply that by 2 or 3 in payments. You may have to sell multiple stakeholders: users (retail or corporate), merchants, processors, banks, networks. Better be prepared.

9. Overlooking legal aspects
Certain financial services sectors are ultra specialized when it comes to the legal world. Think of securities law in capital markets. Think of laws protecting borrowers. Think of privacy laws when applied to personal data. I could come up with many more examples that can potentially trip you and your company. Legal is sometimes different than compliance. Make sure you cover legal aspects too when developing your business plan.

10. Not paying attention to business cycles
Whether the economy is expanding or contracting will have an impact on your business. This goes without saying. Doubly so in fintech. Let’s take the example of alliterative lending platforms. If the management team of an alt lending platform has built its business model off of low interest rates and related assumptions regarding default rates… said management team will be in for a rude awakening when interest rates will start to rise.  Building a business model in fintech off of where one is in the current business cycle is short sighted. Think of credit downturns, think of interest rate cycles, think of monetary policy and start scenario planning.

Conclusion: Do your homework. Study the space. Seek expert advice from law firms that specialize in financial services law, regulatory work, compliance. Seek and hire specialized team members early. Learn from these specialists and include their advice in your business plan, your product or service offering, from the start. Specialized fintech planning is different than mainstream business planning.

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