Fintech Startups, Big Banks, and the Bubble

Startups are all the rage today - I probably have four different startup-related podcasts on my podcatcher and it seems I can't go anywhere on the interweb without tripping over someone talking about startups.  Money is being poured into the startup market (read: Silicon Valley) faster than it can be spent, with the certain knowledge that each check gets the check writer in on the ground floor of a unicorn.  This bubble is going to pop.  Probably soon.

I just read a really thought-provoking article over at The Economist entitled An uneasy symbiosis (subtitled Fintech has made inroads, but the incumbents still dominate day-to-day banking. For how long?).  I recommend reading the entire article yourself; I've pulled out a few of my highlights and notes below, which will probably make more sense after reading the whole thing.

The article starts off talking about a fintech startup accelerator that's leasing space for its startups in a banking building in the middle of London's financial center.

The banks are doing what the old adage tells them: keeping friends close but enemies closer.

I can't say that the two necessarily have to be enemies.  Some of the banks are even doing things to support the fintech startups - mentoring programs, cupcakes, financing, and other things.

Most fintechers do not feel half as warmly towards their incumbent rivals. One dismisses them as “the Kodaks of the 21st century”, another as “financial vacuum-tube makers in the age of the transistor”. They see banks as tomorrow’s telephone copper wires, vestiges of an earlier age, and believe that in essence banks cannot adapt. “How often have you seen an incumbent really reinvent themselves?” a startup founder asks. The best thing anyone can say about banks is that they will always be around. “People like to whinge about them but they will never leave,” says Neil Rimer of Index Ventures, a fintech investor.

Ah, the proverbial arrogance of the startup founder.  It's almost considered a sine qua non for a successful startup.  Some VCs today won't even consider funding one without one of these abrasive personality types.  But as I read the founder quotes, all I can think of is this:

Sorry, I couldn't find a picture with someone flipping off the shark.

Given their size, banks are perhaps not as incapable of evolution as their fintech critics make out.

All it takes is one little bit of flexibility by a big bank for it to engulf the startup's niche.  

[Bankers] are keeping a close eye on how their products compare with those of the newcomers, and many of them understand their limitations when it comes to innovating. “If you want to come up with a new product in a bank, any one of 50 people internally can shoot it down. If you’re a startup, you can go visit 50 venture capitalists and you only need one of them to give it a green light,” says Tonny Thierry Andersen, head of retail at Danske Bank.

Again, all it takes is one green light from within the bank, or, better yet, a teeny-tiny culture change trickling down from the top that says "we need to be a bit more flexible and inventive."  

Incumbents are likely to copy, license or buy many of the innovations served up by fintech once they have proved popular. Banks did not invent the ATM but they co-opted it efficiently. Wealth managers will do the same with robo-advisers if they keep attracting new money. For any large financial firm, it would not take more than a few weeks’ worth of profits to gobble a fintech star. [Emphasis added.]

Bingo.  Exit strategy.  That's what the VCs are all about.  I'd bet dollars to donuts that the whole point of the accelerator spending the money on rent in a major banking building for its startups is so that they can save money on car fare when they're negotiating the sale of the startup to the bank - it doesn't cost anything to ride the elevator.

And here's where that arrogant startup founder needs to watch his/her step: they may want to be in it for the long haul - rake in the cash as a private firm until an eventually even more profitable IPO - but the VCs want out as quickly as possible for as large a ROI as possible.  And selling the startup to the bank upstairs seems like a pretty safe way to do that.