Startups Won't Survive Unless They Play Both Sides

~7 min read

Three months in, and 2020 has already introduced significant risk into the financial services sector, from deposit runs to loan losses and mandatory closure of branches. Startups, on the other hand, are finding themselves in something of a doubled-edge sword position. They are contending with a cooling investment climate as capital retreats to more cautious position. Layoffs, unfortunately, are already underway. But: many firms also have a unique opportunity to demonstrate and sell the benefits of their products and services, as the new, more-online version of everyday life is creating historically unprecedented demand for seamless digital banking, payments, and e-commerce services. Can startups navigate choppy waters, while at the same time building and promoting their services to those who need them the most?

Over the coming months, banks and fintech firms might engage in collaboration as banks search for ways increase their digital capabilities to better serve customers staying at home during lockdowns. In addition, countries like South Korea are suddenly easing regulations for the fintech industry in order to facilitate the growth of the sector amid the crisis. Startups may be able to leverage the friendlier regulatory environment to grow more quickly. Finally, fintech start-ups are uniquely positioned to help small businesses and individuals who are affected by the pandemic.

Inevitably, some young fintech startups will not make it through the downturn - because of lack of demand for their products, lack of cash flow, or lack of investor appetite. Meanwhile, those with resilient products, innovative growth strategies, and capable management teams may be able to bounce back stronger than ever from the pandemic, and may be positioned to grow all the faster when the worst days of this crisis are over.

An Impending Drought

Due to the slowdown of the world economy and recent stock market fluctuations, funding activities in the fintech space will inevitably slowdown - probably for the rest of 2020. Naturally, many investors and venture capitalists will flock to safer pastures. Research suggests that fintech funding total will be down for Q1 2020, and this effect could persist through the rest of 2020. It is also possible that startups may not feel the effects of a slowdown right away; some research has suggested that the eventual effects of the current slowdown could take up to six months to arrive.

Fintech start-ups who are consumer-facing (B2C) may face disproportionately more funding trouble, as their revenue may be most heavily affected by the economic slowdown. Quarantine measures, closed stores, and cancelled events will heavily affect consumer spending, resulting in drop in overall transaction volumes - particularly for firms providing point-of-sale solutions. Even pure-play digital firms are not exempt from the negative effects of COVID-19, however; Moven, one of the first U.S. challenger banks, recently announced that it would be shutting down due to the withdrawal of funding from investors.

Henri Arslanian, the chairman of Fintech Association of Hong Kong, also points out that smaller start-ups with pre-existing cash-flow problems would also be particularly vulnerable as investors flock to safer investments. Those struggling firms may be forced to lower their valuations to raise capital during this crisis. In addition, the stock market slump could become a catalyst for lower valuations in general, especially given the astronomical valuations granted to startups by Venture Capital firms in the recent years. At the same time, some observers have pointed out that funding shortages and lower valuations may attract some bargain hunting investors into the market.

As a result of the year's events, many early stage fintech start-ups with no established products or sizeable market share may be forced to downsize significantly, possibly laying off talent and reducing office space in order to slow down cash burn. A little extra caution when it comes to spending, plus a shift to a less cash-heavy business model, will be a wise (if not necessary) strategy for start-ups hoping to weather the storm.

A Fintech Oasis

Despite the foreseeable challenges ahead, there are reasons for fintech players to look forward to 2021 and beyond. According to Paul Grieger, president and co-founder of asset management firm Theorem Technologies, “fintech companies are probably some of the best-equipped organizations to take on this [Coronavirus] crisis.” Since the whole world is working online, shopping online, and even socializing online, the COVID-19 crisis is almost certain to spur global interest in contactless payment and other digital financial solutions.

In India, Australia, New Zealand, and many countries in Europe, governments and national bank officials are encouraging the use of mobile and internet banking. In some of these nations, like India, the pre-COVID mobile banking adoption rate was extremely low compared to the rest of the world; this pandemic could become an opportunity for the nation to embrace the new technology with renewed enthusiasm.

In Africa, the pandemic could turn into an opportunity for faster adoption of certain fintech solutions in the region. For instance, government and start-ups around Africa are implementing measures to shift payment transactions to mobile money, away from cash. That said, depending on the type of the technology, adopting fintech solutions in Africa amid the crisis may not be easy considering the infrastrucutre challenges and other barriers to adoption which, COVID-19 or not, continue to affect the continent.

Where There's Water...

Either way: fintech players around the world - and startups in particluar - should look for unique opportunities driven by the crisis, and embrace growth wherever it can be found.

First, start-ups should leverage the favorable changes in regulatory climate created by national governments in response to the COVID-19 crisis. In South Korea, for instance, where regulations were once considered rather strict when it came to fintech, government has decided to ease regulations to promote continued growth of the sector amid the crisis. Specifically, the current law in South Korea that limit equity investment of non-financial business in fintech companies will be eased. In addition, government will also set up a conflict resolution committee to play a mediating role in cases of conflicts between traditional banks and fintech firms.

However, South Korea is hardly the only nation adopting drastic regulatory changes in response to the pandemic. The UK has also announced an increase in the limit for contactless payment from £30 to £45 to facilitate the shift to digital banking. As a result of these relaxed regulations, consumers in Asia and Europe may be adopting en masse. Early results are promising; in famously cash-loving Germany, for instance, more than 50 percent of payments currently being made by card are contactless, compared with 35 percent before the crisis.

Second, the COVID-19 crisis could become an opportunity for fintech start-ups to secure partnership relations with legacy banks to increase their customer base and gain more consumer trust. To comply with the “social distancing” measures, banks are closing down their regional branches and looking for ways to quickly increase their online banking capacities. According to Sandeep Todi, co-founder of payments platform Remitr:

“The relationships between banks and fintechs are playing to each other’s strengths more than ever.... the need to catering to consumers’ needs wherever they are is more important than ever before. This is where fintech makes it possible to face crisis situations like this with agility.”
Sandeep Todi, Co-founder, Remitr

In Europe, banks are encouraging retailers to partner with fintech firms as they temporarily close branches to prevent the spread of the virus. In the U.S., digital mortgage software Blend has also seen spike in usage since the crisis. Timothy Mayopoulos, president of Blend, pointed out that the virus is creating an additional sense of urgency for traditional financial institutions to form partnerships with fintech firms, even for the banks that were previously hesitant about investing in digital mortgage technologies.

Finally, fintech start-ups are uniquely positioned to help the small businesses and individuals who are negatively hit by the crisis. With sudden closures of all non-essential businesses across the world, small business owners are facing serious liquidity problems: they may sustain reduced or entirely eliminated cashflow, but are still forced to pay rents and pay employees. In the U.S., more than 15,000 stores are expected to close in 2020.

While traditional banks often refuse loans to smaller businesses and are tightening lending standards for all businesses, many start-ups have already been targeting small businesses as their client base. Four fintech firms in the U.S., for instance - Wiserfunding, Nimbla, Trade Ledger and NorthRow – have recently formed a joint lending platform that will be able to rapidly deploy funds to SMEs in need of credit. While this is just one example, many fintech firms around the world are leveraging this opportunity to grow their base and reach new users in need of financial support during this uncertain times.

Start-up & Sail Away

No-one knows how the COVID-19 crisis will unfold over the coming weeks, nor what its long-term effects on the fintech sector would be. For many young startups, the pandemic could be the first economic downturn they experience, and they may not necessarily have the right tools to survive the crisis. Therefore, for the rest of 2020, start-ups should be extra careful about engaging in cash-heavy activities and consider shifting to a more sustainable business model, at least temporarily, in order to stay afloat until investor enthusiasm returns to normal.

For what it's worth, the outlook is brighter for the long-term than for the short term. In Italy, one of the hardest-hit countries during this pandemic, ecommerce transactions have soared 81 percent during the month of March. This is an example of opportunity, and fintech firms around the world should take note. Fintech services, properly implemented and adopted, can make life more convenient for all during the crisis - not to mention afterward. Overall, a friendly regulatory climate, increased opportunities for bank-fintech partnerships, and an expanding customer-base could boost start-ups who can survive a short-term drought. There's no doubt that funding challenges await in the short-run, but aspiring fintech players should use this crisis as a chance to build stronger products and relationships, and diligently prepare to bounce back stronger than ever when the worst days of the pandemic are over.

© Mondato 2020

Image courtesy of Lucas Davies
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Mondato is a boutique management consulting firm specializing in strategic, commercial and operational support for the Digital Finance & Commerce (DFC) industry.
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