...and why the market needs to be revolutionised to capture its full potential
This is the third and final part of a Series about what’s wrong with the Fintech lending value chain as we know it and why we believe it needs to be revolutionised for it to truly prosper and grow into what it can be. If you haven’t already, you can read the first part and second part here.
In the first two parts of the Series we discussed the poor product-market-fit of the debt facilities currently being offered to Fintech lenders. The structures were designed for a different purpose in a different time and their complexity with layers of fees are not helping anyone but the debt investors. So what to do? How can the rewards better reflect the risks?
No incentive to innovate
We all know it’s not easy being a founder of a tech start-up – try being a founder of a Fintech lending business, it’s definitely on the more challenging side. But does it really have to be this difficult?
Short answer, no it doesn’t.
But if this is such a huge problem, why hasn’t anyone solved this?
In the early days of Scayl I explained the issues I’ve seen in the market and my proposal of how to solve them to a relatively well-known bank in the Fintech lending sector. Their response was “we can’t do this, what makes you think you can?”
I was thinking for myself; of course you can, but you don’t want to! The current state of the industry works very well for you – the power dynamic is well in your favour, there’s no reason to change.
I’m all for taking advantage of a business opportunity and going for it, which is what debt investors have done. But there’s huge room for improvement and a need to even out the playing field a little. More of the reward needs to end up with the parties taking the risk. That’s what we’re trying to do with Scayl.
Research has shown that incumbents can only achieve incremental innovation since the processes and ways of working are so deeply rooted in their organisations, which leads to only incremental change being obtainable. On the other hand, start-ups can achieve radical innovation since they’re more nimble and agile without complex processes and ways of working. As a matter of fact, radical innovation is needed in this case, because Fintech lenders need access to better suited debt facilities than what they currently have.
Equity investors’ perspective of Fintech lenders
Many of the largest and fastest growing Fintech lenders have raised money from VCs. However, many of the lenders you don’t read about in TechCrunch are struggling because of the (unnecessarily) capital-intensive business model enforced on them. It’s just a fact that Fintech lenders require more capital than other tech start-ups since they are different in nature. But apart from the junior equity in the capital structure, should they really need to pay for such huge set-up costs, and should they really need to give away warrants in their business despite taking all of the risk?
No wonder VCs are shying away from Fintech lenders.
The market opportunity
I think we all can agree that the market size is there. Incumbent banks are just too slow to capture the market and they’ve left it wide open for challengers. According to Allianz, the SME funding gap is 3% of GDP in Europe and in the US it’s 2% of GDP. In total; €900bn.
That’s 100 Unicorns at least, or 10,000 mid-sized Fintech lenders. Only for the untapped portion of the SME market.
Market size, check!
What needs to be changed?
Since the market opportunity exists, what is required for the Fintech lenders to capture its full potential?
First of all, it needs to be easier to build a Fintech lender, it’s just too darn complicated and takes too much time, mainly because of the need for a debt facility.
Secondly, the capital efficiency needs to be improved and come closer to other tech start-ups. It’s more or less impossible to bootstrap a lending business since you need substantial start-up capital.
When we started Scayl, these were the two key questions we wanted to solve for Fintech lenders. What we’ve built is a product that makes it easy for Fintech lenders to set up and get going – providing a debt facility without the bells or whistles. It works just as well as a fancy one and gets you from point A to point B, or in our case, from a €0 to a €50m loan book, while maximising capital efficiency. All enabled by technology.
To be transparent, we can’t yet say that we can help Fintech lenders in achieving the same capital efficiency as a B2B SaaS start-up, and I’m not sure we’ll ever get there, but we’re close enough to again make it attractive for founders and their equity investors.
Remember the Ford Model T – you can get any colour, as long as it’s black. It’s the same with us. The moment you want something that’s outside the box, it creates complexity and drives unnecessary costs. After talking to over 200 lenders, there’s a need for simplicity with embedded flexibility, which is the opposite of what is available in the market today.
It all boils down to that round peg and the square hole. While debt investors have been trying to make the hole round, we’re building a square block using technology and “productifying” the debt facility.
How we create that square block? That’s our secret sauce.
Gone are the days where it takes up to 12 months to get going with a debt investor, paying at least half a million in unnecessary fees and giving up 10% of your business.
Let’s move forward towards a short time to market, maximised capital efficiency and a debt facility that works in favour of the Fintech lender, not only the debt investor!