Companies that aggregate consumers’ financial lives are having a moment.
Startups abound offering to help people better manage their money, restore credit and shop for loans. Banks are playing defense by building their own versions in order to retain their customers.
Venture capitalists are paying attention, too. But for them, or for at least one of them, it is a bit of a tough sell.
On the one hand, there is clearly value in fintech startups that manage to build strong customer engagement. On the other hand, well, it ain’t lending — where the business case is rather clear.
American Banker caught up with Brendan Dickinson, a partner at Canaan Partners, at his office in lower Manhattan overlooking the famed Strand Bookstore. In the conversation, Dickinson discussed the power of aggregators, the future of lending and where the firm is now placing its bets.
The following transcript has been edited for clarity and brevity.
How did Canaan get involved in fintech?
BRENDAN DICKINSON: The firm has been around for 30 years this year and we are in our tenth fund currently. We’ve always invested in different forms of IT. Fintech really got serious when we lead Lending Club’s Series A. I was not around then, but my colleague Dan Ciporin is still on the board and led that investment for us then. But that led to us looking at a lot of things in finance.
Broadly speaking, we saw an opportunity to leverage our experience in marketplaces and marry that with opportunities we saw in fintech. That led to Lending Club, and that led to CircleUp, Orchard and others. All of those blend marketplace dynamics with financial services.
What are the most striking things to you about the evolution of the online lending space?
Online lenders are selling a relatively commoditized product. It is ultimately money at a rate. The borrower is fungible across lenders. We saw a huge opportunity in stripping out the cost, which means a lower cost to the consumer. The reality is that it is a scale game. Underwriting is regulated strictly and it is well defined. Differentiating on underwriting is hard — impossible maybe. So, the larger you are, you have better access to cheaper sources of capital and you can also more effectively advertise.
It’s quite clear now that there are leaders established in all the major categories of lending — consumer unsecured, student, small business, etc. It makes it very difficult for anyone to build up a sizable position in the market.
If we are talking a year from now, what will you be saying about the state of online lending?
From the industry, I would expect increased consolidation around the largest names. I don’t necessarily mean a bunch of M&A happening. Some of them might just go away. Like I said, it is a commodity product and scale matters immensely. Consumers in general are going to take the lowest-cost loan because there is no reason to pay extra to have a loan from “Startup Y.” The lowest cost of capital matters in a rational market. Also, because you can’t meaningfully differentiate on underwriting, the tech of any one of the companies is not terribly different. There isn’t a high strategic rationale to pay a premium to acquire any of these companies for the leaders. The other problem is that a lot of these private companies in their Series B or C are sitting at high valuations. Are they able to continue to raise money at those valuations? I would be surprised to see that, too. So, a year from now? The leaders are in a good position and the rest are not.
What about M&A in companies that complement online lending in an attempt to deepen their relationships with customers?
Right, online lenders do not have a deep relationship with their customers. It is typically some sort of ACH payment that happens each month. But also, the reason that most of the large startups are on the lending side is because where do banks make their money primarily?
On the lending side, and deposits are a way to finance the lending. A lending revenue model is far more attractive than one based on interchange fees.
But something I’ve often thought of is the long-term risk for these digital monolines is that they don’t have a meaningful relationship with the borrower and somebody else does. It might be a bank, but it also might be the aggregation points that are sending the borrowers to the lenders. For instance, Credit Karma, which unfortunately isn’t in our portfolio, has an incredibly powerful position. They have an active user base that logs in on a regular basis to check their credit score. That notification that your score has changed pulls people in. It pulls me in.
That is a meaningful relationship. And then once you aggregate that you can make money in a lot of different ways. Right now, they pass people to other platforms and they’ve stated that they aren’t going to offer their own products. But that would be lucrative way because they have a captive audience. One of the risks for online lenders is the aggregators getting more and more powerful.
Do they realize that risk?
I don’t know. In the past year, there have been more pressing, imminent risks to deal with. Last April, we spent a lot of time talking about working your cost of capital down and other strategic things.
Then the industry dealt with a bunch of other stuff for the last 12 months. Now, I know some of the leaders are starting to think again about how they build that ongoing relationship with the borrower.
Do you think those pressing issues — especially around transparency — have been solved?
I hope so. To be clear, I’m not on the board of these companies. I would like to think they’ve been addressed. At the end of the day, if we are talking about strategic dangers, it is a risk to not have those issues addressed. This model is built on trust and transparency. To have those things at risk is core to the brand. That would be a great way to destroy shareholder value for anyone. There is a real imperative to solve for that.
Do you have a good read on how your portfolio companies are viewing the OCC’s proposed fintech charter?
It is something we are looking into at the board level, but it is not something we have dove into. There seems to be some onerous aspects of it from a reporting standpoint. But, look, it is great.
When you look at some of the challenges of innovation for fintech in the U.S., things like bank charters are difficult. If you look at Europe, with some of the regulatory advances there that have led to more innovation in core banking, you can say it would be great to have a different regulatory approach here that fosters innovation. The fintech charter is an excellent step.
What types of fintech startups are catching your eye right now?
For the last six months, there have been a number of what I would call digital aggregation points — think Mint 3.0 models. The newest version of it is using artificial intelligence to understand your spending, make recommendations, move money. It has been a huge uptick and I think it goes back to the point about the power of aggregation.
The challenge there is that it is expensive to acquire customers and the revenue model is largely lead generation to other platforms, all with the vision of being the core relationship point for the customer. Someone is going to win because the modes of interaction for consumers are changing. But it is an expensive process from here to there.
So, we are actively looking at that space, but are struggling with the economics of it. But again, a digital aggregator will be valuable if they are able to build that core relationship with consumers. Credit Karma may have won the race, but I’m not sure.
Any other areas of interest?
Infrastructure in financial services. At the bare minimum, the next generation of platforms is going to be built on top of APIs. The types of things banks will need as they start to look at building their robo-advisers or their personal financial management tools.
[Editor’s note: Dickinson’s partner Michael Gilroy wrote a lengthy BankThink post about this area earlier this week. Read it here.]
Insurance tech is also a big deal for you now. Why?
You’ve got an industry that hasn’t seen a lot of innovation in the way it delivers products to consumers. It has incredibly low net promoter scores. Millennials are not engaged. And you see consumers changing expectations around services and financial services. Look at Uber. Look at the way consumers get loans through Lending Club and SoFi. Look how they send money with Venmo. Even look at banks’ mobile banking apps. None of that has come to insurance. It is much further behind banking. Insurance is still primarily distributed by 59-year-old men whose top skill is being able to write upside down. There is so much data and tech to make it better. Changing distribution is going to be table stakes for the next generation, but what really excites me are the people who are looking differently at underwriting. Those are big opportunities.
There have actually been very few multibillion-dollar exits. There is a bunch of stuff waiting in the wings. I’d say Stripe, which isn’t one of our companies, will be in that group one day. What you see when you look at the companies that have achieved it, they are all playing in very, very big markets and there has really only been one per market. Insurance is a huge industry and there has been almost zero innovation in a century. We are going to see large companies built there.