We’re sailing into choppy waters, now it’s time for fintechs to prove their business models

Profit, not pure growth, is how this generation of disrupters will be judged, writes Cashplus CEO Rich Wagner.

Rich Wagner is CEO and founder of SME banking service Cashplus.

The founder of Metro Bank, Vernon Hill, once said that when measuring the strength of a business the British would always look for profitability whereas Americans would prioritise growth.

Today, on both sides of the Atlantic, profit is increasingly viewed as a ‘nice to have’. The scale-at-any-cost approach adopted by Uber, WeWork and others has been enthusiastically adopted by challenger banks and their investors.

The co-founder of German challenger bank N26, Maximilian Tayenthal, recently said “profitability is not one of our core metrics… in the years to come we won’t see profitability, we’re not aiming to reach profitability.” Extraordinary, perhaps, but similar approaches are being taken by a host of UK players.

I’ve been asked a few times now whether this prevailing attitude, and the seemingly endless supply of investment that enables it, represents a ‘fintech bubble’ in the mould of the late 90s dot-com gold rush. I think there are three key questions to answer here.

One, why are these companies losing so much money? 

Two, why are investors willing to fund growing losses with no apparent path to profit? 

And three, what are the factors that could cause the ‘burst’ that defines the bubble?

Why are fintech startups losing so much money?

First, let’s think about why these companies are losing so much money.

At this point, I should declare an interest. I’m what some might call ‘old school’. My company, Cashplus, has been profitable for the last eight years, generates revenues of nearly £50m and has only ever raised £14m in equity capital. These days (absurdly, in my view) this is something of a contrarian position.

Anyway, in today’s market, the race to win new customers and sparkle in front of cash-rich investors is fierce. This often means launching gimmicky new features, like the sudden trend for metal debit cards. Don’t get me wrong, it’s important to innovate but, chasing after every shiny new toy doesn’t come cheap.

For me though the really worrying, and baffling, issue is not the money being spent, but the lack of revenue being generated.

We are seeing businesses with massive valuations return tiny or even negative revenues.

In some cases this is a symptom of relatively new businesses operating in tough markets—Atom Bank is paying its savings customers more interest than it is receiving on its mortgages, and a negative interest margin = negative revenues—but in most cases it comes down to one simple factor, these companies are giving their products away for little or nothing in the quest for growth.

This is plainly not sustainable, and there are signs that some are trying to turn on the taps by moving to a more traditional deposit and lending model, or introducing ‘premium’, paid-for products. 

Only time will tell whether those customers who signed up for a cool card and free banking are interested in borrowing money or paying account fees.

So on to the second question. Why are investors willing to tolerate such enormous losses?

Why are investors tolerating such losses?

Of course, there is an understandable appeal to fintech investment. It’s a dynamic sector, brimming with talent, disruptive ideas and an undeniable ‘cool factor’; no one wants to miss out on a possible Next Big Thing.

But, is this enough to explain the billions of pounds handed over in a series of frenzied funding-rounds, putting astronomical ‘unicorn’ values on unproven, loss-making firms?

We are living in unusual times, in which central banks across Europe have introduced negative interest rates and yields on long-term bonds have followed.

This leaves lots of money ‘looking for a home’ as fund managers and investors desperately seek returns. I’d suggest that, in this environment, some investors might take risks that would be unacceptable under different circumstances.

Finally, let’s consider the external factors that might lend some weight to those fears of a ‘fintech bubble’.

What could cause the ‘burst’ that defines the fintech bubble?

I’m not an economist, but, even to the casual observer, there are indications that the global economy is weakening. I believe the question of a UK recession is not ‘if’ but ‘when’.

Many fintechs have never sailed in those choppy waters. 

Funding Circle, the rock star fintech that fell to Earth, is a classic example of an unproven business model. Valued at £1.5bn at its listing last year, it has slumped to a valuation of £360m.

I fear that others, in particular those with new lending operations, could be vulnerable to a downturn and that, when trouble strikes, investor confidence might cool.

So, it’s all doom and gloom, right?

No. In the dot-com bubble, there were survivors, the companies that really added value to people’s lives by revolutionising shopping, music, and even dating.

I believe fintechs that focus on genuinely transforming and improving the way people bank, pay and borrow money will also have a future in challenging the complacency of the UK’s high street banks.

Recessions are always challenging but they are surmountable—my company has been around for 14 years, we’ve been there and done it.

I also believe that regulators will want to protect challenger banks, not just those that are ‘too big to fail’ with arranged buy outs, or mergers of unequals, more likely than outright collapse. 

Investors will, and should, back companies with viable business models, enabling growth. But downturns separate the wheat from the chaff, and fintechs will need to prove their ability to deliver more than just user growth.

They’ll need to be judged on something more meaningful, like, I don’t know… profit?

Rich Wagner is CEO and founder of SME banking service Cashplus.