I have given this episode a huuuge write-up as it’s such a vital topic. So if you don’t want to read 2,500 words, listen instead 🙂
Let’s simplify a Fintech’s journey into three schematic stages:
- Stage 1: “turning an idea into a product”
- Stage 2: “turning a product into a business”
- Stage 3: “turning a business into a grown-up business” (IPOs, M&As etc)
In recent months I have come to see as London Fintech’s greatest strength in-depth right now as Stage 1. We could call this a Fintech-Startup … building your plane, taxiing to the runway, then accelerating down the runway and trying to get the wheels off the ground (clients).
Stage 2 is the bleeding edge in London which many are struggling with. The Fintech-Scaleup, going beyond a handful of early-adopters, Crossing the Chasm to use Geoffrey Moore’s famous title.
Stage 3 is a rarefied level where very few are at (generally the ones with eight figure funding). You might perhaps call this moving from being “a Fintech” to a “Mature Business in the FS sector” – they gradually start looking, feeling and acting more like young corporates. They may IPO, they may remain private, they may sell themselves to an incumbent – but they are recognisably a mature business.
Historically a successful journey from inception to IPO/exit takes up to a decade. If you look at UK Stage 3s who aren’t at the exit yet eg Zopa was founded in ’05, Funding Circle in ’10, Crowdcube in ’10, Transferwise in ’11.
The bleeding edge phase changes of Stages 2 (“gas to liquid”?) and 3 (“liquid to solid”?) generally require accessing two elements – Capital Markets and Savoir Faire. It is the relative lack of these two factors perhaps that is proving a real “invisible barrier” for many London Fintech Startups and Scaleups right now.
In this episode we discuss why this is the case in London. How did it come about? What can we learn from the US? What advantages do we have under our nose?
Quite a lot for one episode!
I am extremely fortunate to be joined in this episode to discuss these issues by a man who has spent his whole career to date working with tech companies, and now Fintech companies, at all of the above three stages. Richard Goold is a partner at international lawyers Wragge Lawrence Graham who are the premier Fintech lawyers in London (they have the largest IPO practice on AIM for example).
Richard co-chairs the firm’s global Tech Sector Group which comprises 125 lawyers & travels a lot to San Francisco, New York and Boston.
He works with all stages of Fintechs from very early Stage 1 (who make use of the firms Jumpstart platform – a suite of free advice and documents) through to nine-figure deals for Stage 3s.
He started his career at the firm working with 3i on over 30 transactions in the days when 3i was the biggest investor in technology in Europe. Thus he has a deep historical understanding about why we are where we are right now.
We have a wide-ranging conversation – but for the purposes of a summary I shall gather into “London’s (many) Advantages” and “London’s Four Challenges” (Capital Markets – Funding Gap, Capital Markets – AIM, Savoir Faire, and Savoir what Not to Faire).
“Amazing things are happening here” … “Energy and enthusiasm in the tech ecosystem and Fintech ecosystem specifically is amazing. It’s unlike anything I have seen in any part of the UK economy before”
- “In Fintech in particular, we have better cornerstones than even the US”
- Regulatory framework – lighter/better red tape in many cases than elsewhere
- So many global banks and retail banks have HQ or innovation centres or technical centres here
- Breadth and depth of Financial Services – eg Lloyd’s insurance market world-beating
- Lots of folks have left mainstream firms and want to do their own things and know how to tap into the Square Mile/Canary Wharf
- Tech ecosystem here, high profile political support
- Entrepreneurial spirit
- Liberal, cosmopolitan
- Attracts international business, an international audience.
- Seed funding is readily accessible – either through incubators/accelerators or (not discussed explicitly) as folks exit Financial Services having built up significant personal funds to start their own startup without external capital.
- EIS/SEIS are tax advantageous for investors so raising £150k upwards is very much facilitated
LONDON CHALLENGES (1st of 4) CAPITAL MARKETS – THE FUNDING GAP
3i was set up after the 2nd World War to help build the SME economy and grew into Europe’s largest investor in technology. It became a combination of a very large buyout house, growth capital house and VC house. The stockmarket didn’t particularly value the mix.
The VC arm was well run (albeit lowest returns of the three businesses). This institutional experience is identical to Michael Nulty’s own empirical experience and investment lessons learned discussed in the prior episode – LFP007 – namely that growth capital and buyouts offer the best and safest returns. This is a vital fact to which I shall return in the 3rd challenge below.
Broadening the dataset out beyond 3i and my last guest 😀 Richard quotes an investment banker whose research into European VC returns over the past 15yrs showed a median return of just over 1% [cf growth capital, buyout which can be ~15-20% IRR].
Due to these poor historic VC returns, 3i pulled out and no-one has back-filled. In contrast to an incredibly diversified VC community in the US, in Europe the list only runs to about ten VCs at which point funders are then into the “super-angels”.
US houses are beginning to come over here and invest (excess capital, excess competition for investments in the US and attractive under-VC-ed European market). Furthermore when (and if…) returns pick up should see more money flowing into the sector from pension funds etc.
Classically tech funding rounds look like:
Seed: £0.5m-1m to build a product [MB: NB: many Fintechs are building their product for far less (“Fintech 10x cheaper than a decade ago”)]
A Round: £1-3m in Europe [up to $10m in the US). This is a key round as you are just starting to get traction.
B-C rounds growth or expansion capital – scaling the business.
Due to the historic performances outline above, the absolutely critical “A round” (my Stage 2) has become very difficult to get in Europe and it is the funding gap as Richard sees it. “Europe needs a big volume VC that puts money into a large amount of A rounds”.
By contrast in the US market there is a lot of activity and froth at this level – so many VCs, so much capital. Whilst fund-raising is never easy, in the US it is easier and you get VCs trading term sheets etc that you don’t see so much of in Europe.
In passing in the UK the much-discussed “froth” is around Stage 1 “startups”/”products” (MB: and in the associated incubators/accelerators space)).
LONDON CHALLENGES (2nd of 4) CAPITAL MARKETS – AIM
“One of the problems with the UK tech scene generally but the Fintech scene specifically is that we haven’t had a properly functioning capital market for some time actually”.
This looks like a problem for the “Stage 3s” rather than “Stage 2s”; however it is the lack of funds that flow from IPOs that feeds back into the funding gap challenge above and into the savoir faire challenge below.
New York has pulled away from London in the tech space at least, due to some really good exits and a really well-functioning capital market in NASDAQ.
Listen to the podcast to hear what Richard says about the background to this and how things are changing right now.
For those of you who haven’t kept a close ear to the ground a flavour of the issue is that the Financial Times – of all newspapers – yesterday ran an article astonishingly entitled “The Muppet Market in Numbers” with a picture of Kermit the frog (!!). It pointed out that a strategy of buying the ten biggest stocks on AIM and holding for one year would have lost money in 30 of the last 34mts.
LONDON CHALLENGES (3rd of 4) – MORE SAVOIR FAIRE in FIN, TECH & BUSINESS
This is vitally important. Given the very poor historic European returns from VC it’s not just a question of (as time and time again one reads :rolls-eyes:) “more money being poured in” – if you pour water into a leaky bucket it just disappears.
We must plug the holes in the bucket, we must change the dynamics of scale-up companies in order to make investing in them a better proposition..
a) What type of savoir-faire to be aimed at? We don’t drill into this in the episode but touch on it in passing – perhaps three types Fin, Tech, and Business.
Fin in terms of those who have a deep domain expertise and knowledge of how the City, Wharf, Regulation etc really work. Right now there is a trickle from mainstream FS into Stage 1 Fintechs but this needs to mature into joining Stage 1s to help them become Stage 2s and Stage 3s (rather than just creating more Stage 1s).
Re Tech and Business – these are folks who have built successful businesses, exited and remain within the sector (as happens in the US eg Buddy Media guy, $700m deal, set up own VC fund (as well as running division of Salesforce)).
b) What is the savoir faire aimed at? What I call “creating a 360 degree company” – the “180 degrees above the waterline” Product-Marketing-Sales-Client development to the 180 degrees “below the waterline” of infrastructural support for all the above-the-waterline items. [And to go one stage further looking beyond one’s 360 degree company as per Michael Nulty’s LFP007 insights into what sinks otherwise good businesses].
Unless you get these building blocks right you can’t build a Seed company (Stage 1) to an A company (Stage 2) or even if you get the A round you can’t build a global beating company (Stage 3).
This savoir faire needs to come to Fintechs in terms of advisers, mentoring, non-execs, in any form – but for sure they need it. There are some first-rate, very experienced, FS folk, Tech folk, and Business folk out there in the sector but (my feeling) is that across the whole sector they are very much in the minority.
LONDON CHALLENGES (4th of 4) – SAVOIR WHAT NOT TO FAIRE (groan!)
If savoir faire is what we need to add to the recipe then this section is things we need to take out of the recipe. The recipe for “making Instagram” will differ from “making a fintech” (and there is huge range of types and sub-recipes there) “making a biotech”.
Whilst what is missing is perhaps easier to spot, what is there and needs removing appears to be less so.
a) I rarely see 360 degree companies in early Fintechs – indeed I even meet some who pride themselves on not being a 360 degree company :-O One smart Fintech chap was convinced that this was “following the Silicon Valley model” – stick to your USP etc. An interesting if deceptively attractive argument. In “the Valley” with the value-add from the VCs, the relative ease of funding and the 360 degree components “lying around” that might work. But not in London.
This is a good example of too slavishly following the “Silicon” model. London will never overtake anywhere by being a poor photocopy. Rather we need to decide what to copy, what not to copy [hence points 3 & 4] and add that to the London Pros above for our own unique recipe.
b) as per Richard and passim in prior LFP episodes, there are very different requirements across tech – consumer internet businesses require a different skillset and a different personality to a Fintech company [& also B2C vs B2B Fintechs]. London Fintech won’t be world-beating if we mis-apply consumer web business lessons that are inappropriate (see LFP005 for an “ultra-B2B” Fintech example which has very little in common at all with a Valley approach; ditto LFP002 on the banking side of their innovation marketplace).
c) one of my hobby horses, as I have commented in prior episodes, is that in the early stage in London, the explosion of incubators, accelerators and the like can be very juvenile – ping-pong tables, bean bags et al (I even went somewhere this week where we were asked to give our feedback by writing on the wall (?!?) – ooh graffiti how cool (…not)). As John Shaw, Head of Innovation at Direct Line (LFP006) says, it is a mistake to equate innovation with being childish.
d) Finance is a mature, highly-regulated industry – you need deep domain expertise. You also need to be trusted with people’s money (no easy matter) – you need perhaps to look more like bankers or lawyers than in other tech sectors (eg MediaTech perhaps). Why hasn’t Transferwise hoovered up all retail currency exchanges as it is 10x cheaper? – as they are not yet trusted as much as existing banks (who also happen to be insured). Furthermore the “360 degree Fintech building blocks” are more complicated and more costly eg regulatory capital, regulator engagement.
e) [LATER ADDITION] one needs to track closely the research on US tech/VC/ecosystem data (and not just channel HBO Silicon Valley :-D). It’s easy to get sucked into the propaganda/image/spin in our PR-world and not drill down into the actuality (often the data shows that the US model is not as succesful as one might think). Notable recent examples of drilling to the real bedrock are Diane Mulcahy’s excellent Harvard Business Review article “Venture Capitalists Get Paid Well to Lose Money” which points out the poor US VC returns over the past decade, their minimal “skin in the game”, high fees and (ironic this one) a lack of innovation in the VC sector; TechCrunch “Corporate Accelerators are an Oxymoron” and Cohen/Hochberg’s fascinating Seedrankings research on accelerator performance (pdf here, wmv presentation) which is definitely under-reported (& probably under-read :-!) on the UK scene (for example the average participant in the average (US) accelerator program would not recommend to a friend (!); although the best get great approval ratings).
THE FUTURE OF LONDON FINTECH
If the right things fall into place we could pull away from New York in 3 to 4 yrs time.
It doesn’t need a lot of government intervention, but there is a role for government in making sure we keep red tape low, keep regulation relatively light, making sure the UK is a good place to do business and keeping the tax regime benign.
In a world where capital is very mobile the more we “upgrade” London Fintech – the more money will flow here and oil the engine and the more prosperity and innovation will be created.
Both Richard and I, coming from divergent backgrounds and exposures to Fintech, both agree that London has the opportunity to be world-beating in Fintech.
However in order to do this we need more open debate and recognition of issues involved in upgrading “London Fintech 2014” to “London Fintech 2015″… I hope this episode and this write-up stimulates that debate.