Arthur Goldstuck

A new story, laced with cliffhangers, drama and intrigue, is being written across the pages of the world’s financial newspapers. The plot does not include gangsters, espionage or murder – yet – but it has its readers riveted.

The story begins with the well-worn premise of how technology is changing the world of financial services. But it quickly hurtles into the heady world of start-ups that are rewriting the rules of this nascent industry called fintech. It then charges across the balance sheets of venture capital firms transfixed by unprecedented opportunity to return untold multiples on investments. 

Depending who does the counting, anywhere from $17 billion to $25 billion in venture capital went to fintech firms globally in 2016. According to CB Insights, 2017 was on track to become the biggest year ever in fintech VC.

Local is lekker!

In South Africa, start-ups seem to pick up million-rand cheques on the basis of little more than PowerPoint presentations. Relatively young businesses that have already proven themselves are pulling in hundreds of millions.

Three recent examples encapsulate the scope of fintech and the scale of investment:

1.              Prodigy Finance, a company started by a South African in the United Kingdom before being brought back to South Africa, offers loans to postgraduate students accepted into leading universities around the world. This “borderless credit” provider has accumulated funding of R4.2 billion, with R3.19 billion raised in 2017. One of the participants in the latest funding round, AlphaCode, the fintech investment arm of Rand Merchant Bank, is becoming a familiar brand behind much of the fintech VC in South Africa. It recently hosted an event where R1 million was handed to each of four winners of a fintech competition for black-owned start-ups.

2.              Luno, a trading platform for cryptocurrencies like Bitcoin and Ethereum, announced a R120-million funding round, led by UK-based Balderton Capital, and also including AlphaCode. An earlier R60-million investment came from Naspers.

3.              Synthesis Software Technologies, an established fintech company that approaches innovation like a start-up, was acquired by JSE-listed Capital Appreciation for R132.1 million. While it provides software development and integration services to financial institutions like Investec, Absa, Standard Bank, Capitec and Nedbank, it has also become a leading player in the rapidly evolving cloud computing space. It recently became the first company in Africa and the Middle East to be named an Advanced Partner by Amazon Web Services (AWS), the fastest growing division of Amazon.

The last is the most intriguing of the three, given that its value and potential are not grounded in a specific trend or marketplace. With the cloud as backdrop, its innovation plays out in the fields of financial channels, blockchain, big data and artificial intelligence.

“We constantly review current technology trends and formulate products and solutions based on common industry needs using current and available technologies,” says Synthesis MD Michael Shapiro. “This is where our focus on cloud technologies was incubated and formulated five years ago.”

The combination of a 20-year track record and a fresh, start-up-like approach to cloud computing, has given Synthesis a head start in an environment where the starting point is often not clear. It assists financial institutions in “becoming cloud-ready, to execute mass migrations, to harness the benefits of big data analytics and to extract the cost savings and regulatory benefits of the cloud platforms,” says Shapiro.

“In the world of fintech, technical innovation and business innovation are often interchangeable – and we have to unlock this value. We translate the institution’s business strategy into solutions with real, measurable impact.”

Shapiro points to a fascinating twist in the plot, however: financial services companies that plan to disrupt themselves with their own, internal fintech start-ups.

“Cloud platforms such as AWS give new start-ups the opportunity to disrupt. That is why our customer base of established players is seriously evaluating and using the same technologies to up their game and provide better banking, insurance and investment solutions to the market.”

Who disrupts the disrupters?

A striking example is First National Bank (FNB) in November awarding R10.5 million to employees in a contest to come up with innovations that would create radical disruption in the financial industry. The programme has been running since 2004, and has awarded a total of R54.5 million.

In October, FNB had been named Most Innovative African Bank at the 2017 African FinTech Awards, for the second year in a row, as well as being named Master Innovator in the 2017 Accenture Innovation Awards. 

FNB Business CIO Peter Alkema puts the strategy simply: “Our aim is to disrupt rather than be disrupted. A new way of thinking is needed to demystify banking within the financial services industry. Fintech helps grow, educate and enrich the market. We find that businesses are incorporating innovation in their business models which encourages us to think and act differently. This radical disruption is necessary for cross-industry collaboration and is crucial for future value generation.”

However, investing in a fintech start-up is a very different process from incubating an idea in-house. For one thing, the team behind a start-up hasn’t been recruited by the parent company. Yet, it has to fit in with the ethos and goals of the investor.

“The cultural fit of the team is critical,” says Bradley Sacks, joint CEO of Capital Appreciation. “A large component of any fintech company is its people, their entrepreneurial drive, their innovation and their understanding of the market opportunity their product or solution is trying to address. Ideological differences, be it in terms of architecture or otherwise, can be quite disruptive, and it is important to understand this as part of a due diligence process.”

Money talks

The bottom line, however, is the bottom line.

“The financial returns of any investment are obviously important, and we place a great deal of emphasis on this, including the benefit the acquisition may afford other initiatives we already have in the group. Our analysis does not only consider the direct impact within the quarter or half-year results, but also a medium-term horizon. Often the impact of innovative solutions is not visible until the solutions have reached critical mass adoption.”

This is probably the biggest conundrum in fintech investments: how to assess the potential of a solution before it has taken off, and before every other investor lines up to fund this potential. It is into this gap that many VC funding rounds have plunged and many promising fairy tales have ended in financial tragedy.

In many cases, the flaw in the story has been the belief in a good idea rather than a good business. But there is a formula to differentiate the two.

“The distinction between a good opportunity and a good idea is the viable economic application of the good idea,” says Sacks. “If the idea does not have a viable economic business case, it will never evolve into a real opportunity. Where clients derive value from an idea or application, they are happy to compensate us. Value to a client arises from the more traditional sources such as lower costs or increased revenue, but equally can arise from user experience, customer satisfaction and retention and brand awareness.”

Sacks and Alkema sound like they are reading from the same script. But that is probably because most good new fintech stories still depend on the same tried and tested plots.

“...venture capital firms transfixed by unprecedented opportunity to return untold multiples on investments”

“Our aim is to disrupt rather than be disrupted”