The Vicious Lifecycle of FinTech (& Most Other Sectors, TBH)
This week we talk about innovation waves in FinTech & how this framework can be applied to other sectors, along with the current state of Pre-seed and when founders should take intros from investors.
Greetings! If you’re in the U.S., we hope you’re preparing for a relaxing Labor Day.
Quick programming note: With Labor Day and what will likely be a slower news cycle, we will not be publishing a newsletter next week. We’ll pick things back up the week of September 9.
📃 State of Pre-seed: Q2 2024
Carta released a new report focused on Pre-seed funding data, which is loosely defined by Carta as the earliest round of financing done on a SAFE or convertible note before a priced round occurs. Noteworthy data points include the following:
In Q2, 73% of Pre-seed round sizes were for less than $1M.
The preferred financing instrument of choice for 88% of companies was a SAFE.
At a round size of around $3M, the majority of financings switched from using SAFEs to priced equity.
STV Take: Despite the perceived slow down, the amount of dollars going into Pre-seed rounds is still higher than the first three quarters of 2021. Sure, it isn’t the best of times to be raising a Pre-seed, but it’s still great, relatively speaking.
The other interesting data point in this report is that over 90% of SAFEs include a valuation cap; however, the percentage of SAFEs with just a discount and no valuation cap is higher than in previous years. Honestly, I’m a bit surprised by this. I would have expected this to come down following the heydays of ‘21 and ‘22 but that is clearly not the case. I’m not sure who is agreeing to these terms, but most investors I know would walk away from a SAFE without a cap. Unless the discount is very meaningful, without a valuation cap there is no incentive for the investor to take that early risk.
🎧 The Vicious Lifecycle of FinTech
In a recent podcast, Alex Johnson, a 20-year FinTech operator, discusses the lifecycle of FinTech with two lawyers who have spent decades working within the sector. A big part of the discussion centers around the waves of innovation within FinTech and how the regulatory landscape evolves to potentially create existential risk for fledgling companies. In tandem, industry stakeholders get more sophisticated and over time the bar for new startups rises.
“This has been the maxim that I have learned over the last decade of bank partnerships on the FinTech side, which is [that] your likelihood of success is inversely proportional to the amount of time it takes you to onboard with your bank partner.”
— Jesse Silverman, Counsel, Troutman Pepper and guest on FinTech Takes
STV Take: While the above quote is clearly focused on a specific area within FinTech, I actually think a lot of the discussion can be applied to other sectors. Essentially the point about doing really difficult things, such as cultivating valuable partnerships, is about building a moat. If something is easy to generate, more people will do it, creating more competition and making it harder for founders to differentiate themselves.
The other element I contemplated while listening to this podcast is the timing of the different waves of innovation within any given sector. This gets reflected in the type of businesses that get created and can absolutely impact a company’s success. For example, I would argue that the telehealth wave crested during the pandemic. Companies that were working in this area before COVID were able to ride the wave up and capture a meaningful share of the market before competition got too intense from other startups and incumbents who moved quickly to capitalize on the innovation. Companies that started after this peak have likely struggled to breakout because of the intense competition and overall market saturation. For founders, pinpointing where they’re at in a given cycle is critical to understanding what will give investors pause.
🧭 A Guide to Optimizing Financial Performance
AVL Growth Partners released a new guide that highlights the key three financial drivers of a startup, along with recommendations to help founders avoid common financial modeling pitfalls and the best way to project business growth. A few of the common mistakes AVL Growth discusses in this guide include:
Overestimating attainable revenue
Misunderstanding how quickly revenue can grow related to COGs
Underestimating customer acquisition cost
STV Take: Investors understand that a company’s revenue expectations and growth projections presented in a pro forma are educated guesses at best and shots in the dark at worst. Investors can sniff out the latter. While uncertainty is inevitable regarding early revenue growth, there are techniques and best practices founders can use to generate a solid understanding of their cost drivers and present realistic expectations for potential revenue growth. AVL Growth’s latest guide offers valuable tips to help founders craft the best version of their pro forma. (Sponsored)
🤝 To intro or not to intro?
Rich Maloy, Managing Partner at SpringTime Ventures (you probably know him from the VC Minute podcast but just in case!), solicited feedback from LinkedIn on whether founders should take intros from investors who aren’t committed to investing in the round. If you have ever met Rich, you know he genuinely wants to help founders connect the dots where relevant, even if the company isn’t a fit for SpringTime. It had never occurred to him this might actually be sending a negative signal until a founder questioned him about this. The comments Rich received were varied. Some founders believed in casting a wide net and taking the intro while others were very hesitant that an uncommitted investor might not be as effective.
STV Take: This is not the first time I’ve heard that founders shouldn’t take intros from investors who aren’t committed to the round, but like everything in venture, it really depends on the situation. If an investor straight passes on the round, I think founders should be cautious of having that investor facilitate intros, especially if the investor is known for having deep expertise in that area; e.g., a FinTech-focused VC passing on a FinTech company. That runs a real risk of sending a negative signal. Generalist investors who would typically look to that sector-focused investor for guidance might see them passing as a red flag for the market or potential for the business.
For me at least, I think intros make sense in two situations. The first is when the company is building in a space very much outside the VC’s purview (think a deep tech space company and a FinTech VC). Most investors have hard limits on areas where they won’t invest, so this is a generally accepted reason for passing. This type of intro works best when the founder has some semblance of a relationship with the investor. Just randomly emailing investors in hopes of leveraging anyone who answers for better intros doesn’t typically work.
The second situation where an investor intro can be effective is in the early stages of diligence before an investor has made a decision one way or another. Many Seed investors are collaborative and like to talk through potential investments with other investors. Naturally, this can lead to opportunities to connect founders with interested investors. Investors know other investors need to run their process and won’t read anything into another investor not committing if they’re still doing their work.
These are my opinions, though! I am curious what your take is.