We’ve been seeing quite a spate of fintech acquisitions. It started with Visa’s acquisition of Plaid; then came Morgan Stanley’s acquisition of eTrade, followed by Lending Club’s acquisition of Radius Bank, and then, over the weekend, Intuit’s acquisition of Credit Karma.
All of these deals have happened at eye-popping valuations, leading some commentators to suggest that we are in a fintech bubble or that this will imminently end. Neither of those is true. Instead, similar to the bank consolidation that lasted from the mid-1980s to the late 1990s, I think we’re in the early stages of an industry-wide transformation of financial services in the United States.
First, it’s worth remembering that for most of the past 600 years there have been two ways to make money in financial services: you can move money and you can lend money.¹ With the rise of software-driven fintech, observant entrepreneurs have also found clever ways to make money by providing businesses and consumers with data and insights on the state of money and credit. This is a relatively new phenomenon — and worthy of its own post — but for sake of simplicity, let’s focus on the fact that even most of these information-driven fintech innovations have an impact on the market for lending and moving money. This article isn’t about why there is value in fintech, it’s about why so much value is being realized now.
The reality is, what is happening now is something that has happened for decades in financial services: consolidation. Consolidation is often driven by one or two dynamics: 1) recessions, which make it harder to collect loans, and/or 2) low interest rates, which make it harder to make money off of loans. If you can’t make money off of loans the next obvious place to look is the business of moving money.
We’re in a very, very low interest rate environment. It’s harder to make money by lending money, but it’s simultaneously easier to buy assets because it’s cheaper to borrow money. As such, we can expect larger firms to scoop up smaller firms that allow them to make money doing things that are not lending (Credit Karma/Plaid/Cardworks) and firms that give them access to even cheaper money (eTrade, Radius) so that they can still try to eke out a margin in a low-rate environment. In a future post, we’ll discuss how this particular game of musical chairs almost always ends very badly. What you should know now is that access to deposits can put this reckoning off for a while, but it is basically the equivalent to jamming two butts into one chair. It takes a while to figure out who is actually sitting and who is pretending to sit.
All of the acquisitions have fallen into one of these two camps — which I think answers the question of timing.
So then why are we seeing so much in fintech? Simple: these firms are the easiest to acquire, especially if the acquirer is not a regulated entity itself. They generally don’t require much, if any, regulatory approval to get done, unlike a traditional bank acquisition (see the 18-24 month Lending Club/Radius timeline).
Will this stop? Not soon; interest rates seem to be staying low for a while. Instead, I think it’s just getting started because the big banks — who have a lot of money — aren’t yet even in the game.
Is this a race to sell by every fintech firm? No. This is going to last a while and there are a few moderating forces at play. First and foremost, if you can believe it, most banks don’t think they have a problem. But we all know they do. The product suite is commoditized and boring and, of course, interest rates remain stuck at historic lows.
Second, it’s super expensive for banks to acquire VC-backed software companies.² And, truth be told, very few fintech firms have the scale to make any impact on the earnings of one of these acquirers in the near term. But both of these dynamics are likely to change if the market begins to recognize that we’re in a consolidation phase. So far public shareholders seem unbothered by these acquisitions. I think we can expect some of the big banks to see if that logic applies to them as well.
For a fintech founder, it’s a very good sign. It means that there are likely to be more opportunities for exits and liquidity in fintech than in some other tech verticals over the next few years. Of course, companies still need to execute, and they need to create value, but the idea that this is the top of the bubble, is I think, deeply misplaced. Instead, I think we’re in the early stages of a broader industry realization that fintech has become the growth driver for the banking industry.
For an early stage investor, like myself and our team, it’s a very exciting time.
¹Arguably, since the 2008 recession you can also make money by holding money (deposits) and lending it to the government, but let’s hold our noses for a minute and just act like that’s normal lending.
²Basically, banks can’t just write off the amount they grossly overpay for an asset as “Goodwill” like any other Tax-Avoiding Great American Corporation. Instead, they have to immediately deduct that amount from their capital — which reduces their ability to make loans, decreases their operating efficiency, hurts the stock price, and then, most sadly, how much their executives will get paid this year, despite their brilliant strategic acquisition. Sad.