How community banks are driving the growth of Fintech

OBSERVATIONS FROM THE FINTECH SNARK TANK

Fintech startups looking for funding in 2023 are finding that it wasn’t as easy as it was a few years ago.

According to CB Insights, US fintech funding totaled $3.9 billion in Q4 2022, down 79% from Q4 2021. The total number of funded deals fell from 423 in Q4 2021 to 342 in Q4 2021. quarter 2022, which represents a decrease of 73% on average. funding amount per increase from $43 million down to $11.4 million.

However, not all venture capitalists (or VCs) cut back on investments.

Community banks as venture capitalists

In fact, not all providers of venture capital are venture capitalists. Increasingly, banks are filling the void created by VCs. And not just the big megabanks.

According to Cornerstone Advisors’ What’s Going On in Banking 2023 study, there are about 500 community banks and credit unions making direct investments in fintech startups.

Among community banks investing in fintech startups, the average investment was nearly $3 million per bank in 2022. That number is expected to grow by about a third to about $4 million in 2023.

Overall, Cornerstone Advisors estimates that community banks and credit unions will pump about $1.5 billion in capital into fintech startups by 2023.

Banks operate in the Enterprise Fintech category

However, banks do not necessarily invest in all categories of fintech.

Most of the investments are in a segment of fintech called “enterprise fintech” which Blackrock defines as:

“Software and platforms for financial institutions that streamline and/or automate operational and business processes.”

In other words, fintechs whose products and services can help financial institutions – not disrupt or supplant them.

Deloitte estimated that this category of fintech attracted $1.9 billion in funding in 2022, down from $4.3 billion in 2021.

By 2023, community banks alone will account for two-thirds to three-quarters of the total 2022 funding for the corporate fintech category.

The VCs help the banks become VCs

Many of the banks making fintech investments are doing so through organizations specifically designed to help the institutions identify and evaluate potential investment candidates, and to manage their investments, including:

• Alloy Labs. This consortium of 80 mid-sized community banks has made 13 seed to Series A investments that focus on “the edge of money versus the center of the transaction.” Current portfolio companies include Dapi, Moov, Atmos and The Bean.
• BankTech Ventures. Since its launch in November 2021, more than 100 banks have joined the BankTech Ventures Fund which has invested in eight fintechs including Fintel Connect, ZSuite Technologies and PortX. BTV includes its banks in the entire innovation process from strategy and task development, prioritization, technical relevance and business case validation.
• JAM Fintop. The 90 banks in JAM Fintop have 33 active investments with more than $700 million in committed capital by investing in banktech and blockchain companies that develop solutions that allow financial institutions to compete more effectively and serve their customers.

Getting Fintech Investments Right (If You’re a Bank)

Banks should follow a number of best practices when making fintech investments:

1) Have a business strategy focus. Banks need to be clear about their business objectives for investing and what they expect in return – which is more than just return on investment. It could be exploring a new segment, building a new product or deepening a relationship. However, Jason Henrichs, CEO of Alloy Labs Alliance warns:

“Don’t expect to invest to solve your strategic problems. The investment extends beyond the checks written – the board must invest significant energy in defining the goals, senior management must create an investment strategy, and the operations team must build the infrastructure to extract strategic value.”

Carey Ransom, CEO of BankTech Ventures, adds:

“The banks must start with a vision of what it will look like in a few years’ time, which “community” (not necessarily a geographical community) they can best serve, and which capacities they need to invest in and develop. Much of the change will involve fintech investment, and a culture and team that understands how this will best serve their customers and the bank’s business.”

2) Define investment parameters. According to Henrichs, banks like VCs need to define: a) which segments or deal profiles they want to focus on; b) how much they plan to invest over a defined period of time; c) their comfort level with loss; d) how many startups will be in their portfolio; and e) which stage(s) they wish to invest in.

3) Establish operational responsibility. Where do the offers come from? Who should do the due diligence? Who makes the investment decision? Who is responsible for ensuring that strategic goals are achieved? Joe Maxwell, Managing Partner at JAM Fintop advises the banks that they must define a point person with whom the fintechs can interact. In addition, Maxwell warns the banks that:

“The board and senior management team must have technology-savvy people – that is an imperative. It is difficult to support a VC approach if the board and management team cannot articulate the ‘why’ behind the investments.”

4) Consider technological capabilities. Maxwell believes that banks that are “honest about their technology stack and operating costs make better investment decisions because they chase fewer shiny objects, can better articulate the pain and identify a technology fit.”

Finally, there is strong consensus (unsurprisingly) from the experts that banks should not lead deals, but instead bring in a partner VC firm to put together the pricing and deal structure and do due diligence. It may sound self-serving, but at BankTech Ventures Ransom says:

“Knowing how startups work and how to invest in them are specialized skills and knowledge that are usually gained through a lot of learned experience, so they tend to lend themselves naturally to partnerships from a bank’s perspective.”

For a free copy of Cornerstone Advisors’ 2023 What is happening in the banking system study, click here.