The question advisors need to ask fintechs: What about your funding?
When fintech companies seek to launch or grow, one question often becomes paramount: Where will the funding come from? Building a business takes time, commitment and vision, but above all else it requires capital.
There are a number of different funding sources available for firms to choose from, including venture capital, synergy buyers, public equity, organic growth and private equity. Each option has distinct benefits, though none are free of potential drawbacks with implications not only for the success of the firm, but also the advisors who use their technology. Influence from poorly-chosen funding partners can significantly impact the user experience and level of service from a fintech firm’s offerings. Before you choose the technology that powers the day-to-day work of your business, it’s sensible to ask how each potential partner is funded.
Orion Advisor Services is backed by a private equity partner. This model makes the most sense for our firm, but the calculus differs for other tech providers depending on their goals, what they need to achieve them — and what they’re willing to accept in return for funding. The most common ownership structures all possess their own advantages and trade-offs.
Venture capital is more often associated with startups than established companies, and many fintech providers in the competitive landscape have accepted VC funding. Venture capitalists tend to be well-connected in the financial industry, so VC-backed fintech firms may benefit from these relationships. Venture capitalists can also provide guidance and consultation on matters ranging from human resources management to legal issues.
On the flip side, VC-backed firms may have less control than they’d prefer since venture capitalists often demand a significant percentage of ownership and install their own hires to help shepherd the investment. This lack of strategic input can extend to how a fintech firm approaches innovation.
Gaining backing from a major financial institution, which has occurred frequently in the industry of late, is the most interesting dynamic to observe. Acquisitions of fintech providers by financial institutions are often based on the concepts of 'buying innovation' and autonomizing a broader ecosystem. The purchaser typically seeks operational synergy and will look to cut costs related to overlapping processes or personnel.
Financial institutions leverage fintech to create differentiation from other asset managers, custodians or banks, but such transactions raise the question of whether the purchasing company is a builder or just a buyer. Will they focus on sustaining fintech innovation or is their goal simply to promote the newly acquired brand and integrate its current assets?
Going public is a move typically seen with midsize to large companies seeking to raise capital. Public companies are held to stringent regulations and tend to have high compliance costs. They must protect the interests of shareholders and provide accurate, equal information to capital markets. Additionally, governance issues such as audits, compliance and risk management are greater concerns for public company board members. Market pressures can also compel public companies to focus on short-term results over long-term plans.
Organic growth is the old-fashioned option relying on the financial resources of the founders and any income earned by the firm, possibly augmented by a line of credit. With organic growth, firm owners maintain control of the company’s direction and assume only a level of debt they feel comfortable with.
The inherent drawback is a limited ability to make significant investments in the business unless the owners are independently wealthy or the company proves extremely profitable. Often, fintech firms that depend on organic growth are not able to innovate as quickly or reinvest as deeply as competitors with access to alternative sources of capital.
Finally, there's private equity funding, which is different than venture capital. Private Equity firms typically invest in companies that have both strong revenue growth and EBITDA margins. Private equity companies can help provide funding for owners with concentrated stock positions (think family businesses) take some chips off the table yet continue to have an ownership stake.
In addition to capital, private equity firms have the ability to bring a broad set of skills to the table to help accelerate growth. These skill sets can range from corporate structure and governance, to legal, HR or even accounting expertise. Private equity partners can also contribute strategic capital in the form of board members with impressive educational backgrounds and extensive experience in the building businesses.
Private equity firms are typically funded from large institutional investors, pensions, or even family offices. These investors typically invest in a fund which then invests in a portfolio of privately held companies. When selecting a private equity partner, it’s important to do due diligence on average holding periods for their investments, learn about their investment and management approach, and of course get a feel for the culture of their firm. At times, private equity firms can have a reputation for brokering highly leveraged deals, so it is important to get a feel for how much debt they plan to take on in partnering with you.
At Orion, this is the route that we decided to take and are proud to be partnered with TA Associates. We had discussions with TA Associates for a number of years prior to partnering with them, and they have certainly accelerated our growth by focusing on our respective strengths.
There’s no such thing as a universally-applicable ownership structure with no downsides or risks. It’s important to ask your tech providers about their financial backing, but when it comes to ownership structures, you should look for alignment of beliefs and goals.
A shared, strategic direction is the single most important consideration for tech firms deciding on a capital partner. Their funding decisions have a direct impact on the people who use their technology. You don’t want the rug pulled from under your feet because your tech partner’s ownership structure threatens their longevity or culture of innovation.
When choosing tech providers, these questions should be part of your due diligence: Do the owners understand the companies in which they’ve invested? Do they share the same, clearly-articulated vision of what their product does best? Do the owners prioritize long-term results over short-term performance?
Or do the owners of your software care more about the margins on their investment than your user experience?