Using due diligence to avoid risk and maximise returns
The fintech industry is booming, disrupting the financial sector and attracting billions in investment globally.
Let’s look at the numbers
The global fintech market was worth a staggering $127.66 billion in 2018, with a predicted annual growth rate of ~25% until 2022, to $309.98 billion.
The UK broke its fintech investment record in 2019 by raising $4.9 billion. An increase of over 30% year on year that catapulted the country to second in the global rankings for VC investment. Now, more than ever, the UK is a hub and breeding ground for fintechs.
With increased funds chasing more deals it is imperative that funds make smart and strategic investment decisions. Thorough due diligence, therefore, needs to be embedded within the investment journey.
According to industry leaders, investors who devote at least 20 hours to the due diligence process will see a 500% return on investment, or more.
Siding with Angels; Robert Wiltbank, Nesta-UKBAA
However, with venture capital firms juggling a vast number of deals and numerous fintech opportunities, time is the biggest constraint – everyone knows the old adage “time kills deals”.
Limiting the time dedicated to due diligence can not only reduce the depth and quality of the due diligence, but can ultimately reduce return on investment by increasing the likelihood of 3 keys risks for Venture Capital firms.
1. Outright failure
The simple fact is that 9 out of 10 startups fail. This is by no means an easy business, so extreme detail and care is required when deciding to invest.
Innovative technology fuels fintechs, but this heavy reliance on technology infrastructure means that they can be vulnerable if the technology is not robust, reliable and scalable.
Wonga is one cautionary tale that illustrates this. Founded in the UK in 2006, Wonga raised a total of around £145.5 million from numerous investors. After admitting its algorithmic technology had been lending money to people who couldn’t pay it back, Wonga agreed to write off the loans of 330,000 customers. Wonga went into administration in 2018, which will be a painful memory for those that invested in the company without appreciating the issue in its underlying technology.
2. Reputational damage
Information and data security should be at the heart of the fintech business model.
Failure to comply with data regulations or to maintain a robust security framework will lead to security breaches, heavy penalties, reputational damage and could inevitably lead to the demise of the fintech.
An example of an inadequate security framework resulting in reputational damage and ultimate failure is MyBizHomePage. Founded in 2006, they worked with QuickBooks software to help companies keep a track of their finances. At one point, the company was valued at $100 million. However, the company collapsed when the site’s security was compromised. After a series of cyber-attacks, hackers managed to completely sabotage the website and use the company’s own email and Facebook accounts to smear the founder’s reputation.
Even without the imposition of fines, the reputational damage that comes from data and security breaches is hard to recover from, especially as a fintech that manages customers’ money.
An investment with a vulnerable platform and insufficiently rigorous security processes will be highly likely to under-perform.
3. Inability to scale and maximise returns
Research has shown that if you commit less than 20 hours to due diligence, your average expected return is 1x. But, if you do 20 hours or more, your expected return is more than 5x. Numbers like this really prove the value of thorough technical due diligence.
According to the Startup Genome Report, 74% of startups fail because they are not adequately prepared to scale – financial services is no exception. Investment returns are intrinsically linked with the fintech’s ability to scale effectively.
This was the case for retail impact investing platform Swell, who ceased operation in 2019 due to their inability to scale and sustain operations. Scaling successfully is what separates eventual industry leaders from long-forgotten fintechs. More often than not the underlying technical platform will be the limiting factor for a start-up seeking to build out their use base.
Maximising returns through due diligence
Due to the nature of fintechs, the product is tightly coupled with the underlying technology on which it is built. Hence, it comes as no surprise that the common thread with most fintech failures is inadequate technology, with ineffective supporting processes and organisational structures.
There is no silver bullet for guaranteed success when it comes to investing in fintechs, but the chances of success can be greatly increased by conducting an impartial, trusted technical assessment that gives a holistic overview of a business’ potential for growth, without spending excessive time, effort and money.
Woodhurst has created, tested and delivered a repeatable but flexible model for assessing how well a fintech’s technical platform, team and processes will scale with customer growth. Our approach to technical due diligence can take only two days, with minimum disruption to the leadership team of your target investment, but giving you a clear view of the underpinning tech platform and its ability to scale.
Contact us if you’d like to discuss how Woodhurst can provide an independent, trusted and cost-effective Tech Due Diligence which could help you realise maximum the return of your investments.
