The Y Combinator Problem
By Alex Johnson
3 Fintech News Stories
#1: The Y Combinator Problem
Brex decided to abandon its small business customers:
Brex had sent emails to tens of thousands of small businesses, telling them that the financial services company would no longer be able to serve their needs. After expanding its business from tech startups to traditional small businesses, including mom-and-pop shops, Brex had decided to pull back to its original core customers.
And who exactly are those core customers? How is Brex defining a “startup”? Here’s Brex co-CEO Henrique Dubugras:
It’s not a perfect definition. Our definition is anyone who received any kind of funding from either venture capital, angels, accelerators, any kind of professional funding.
Here’s a pattern — let’s call it the Y Combinator problem — which I see play out a lot:
- A fintech founder finds early product-market fit by solving a financial services problem for people like them (young, well educated, high income, works in tech, etc.)
- They grow their company by rapidly acquiring more customers within that core market and raising money from investors based on that growth.
- They attempt to pivot into a broader growth strategy by generalizing the needs of their core customers to a larger market and adjusting their product accordingly.
Step 3 is the hard part. Some fintech companies (like Stripe) manage to do it. Some are in the midst of trying to do it (see Pipe’s expansion into media and entertainment). And some, like Brex, fail to do it because they underestimate just how different that larger market is from the one that they know. Here’s Dubugras again:
I’d say we were pretty surprised by the sheer amount. There are tens of thousands of startups in the U.S. versus tens of millions of small businesses.
The needs of these customers are actually quite different.
I think Brex deserves credit for realizing that they can’t serve non-startup small businesses well and making the difficult decision to focus on what they do best.
However, I also think the fintech industry (particularly early-stage investors and startup accelerators) must find more ways to support founders from diverse backgrounds and expose early-stage fintech companies to a much broader universe of customer problems. It can’t all be tech building for tech.
#2: I’m Going to Teach You to Hate Spending Money
Klarna continues to have a tough time raising money:
The Swedish payments firm is in talks with investors about a deal that could value the company at around $15 billion, the people said, less than it was seeking just last month. The Wall Street Journal reported Klarna was in talks to raise up to $1 billion at a low $30-billion-range valuation. One of the people said the current talks could yield at least $500 million. There is no guarantee a deal will take place.
A $15 billion valuation would be a substantial comedown for Klarna, which became Europe’s most valuable financial-technology startup last June when SoftBank Group Corp.’s Vision Fund 2 led an investment that valued the company at $45.6 billion. Other investors include Sequoia Capital, Silver Lake and Dragoneer Investment Group LLC.
You ever see the movie Brewster’s Millions? It’s about a broke Minor League Baseball player named Monty Brewster (played by Richard Pryor), who is offered the chance to inherit $300 million, but only if he is able to spend $30 million in 30 days without accumulating any assets. [Spoiler Alert!] The movie ends with Monty narrowly succeeding in spending the $30 million (and learning to hate the experience of spending money along the way), inheriting the $300 million, and earning himself a happy ending.
The last couple of years for Klarna (and fintech generally) remind me of Brewster’s Millions — investors go to a private fintech company and tell it that it can be worth tens of billions of dollars if, and only if, it can spend hundreds of millions of dollars incredibly fast.
The irony is that Klarnadid exactly what its investors asked it to do— it burned tons of money really quickly as it expanded geographically and added lots of new merchant partners.
Apparently, that doesn’t matter.
The distorting effect that investment dollars have had on fintech over the last couple of years cannot be overstated.
#3: It’s Still So Early
A fintech startup has emerged from stealth:
Able has built an engine to speed up the processing of documents and other data required for commercial loans (typically $100,000 but sometimes up to $100 million in value), which it sells as a service to banks and other lenders. Today, it’s coming out of stealth mode with $20 million in funding and a launch into the wider market.
The Series A is being led by Canapi Ventures — a specialist fintech investor — with participation also from Human Capital, which also led the startup’s seed round.
I generally cringe when folks in fintech say — in response to concerns about the overwhelming amount of investment that has poured into the industry and the sheer number of neobanks we now have — “it’s still so early.”
(when folks in crypto/web3 say that, I do a lot more than cringe)
However, this is a good example of where they’re right.
Commercial lending is an absolutely huge market — $6 trillion annually. It’s stuck in the past — globally, banks spend about $60 billion a year to process commercial loan applications, mostly by passing paper back and forth. And yet there’s hardly been any fintech innovation in the space, as illustrated by this amusing anecdote from the co-founder and CEO of Able, Diego Represas:
Represas said he came to the idea of fixing this after a meeting with a cousin of his who worked in business finance and told him about the painful process that went on behind the scenes.
Represas and Hurst at the time were engineers at another fintech, Digit, and so Represas’s natural inclination was to think that there was likely already a solution in the market to cut this down.
It turned out there wasn’t. He couldn’t believe it, he said
2 Things to Read and/or Listen To
#1: Reflections on ‘Earn’ (by Mark Grace, Latif Peracha, M13) 📚
This is an interesting overview of the use of tokens in web3 to rewards users, incentivize adoption and usage of web3 products, and overcome the cold start problem in building a multi-sided network.
I tend to think that building ‘transportable economic value’ into consumer-facing products creates more problems than it solves (see: Anchor Protocol), but it’s worth considering the other side of this argument, which Mark and Latif make well in this essay.
#2: Interview: Paolo Ardoino, CTO of Bitfinex (by Jason Mikula, Fintech Business Weekly Podcast) 🎧
Jason’s podcasting skills are too strong to be confined to our monthly Fintech Recap podcast (which we are still doing!), so he has added a Fintech Business Weekly podcast into the mix.
This first episode, with the CTO of Bitfinex, was fascinating. I was particularly interested in the discussion around the differences between Terra and Tether (although I still don’t feel at all good about Tether, but that’s another podcast).