• Incumbent banks need to retrain its people and change things at a scale to keep up with challenger banks
• Fintechs are focused on growing their user base to demonstrate that their business model works
• For a fintech to be exciting, it needs to have products that can be taken to more than one country

DN Capital, a venture firm that primarily invests in Europe and North America, continues to expand its investment portfolio. It is currently invested in some emerging markets in South America and is looking at opportunities in Indonesia.

With his vast career experience as a venture partner, chairman and professor of fintech and innovation, Renier Lemmens elaborates how DN Capital evaluates investments. He also talks about the evolution in the fintech space, regulators in Europe and financial inclusion.

Foo Boon Ping (FBP): I’m very pleased to be speaking with Renier Lemmens. He’s a venture partner at DN Capital, a Europe-based venture capital (VC) that looks at fintech investments mainly in Europe.

You have come from a very rich experience, both from traditional commercial banking and consulting. You see a lot of financial institutions, business, and in the last few years, fintechs have been such a phenomenal development. But we know that fintechs are not new. How do you see fintechs? You invest in them, so there is a very financial-oriented perspective when you look at fintech. You are bound to see beyond the hype.

Renier Lemmens (RL): We look at the fundamentals of the company. Is a company addressing a market that is large? Are they able to achieve accelerated growth? Is the ratio between the cost of customer acquisition and customer lifetime value sustainable? Is the management team ready for the next wave of growth? In the evaluation of investments, we rarely look at how big is this going to be and who is going to be exited to. It’s much more focused on the now and here, and what are the indicators by which we judge the momentum of a company when it’s still a young company.

FBP: When you look at fintech as a company, as a business, how do they operate differently from other companies? Do you look at them as in the same business as banks? Obviously, they are kind of a very focused business model.

RL: They tend to be. Even the fintechs that have new banking models, they tend to be leaner, faster in their decision-making, with founders who have clear views on where they want to take the business. There’s a certain preparedness to break things and say, “Okay, we’re going to try this differently. Let’s see how we do with it.” A lot of emphasis on speed, and culturally, it could not be more different to be sitting in a fintech versus a bank in terms of the frameworks, the organisation, the governance. Especially after the financial crisis, banks have been burdened with enormous amounts of governance, regulation, reporting and the avoidance of downside has become the focus of management teams.

An awful lot of the decision in banks in discussion is about “How do we avoid downside?”, whereas, in the fintechs, it’s more about “how do we create upside?” Now, that’s a different discussion, and I do not quite understand. I mean, banks can have that, but it needs to be led from the top in that case, because so many people in banks work almost in fear of, “Oh, am I going to make a mistake? Am I going to lose my job? Is my boss going to be happy?” That freedom to innovate needs to be created from the very top, and that just doesn’t happen in many incumbents in my view.

Challenger banks vs incumbent banks

FBP: We talked about poor service in one aspect, but the banks were really very busy trying to cope with this whole regime of regulation that has come up post-financial crisis. As they evolve together with the fintech, do you see the banks coming back to feel some of the deficiency that they have kind of put them in a place to be displaced like customer service?

RL: Very little now. I don’t see it in Europe so much. Southern Europe, a bit. Santander and Banco Bilbao Vizcaya Argentaria (BBVA) Spain. Most European banks, not really. The banks still are caught up, it seems, in governance. Also, to be fair, their information technology (IT) stacks are a huge limitation. I opened a joint account with my wife in a challenger bank. It was done from the couch within a minute. Accounts were opened, cards were in the house two days later. I tried to do the same in an incumbent bank. Two-week waiting time, endless interviews in a branch, people putting lots of data in, and at the end of the day, another two weeks for a card. That’s got nothing to do with regulation. It has to do with incumbency. That means you have to change things at a scale and thousands of people need to be retrained.

Whereas, for example, in TransferGo or in Revolut, if they want to make a change to the app, the CEO will talk to a lead engineer or a product manager. They make it, it gets released the next day or the same day, and it’s done. And, of course, basic reviews are done, all that, but everything is done with much more of a sense of urgency and fewer people involved. I am on the board of an incumbent bank and the amount of governance that is involved there, paperwork and reporting, all stipulated by the regulator, which I’m not entirely sure that it, in fact, helps manage the bank better. Endless. Those things take a lot of time than of management.

FBP: Tell us how has the fintech space evolved. A lot of fintech starts out as monoliners, whether in payment or in peer to peer. We talk about this concept of them building on the life cycle value of testaments and trying to build adjacencies spent across other needs and stuff. What are they doing in terms of expanding beyond the monoline business that they first got into?

RL: They’re trying to, but it turns out to be really hard, just like it was hard for incumbents to do that. Cross-sell imperative is there. It’s really hard. And they follow broadly two models. One is a marketplace model, where they say to other providers, “Come and sell your goods in a marketplace format and I’ll take a cut of the revenues.” The other is where they create, captive more integrated user experiences. I am not aware of any situation where the marketplace model works because it creates disjoint customer experiences.

Now, a number of challenger banks are getting into lending. That’s always current accounts, payments, lending. Consumer lending is the first step or small and medium-sized enterprise (SME) lending, and they're trying their luck with that. But that’s a tall order. A consumer who takes your current account because they just love the convenience or they like the foreign exchange deal, it’s not obvious that that same consumer will be keen to take a loan from you. Completely different product. It’s early days. I think, therefore, that we are very much in the first wave of fintech, and that we’re only seeing the beginning. This will iterate a few more times.

FBP: Venture capitalists and private equity investors like yourself have the longer-term view, but how long of a term is that? And where do you see, in terms of fintechs, those that are still building user bases?

RL: Not so long, in the end. We’re talking five years or so, maybe six, seven. Some companies, only three. It’s not that long-term. But the advantage of private capital is that these companies are not suitable for public markets. They’re not suitable for private equity either because they don’t have cash flow. They don’t have margins. The more successful they are, the more money they lose, because it means they spend a lot on acquiring new customers. And that is not a model that a private equity or public markets can deal with, which is why venture capital has its role to play there.

RL: I notice that, if a fintech doesn’t grow, year-on-year, close to 100% or above, that’s already like, “Really? Are we interested?” Everybody is focused on growing the user base. First, in one country, then multiple countries, to demonstrate that the model works.

FBP: Europe itself as a consolidated market is growing not very much year-on-year. Does that necessarily mean that the fintech investment needs to be global?

RL: Macroeconomically, no. I don’t see that. We’re in Indonesia now. I’m not aware of any London-based VC that has an active interest in Indonesia. Some of the larger funds like SoftBank very much takes a global view, but with the kind of money that they want to put to work, they have to take a global view. But it’s really a set of insulated markets: South America versus Europe, North America, Africa and Asia. There are some overlaps, but on the whole, they operate in separate universes. This is my view.

FBP: DN is focused a lot on Europe. The fintechs that you invest in, do they necessarily need to cover the same markets?

RL: A little bit of Africa, North America and South America. There is a certain degree of opportunism in the portfolio. There are fintechs that cover the German market and the Polish market that are Pan-European. That can differ. But a fintech, to be exciting, needs to be one whose products could ultimately be taken to more than one country. Although if that one country is America, or China or Brazil then maybe that’s big enough, in a way. You don't need to go global. It depends a bit on the situation.

The venture firm’s portfolio

FBP: Tell us a bit about the portfolio that you manage today. Some of the bigger, more well-known one is TransferGo.

RL: I’ve been chair of that company now for two years. It’s a company that has raised Series A and Series B. They are very much focused on international remittances, mostly for blue-collar migrant workers. The essence is growth. The discussions are all about growth. “How can we accelerate growth at an acceptable cost of acquisition?” I guess it’s easy to grow if you throw a lot of money at it. The challenge for the CEO and founder and his team is, “How do we accelerate that growth because that’s what investors in a future round will want to see?”, while not wasting the money and not creating a ratio between cost of customer acquisition and customer lifetime value that is so unfavorable that you never make money on a customer.

FBP: The basic proposition for a lot of these fintechs when it comes to cross-border remittance is a cost fund. You need to invest in better technology, but at the same time, you are undercutting the traditional. Is it a sustainable model for a lot of fintechs?

RL: Mostly, fast, cheap and a good experience. Their cost model is very much lower as well, but it wouldn’t be sustainable if they had similarly high cost as an incumbent. These are all digital-only businesses, so they have very, low cost base. That allows them to compete, and you need to offer the customer something, either faster service, better service or cheaper service.

FBP: For venture capital, your ultimate goal is to exit or to bring it to market. A lot of the market reaction to some of the initial public offering (IPO) hasn’t been very positive. Do you see it’s because of the questions about fundamental business model? A lot of peer to peer, for example, coming out from China.

RL: You have companies that talk about IPOs, and they don't even have a gross margin that makes any sense. They’re not so much in the fintech space as of now, but right now, there's a lot of talk about WeWork.

In the West, peer to peer became a bit of a fad, and it’s gone. Because, first of all, peer to peer was not peer to peer. It was hedge fund to peer. You know why? Because it wasn't funded by individuals and institutions. It’s that business model. It’s there, but it’s not nearly as hot. Certainly, Indonesia, in that regard, is at a different stage of development with so many peer-to-peer companies here who are all trying to make it work. Not all will succeed, evidently.

FBP: Do you see that as a natural growth path of what happened to peer to peer and what happened to payments?

RL: Almost all peer to peers that I’m familiar with evolved into marketplace lending, maybe with institutional funding. That makes sense, too, because the underwriting or the risk management of these peer-to-peer companies was not very developed so you’re going to get a relatively uninformed investor or provider of capital, putting loans against people with unclear credit worthiness. It was a challenging model, but some companies have done really well, including some that have gone public.

FBP: In your portfolio, there are, I guess too many peer to peer? Where are you invested in that? Did you invest mainly in late stage?

RL: Remittance. Sales finance. Online sales finance is another one. Sales finance, meaning when you check out at a retailer, you pay with six installments or 12 installments. There's a big growth market there. Companies like Credit Karma in Europe, companies that help consumers build and improve their credit, and in the meantime, meet the lending needs of those consumers. There’s also a portfolio of companies that are active in Eastern Europe, but there’s a fair bit of diversity.

We also have a really interesting company in the US, which is a company where you connect your bank account. The company will make sure that you never go overdraft and put money in your account if you go overdraft, so that you don’t get the exorbitant overdraft fees. Instead, you get a relatively low-cost solution to make sure that you will not be hit by unexpected fees.

It’s called Series A and B, and often as early as possible. But that means you also look at companies that are perhaps not quite right. You look at a lot of things that, at the end of the day, for various reasons, you don’t invest in.

We are heading for a period where investors will be more judicious about which opportunities to invest behind and a better understanding just how the ecosystem will work together.

FBP: Do you work alone or do you work with syndication of venture capital?

RL: Often, no. In a round, there are multiple firms that participate. One tends to be the lead firm, meaning the one who does most of the due diligence, the one who sets the price for the round and then other firms are following. Meaning, they also put money but they rely a lot on the work done by the lead firm. There is usually a syndicate of sorts.

For DN Capital, it’s the same thing. It’s rare that you do things just by yourself. It can happen. But also, founding teams don’t like that. They prefer to also diversify a little bit.

FBP: Your view on fintech is very clearly a competitive one. You either be there to disrupt the market or have a very clear competitive position against incumbent. Some fintechs are working to partner with the incumbents. What are your views?

RL: Many do, but that’s usually, at least in my geography, with enabling services. So, there is, for example, a fintech that I had some dealings with who is offering re-platforming for incumbent banks to take them to a cloud-based banking platform. That is a good example of a fintech that has a proposition for an incumbent, and is not competing with them. There’s another company called ClauseMatch. They help companies follow changes in regulation. When something changes in the regulation, they automatically track which policies, which frameworks and what-have-you need to be changed.

Now, that is also a product that is sold to incumbents. There are a lot of enabling services being sold. I have not seen so much product collaboration, yet. TransferWise, another large remittance company or international money transfer company, has done some partnerships with banks making their product available through the banks’ websites and apps. That’s one of the few examples I’ve seen.

FBP: I know DN Capital doesn’t invest in Asia. What's your view of Asian fintech?

RL: I honestly don’t understand it well so I would make it up. It’s not something I’ve studied. Today, I learned just how much activity there is in Indonesia. Not surprising, being such a large country with such a big, whole market. I’m really not familiar with what’s happening here with the exception of the large Indian and Chinese fintech companies. But no visibility or understanding of what goes on below that very top of companies. And clearly, there's a lot of activity.                                                                         

I would think, particularly in Indonesia, which is such a large country, that there is a lot of opportunity here for fintech because you have such a big, whole market. It’s not exactly a market where foreign fintechs would say, “Ah, my next priority is Indonesia, Asian ones, to an extent,” but there’s a great opportunity with such a big, whole market for companies to prove the concept back home.

FBP: In your portfolio, you are invested in some emerging markets in South America, is that right?

RL: For example, a payments company called RecargaPay. They tend to come to us via the North American network. There's a certain degree of opportunism. Some of the other people in the firm will understand South America better so they are, “Okay, we’re not afraid of South America.” I’m sure that if there was an Indonesian opportunity, tomorrow people would say, “Oh, but we don’t really know. We don’t know the country at all. We have no idea how it works there.”

How regulators work in Europe

FBP: Talk to us about regulation. How important do you see regulation enabling as well as delineating the role of incumbents and fintech?

RL: I don’t see them. I have not seen the European regulators, this delineating of roles. There is a licensing regime, which in most countries they’re trying to be as responsive as possible, and then the actual regulatory regime. Take crypto as an example, very slow. It

is, in my experience, rare, if ever, that the regulator will be the first one to opine on an innovation. More likely, the company goes ahead, and then the regulator follows because by nature, regulators focus on protecting downside. They’re slower. At least in Europe, regulators don’t tend to lead. The industry leads the regulator.

FBP: In some areas, like the second payment services directive (PSD2) as well as general data protection regulation (GDPR).

Even in the UK, the Financial Conduct Authority (FCA) or Financial Services Authority (FSA) regulating the challenger bank is kind of paving the way for this, too.

RL: That’s true, but that’s very macro; a GDPR, PSD2 or the open banking movement. That’s very top-down; those are big moves. I would say, that on the whole, they make life more difficult rather than easier for incumbents.

The challenger bank in many ways has the same obligations as an incumbent bank, the same capital adequacy, the same reporting. But what the challengers tend to do is they apply technology to that part of the business as well. For example, at Revolut, artificial intelligence was applied to dealing with compliance in the most cost-efficient way possible or customer service, high-quality chat bots, self-help and what-have-you. If you do that, then you still have to comply with the same regulation but it’s a much lower cost to do so.

FBP: From your perspective and looking at technology, how deep do you look at technology? There are cycles of technology or cloud thinking for fintech. You talk about blockchain or talk about platform, cryptocurrencies. How deep do you get? And talk about the state of technology when a fintech comes out and says, “No, we have technology that the banks don’t have”.

RL: Any bank, any company can copy or use any technology. These technologies aren’t proprietary. Personally, I look at it deep enough to get a sense for when it is hyped or what is real about it. But that doesn’t make you an expert in the technology, it’s just really that you don’t sort of follow every herd-like thought. That’s what we saw a bit in fintech with blockchains the year before last. You can just see it at the number of Google searches or the number of conferences. The theme goes because people realise that, “Okay, it’s interesting but it’s not going to set the world alight overnight”. And then, we come up with something else, maybe cryptocurrency or big data, and the same thing applies. These are all good tools, these are all really helpful technologies where we can do so many new things that we couldn’t do 10 years ago, five years ago. Folks don’t go to a conference on Excel anymore, correct?

We got it. We’ve been using it for a long time. Some of these technologies will fall in that category. These will just be there. You don’t really need to know everything. In order to drive a car, you don't really need to know the principles of a combustion engine. No need. In order to think about the business application of a blockchain, you don’t really need to know everything about hashes and all that stuff. It’s just not particularly relevant. But we should always be aware when industry pundits start talking about a technology. “Oh, this one will change everything.” I don’t see any evidence in that.

FBP: You are serving the needs where there might not be a strong financial margin to do things. For example, in Indonesia, for ESG-related meeting requirements for either green initiatives. There are fintechs that are moving in that direction. Towards the end of our panel discussion, we talked about some of these areas where there are no clear financial markets or key performance indicators (KPIs). Are those areas that are of also interest to you?

RL: A bit. For example, not so long ago, we looked at a lending business that was focused on Africa. So underserved. In the end, the thing is, it’s a bit tricky. By large, people are underserved either because they have no money, or because they have no access or because they don’t feel comfortable with access. But it’s mostly the first two. They have no money.

“I have no money to put in a bank account, so why do I need one?” And they are not served by the current incumbents because there's no profitable way to serve them. A fintech shows up and says, “Oh, we don’t have expensive branches. We don’t have this, we don’t have that and we can do it cheaper.” Then, that creates an interesting business opportunity, but it will always have to start and end with the business opportunity. The financial inclusion is a nice byproduct. And it will be both nice for the company, the founders and the investors. They all would love to be able to say, “This company’s successful. It will be very valuable and it has helped the country with financial inclusion”.

Any business model that starts with financial inclusion, and only then, worries about profitability, I don’t see how that would work. Maybe if the government wants to sponsor it, but private money is not going to do that.

FBP: That’s interesting because that’s where we see a lot of mainly private money coming into the market. Some corporation or foundation that is looking at, I mean, they have an environmental, social and governance (ESG) mandate. Governments are also driving in terms of the United Nations Development Programme (UNDP) commitment to fulfilling some of these social sustainable development goals.

RL: That’s a different kind of money, isn’t it? That is not your typical venture capital and/or private equity (VCPE) money. This money also is important. It looks at things differently and a lot of companies in developing countries will get funding that way. But it’s not the same as building a sustainable business. I would like to think that even if you are focused on financial inclusion, and it’s hugely important, it is so much nicer if you have a business that actually is economically viable.

FBP: There are some that are interested in private equity money that is also at the same time responsible on social impact and stuff. I guess that’s one of the areas that is developing.

RL: There are a lot to be done there, especially this part of the world: Africa, South America. Inclusion is less of a topic in Europe. It’s a little bit it in the US. There are a lot of underbanked people there. But it all starts with the same problem. They don’t have enough money. There's no point in giving someone a current account even if that current account doesn’t cost anything. If there’s no money to flow through it, what are you going to do as a bank? Which is why people tend to start with lending. And lending, normally, is at quite high rates because you have customers who are not so creditworthy, and that tends to bring up, potentially, a moral issue. In Vienna, we’re working on a financial inclusion product, but we’re charging an arm and a leg for it.

They may not have an alternative or it may be some local thug lending the money. That’s possible. Financial inclusion tends to mean pretty high prices for the financial product because the consumers aren’t so profitable.

FBP: What are your current priorities now?

RL: We got a whole bunch of deals pop in every week. Some we look at quickly, while others we look at with a lot more attention. But that’s just one of seven jobs that I do. My main priority when I get back to London is to develop the materials for my first teaching classes at the university. There are a whole lot of work, so that will take up most of September when I come back.

FBP: Thank you so much, Renier.