By Sasank Chary and Andy Greos

The financial technology sector has undergone seismic shifts in recent years. The narrative often centered around fintech companies displacing traditional financial institutions with superior technology and user experience. However, the focus moving forward is likely to shift towards fintech playing a supportive and enabling role.

During the era of low interest rates, many fintech businesses received substantial capital to compete directly with established financial institutions across various segments, including banking, lending, insurance, capital markets and wealth management. While this created a handful of winners, relatively few of these “disruptors” have succeeded in overtaking incumbents. This path also required immense capital to build a brand, attract customers, and undercut pricing to disrupt entrenched relationships. Ultimately, these businesses need to simultaneously build robust financial institutions and build technology companies capable of delivering modern software products. This is a significant endeavor. It has become clear that incumbents, despite their relative lack of innovation, benefit from several substantial advantages, including scale, a large customer base, lower-cost capital and regulatory expertise.

Coupled with the end of zero interest rate policy (ZIRP) and the decline of momentum-driven venture capital funding, this has led to a significant decline in private financing in the sector. It’s not news to anyone in this space that venture capital investment in fintech is currently at its lowest quarterly level in over five years (FT Partners); valuations are down approximately 70% from their 2021 peak (F Prime Index).

Despite mixed success in directly challenging financial institutions, disruptors have forced incumbent financial institutions to rethink how they can operate and how they need to evolve. B2C fintech businesses excelled at creating user-friendly products, integrating financial transactions into everyday activities and revealing the inefficiency of existing workflows. Most importantly, they offered consumers a glimpse of what a modern financial experience could be.

In our discussions with financial institutions, two key points emerge:

First, they recognize the need to enhance customer experience and pursue technology-driven efficiency within their organizations. Customers can move more easily than ever and will gravitate towards alternatives offering a superior experience. And the interest rate environment and competition for talent necessitates more efficient workflows.

Second, the biggest obstacle to innovation is their legacy infrastructure, which, although reliable, cannot be easily modernized. But the infrastructure is often too difficult to replace; it needs to be contained and supplemented with new solutions surrounding and integrating into it.

This presents a tremendous opportunity for fintech businesses who can collaborate with and enable financial institutions with a B2B approach. The financial industry accounts for a quarter of the global economy and remains the world’s most lucrative vertical market. Fintechs can tap into large existing revenue and expense pools to build significant businesses. The scale of legacy B2B fintechs such as Fiserv, FIS, ACI, and SS&C illustrates the size of this opportunity. A “niche” within financial services software is likely to be more substantial than many vertical software markets.

Five Principles for B2B Fintechs

Market corrections create significant opportunity. Today’s climate is perfect for B2B fintech companies to enable transformation of the financial services industry, guided by five key principles:

1. Depth Over Breadth

It is tempting to try to be everything for everyone or try to win larger accounts by creating bespoke solutions. Businesses that maximize the value of unique expertise and specialized offerings can scale more efficiently and deliver mission-critical solutions to real problems.

One such example of this is our investment in LoanStar, a software company that works with credit unions that have a structurally low cost of capital but limited direct customer acquisition channels. LoanStar connects the existing origination systems of these institutions to the point of consumption via merchants, enabling them to offer seamless financing at the time of consumer need.

2. Cross-sell and Consolidate

Sales cycles in enterprise B2B fintech can be long. However, once the business is won, it tends to be very sticky. After achieving scale in the core product and trust with their clients, fintechs can further engrain themselves with natural extensions of their services.

This can be achieved organically or through acquiring competing or ancillary providers. We anticipate the next few years will bring a wave of consolidation, enabling the best fintech platforms to strengthen their market position.

3. Compliance is King

A lack of direct regulatory oversight does not guarantee free reign. Regulators will naturally begin to focus on new products and paradigms in the industry as they scale. The recent scrutiny of banking-as-a-service providers is one such example. Everything is not a regulatory priority until it is.

4. Consider Alternative Revenue Models

Fintech companies selling B2B understandably gravitate toward traditional subscription Software-as-a-Service (SaaS) revenue models because it is easily portable from other technology verticals. But that can sometimes be an unnatural fit serving financial institutions with engrained payment preferences. Market-leading fintech businesses have an opportunity to think outside the box and evaluate revenue models based on alignment of incentives.

5. Work with Capital Partners Who Want to Lean In

The change in market hype around fintech has led some investors to back away, with questions about the scale of the opportunity or the challenge of selling to FIs. When seeking capital partners, focus on investors that can help entrepreneurs make the most of the present environment. Here are three things to look for in an investment partner:

- Commitment to growth: Partner with investors who take an active interest in operations and have shown a willingness to invest in good businesses despite market headwinds.

- Aligned vision: Rising tides may lift all boats, but in low tide environments, entrepreneurs need to ensure their interests and investors’ interests are aligned.

- Strong networks: Look for an investment partner with a strong network of financial institutions – these translate to new customers, increased sales, or more efficient/smarter operations.

The opportunity ahead in fintech remains as rosy as ever. With these five principles in mind, leading B2B fintech businesses can take advantage of the current market environment and strategically deploy capital to grow and capture market share.