It’s never been harder to be a fintech startup. Especially if you are a nonbank lender where your startup depends on banks and credit unions for lending capital. These deposit-backed institutions are the highest priority partners for any fintech, but landing these partnerships is an uphill battle right now.
The last couple years were characterized by a scorching-hot VC market and high-multiple valuations. But in 2022, the pendulum has swung hard back the other way: Investors are prioritizing profitability over growth, the VC market has tightened, and high-growth startups have seen their valuations contract.
At the same time, deposit-backed institutions have much tighter liquidity today than they did last year. Deposits are lower, borrowing costs are higher, and banks have grown more risk-averse due to an uncertain economic outlook. Thus, lending capital from banks or credit unions might not come as easily for fintech lenders as it did in 2021. All this raises the bar for fintech startups looking for lending capital, venture capital, or both.
In a tighter market for bank partnerships, how can fintech start-ups get ahead?
In this environment, fintechs should prioritize the items that some growth-hungry VCs might find less attractive: compliance, data security, risk, & lending partnership stability. It might sound crazy to focus on anything but ROI in an economic atmosphere like this, where your seed investors are scrutinizing every dollar you spend. But the reality is, a tight capital market is a make-or-break time for proving your reliability as a bank partner. The #1 thing deposit-backed institutions care about when they choose capital partners is dependability: predictable growth, risk control, and strength in compliance.
In PatientFi’s early days, we had to pay our dues to prove our potential as a reliable partner for deposit-backed institutions. We first got capital from private equity (PE) specialty finance lenders at a higher cost than we might have preferred, but it got our engines running. It allowed us to build crucial infrastructure that would later help us cement relationships with banks and credit unions.
Aspiring fintechs are going to pay their dues: showing VCs and banks that they’re strong, dependable, compliant capital partners. If you can pay your dues in a tight capital market, the long-term rewards will be tremendous.
A checklist for fintechs looking to find strong bank lending partners
- Hire a compliance officer—before a head of sales. One of the main things deposit-backed institutions worry about when they partner with fintechs is that the fintech will fall afoul of regulatory guidelines, and the banks will get hit. You need to do everything in your power to prove that that won’t happen to you.
Establish internal policies and procedures (follow and test/audit them regularly) for fair lending and truth in lending (TILA) and create a robust fraud program with anti-money laundering (AML), bank secrecy (BSA), and fair and accurate credit transactions (FACTA) processes to protect both consumers and your lending partners. Excellent compliance is expensive—but it’s also non-negotiable. PatientFi has invested substantial resources into compliance over the years, but we wouldn’t have the lending partnerships we have today without it. No, you might not see immediate ROI from hiring a chief compliance officer, but your business will become more scalable, enjoy higher margins, and have staying power.
- Don’t hyper-focus on growth. The 2010s got startups in the habit of lionizing growth as an end-all, be-all metric with very little eye on profitability and performance. Not only is that not the case anymore—the best businesses have always run on sound fundamentals. And if they don’t, there’s always a crisis lurking to knock their feet out from under them.
Make it a cultural goal to build the right way with a sustainable and scalable business model. Carefully list the lending capital partnerships you want, and incorporate them into your success criteria as much as revenue or growth. Learn what it means to be a sterling bank partner and don’t cut corners on becoming one. Get started on SOC 2 certification, refine and enhance your credit scorecards and risk systems, and have a strong grasp on actively managing performance to control loan losses. There are many ways for fintech lenders to create significant enterprise value beyond growing loan originations and revenue.
- Openly communicate with your lending partners. Not only should you operate as if the bank is in the room with you at all times, but you should be proactive about communicating with them about the status of the partnership. Don’t make them chase after you and don’t make them ask you for reports they can share internally.
PatientFi conducts weekly operations meetings and monthly portfolio reviews with our lending partners. We talk about wins, mistakes, the conditions of their loans, and what we’re doing to remedy any potential issues. They’re your partners; they deserve as close to a real-time view into what’s going on as possible.
- If necessary, seek alternative lending capital. If you’re too early for banking and credit union partners, but you’re facing an existential imperative to run the commercial engine, seek funding from PE funds.
The good news here is that PE funds are less strict than banks on some of the infrastructure needs I mentioned earlier (compliance, data security). PE firms have also never had more dry powder to spend than right now. The bad news is that PE firms have an obligation to make money for their investors, and so the cost of capital is much higher than that of deposit-backed institutions (~15% IRR). And high interest rates aren’t helping them achieve their levered IRR unless they can pass these costs on to the fintech companies they lend to (i.e. you).
Again, you should only really pursue this route under very particular circumstances: You can’t lock down bank partnerships, but you need to get your business operating. If that’s the case, PE can be a way to prove the stability of your partnership as you court banks and credit unions as future partners.
The overarching truth is that fintechs and deposit-backed institutions need each other. Fintechs are innovative and digital-first in ways that most banks aren’t yet. They also help financial institutions expand their reach with cost-efficient customer growth. Financial institutions, on the other hand, have the balance sheet capacity and cost of capital that fintechs never will. Partnerships become essential to deliver the convenience and value that today’s consumers expect.
For fintech startups looking to gain a foothold: Build secure, compliant systems; don’t hyper-focus on growth; communicate openly; and, if necessary, pursue alternate funding sources in the private markets. It may not be the most pleasant journey. But take it from me, if you forge the right partnerships, it paves the way for long-term, sustainable value.
