How Fintech Fits into Startup Growth

The cost and complexity of developing an embedded finance product has declined significantly over the past decade, broadly as a result of advancements in banking infrastructure services. These cost reductions together with the strategic and economic benefits inherent in financial services capabilities has generated a view that within the foreseeable future nearly all companies will derive a significant portion of their revenue from financial services.

This view is fundamentally consistent with emergent market behavior by companies for which financial services exist adjacent or incidental to the core product (such as a SaaS product). But the prediction itself (i.e., every company will be a fintech company) isn’t especially useful as a directional guide, in part because it muddies more than it disambiguates the dependencies of fintech development on third parties for core financial services tasks.

Conventionally, fintech programs are seeded via a referrer or reseller model with a financial services company. For example, a POS provider partners with a card processor/bank and refers customers to that bank in exchange for a back-end contractual revenue share. The bank owns the card processing contract relationship and the transactional infrastructure but the POS provider owns front end sales and perhaps some of the customer service. A corollary to this is an old fashioned white-labeling arrangement where a nonbank partners with a bank to resell a financial service but outsources everything but the contract with the customer. This is fintech without the tech. Thereafter, different components of that third party financial product function may be progressively replicated as an in-house capability (whether it be payments, lending, payroll, etc.) until the nonbank is selling and supporting a customer-facing product built on in-house transactional and compliance infrastructure. At the extreme end of this evolution, if the movement up the financial services tech stack and licensing regime goes far enough, the business of being a fintech becomes indistinguishable from the business of being a financial institution.

The foregoing growth narrative, however, doesn’t fairly reflect the degree to which modern banking infrastructure services can be modularized and nonbanks can make strategic and tactical choices on how a financial services product is marketed and distributed on the front end and delivered or supported on the backend. Determining how and when to make these choices is a complex exercise but at a basic level the analysis is an ROI calculus measuring the upsides (some mix of strategic benefits and revenue growth) relative to the costs, particularly the set-up costs. The costs exist on a sliding scale depending on the backend banking infrastructure delivery module(s) used to support the front-end distribution piece. Companies like Stripe now offer off-the-shelf products that enable a nonbank to deliver a branded fintech product without committing in-house resources to the technology and the compliance needed to deliver it. While there are administrative and operational advantages to this set-up it is often accompanied by a comparatively expensive cost structure in terms of fees paid to Stripe for the service (which if passed on to the end-customer may not always be justified (on a pure economics analysis)). More traditional banks and/or payment processors can often offer (usually if the nonbank has the scale) better pricing provided that the nonbank has the engineering and compliance capacities to own and responsibly manage both the balance sheet risk and a major piece of the tech stack. Somewhere in between these integration models (at least right now) are companies like Adyen and checkout.com. Beyond this are intermediary platform services (sometimes called “payfac as a service” or analogous terminology) which themselves integrate with an established banking partner and wrap the backend functionality with general purpose, easy-to-use APIs and provide some services and compliance adjacent to that.

A reasonable hack to accelerate the ROI analysis and bridge the gap between the tech platform piece (which is the most complex to implement) and front-end marketing and distribution is to make an initial investment in the compliance/legal function. Developing baseline institutional knowledge and/or competencies in funds flow risk management (principally underwriting/fraud management), regulatory compliance and the right partnership contract structure furthers a business’ potential to identify and scope the right financial services partnership strategy (at any stage of fintech development) and takes a step beyond a reseller or white-label model.

This alert was prepared by Jake Molland, a Principal at Bound Legal Strategy P.C. The content of this alert is informational only and does not constitute legal or professional advice. Please note that the law changes frequently and further that the generalized information reflected in this alert may not address the specifics of a given factual situation. Please contact Jake at jake.molland@boundlegal.com if you have specific questions or concerns relating to any of the topics covered in here.