Moving Towards the Fintech Age

The Banking and Financial Services industry is witnessing a rapidly changing landscape, with the rise of fintech companies being the catalyst. Traditional banking products, services, and channels are losing relevance as customers, increasingly influenced by social media and technological advancements in other spheres. There is immense, and largely unfulfilled, demand for better customer experience and convergence in services. Mobile-internet based banking services are being rapidly adopted, resulting in bank queues shortening by the day. Service levels are no longer the differentiating factor. A customer experience that is efficient, convenient, personalized and streamlined at every touchpoint is what sets financial institutions apart. The changing regulatory environment and other macroeconomic indicators have also contributed to making this a never before opportunity for the rise of fintech start-ups and their disruptive digital banking solutions.

Digital banking has influenced world economy manifold. Alternative Lending is probably the greatest innovation by fintech companies if you were to ask millennials. The traditional banking system has extremely rigid norms and mandates a cut-off credit score to qualify for a loan of any kind. Young adults, the self-employed, and people who have moved cities/countries have little or no credit history if they have not taken a loan previously or do not have a credit card. Such people would have a zero FICO or CIBIL score. In emerging economies alone, individuals, as well as institutions, rely on cash nearly 90% of the time. This increases the cost of servicing customers for financial institutions while leaving little or no usable data to assess the creditworthiness of such businesses and individuals.

Fintech startups like the UK-based Aire; Kabbage and Lending Club in the US; Data signs, Capital Float, Rubique, Finomena, OptaCredit and the likes in India have recognized the need for democratizing the credit score. Consequently, they have leveraged the power of Big Data, machine learning and Artificial Intelligence (AI) to assess creditworthiness. App-based lending services have used these techniques to assess “intent to pay” rather than the conventional “ability to pay”. This has helped transform B2B and B2C lending for Micro, Small and Medium Enterprises (MSME) and individuals. Forbes estimates, the 1,000 fintech companies in the world have collectively raised US$105 billion in funding and are currently worth nearly US$870 billion. Investment in fintech firms has more than doubled between 2014 and 2015, with California and New York in the US, the UK and France being the global hubs. They are followed closely by India and China, primarily because of a large population and a fast-rising middle class. In India, experts predict, as people and jobs become more mobile, alternative lending – rather than staying on the fringes – will be the new ’normal’.

It wouldn’t be too far from the truth if one stated that Alternative Lending is the poster-boy of fintech industry. It is worth noting, however, that the young adults living in urban areas aren’t the only beneficiaries of digital banking. It has also started touching the lives of the rural population in emerging economies, which were, so far, unbanked. According to a McKinsey Global Institute study, 2 billion people globally do not have a bank account or access to credit., At least 200 million MSMEs in emerging economies have little or no access to credit, impeding their growth. This gap between demand for credit and its supply is estimated to be at US$2.2 trillion. For governments, the predominant use of cash leads to leakage (estimates peg it at one-third of cash payments), enabling corruption and affecting the efficiency of delivery of government aid and subsidy.

Access to a smartphone, connected to an ecosystem of thousands of mobile apps running securely over a cloud computing infrastructure, provides the much-needed basis for a suite of basic financial services. A digital wallet (linked to a traditional bank account) can be used for payments and remittances, wages and government subsidies, transacting at stores and paying utility bills and school fees. All this at a finger’s touch saves time, money and effort, that too at no risk and greater convenience. Fintech startups can partner with financial institutions to provide digital banking solutions, at costs 80% to 90% lower than the cost of building brick-and-mortar bank branches. Over time, based on the database created by transactions made through digital wallets, credit risk may be assessed for providing loans. As the use of digital payments and other digital products increases, the benefits to all users increase, creating network effects that can further accelerate adoption. According to studies, in Kenya, the use of M‑Pesa mobile money system grew from 0 to 40 percent in the first three years of its launch in 2007—and rose to 70 percent by 2015, much faster than traditional banking could ever hope to achieve.

Uniquely poised among the emerging economies is India with the third-largest smartphone market i.e. 314 million mobile web users as of 2017. Faced with the herculean task of delivering on its promise of financial inclusion and transparency, the Indian Government is relying on innovative digital solutions. Hundred million new mobile wallets have been created in India in the past one year by fintech start-ups that did not exist a decade ago. More than a billion citizens have been brought under the digital grid through India’s Unique Identification Program (UID) in five-and-a-half years, which is probably the fastest digital service growth in history. In a massive exercise, the government has also opened more than 200 million bank accounts linked to the UID to deliver government welfare funds including wages and pensions, aimed at reducing leakage.

The widespread use of digital finance can uplift the GDP of emerging economies by as much as 6%, or US$3.7 trillion, by 2025. Close to 1.6 billion unbanked people can gain access to formal financial services if the India example can be replicated by fintech start-ups in other countries. An additional US$2.1 trillion of loans can be provided to individuals and businesses. Governments can potentially save US$110 billion each year from leakage. Together, the resulting growth in aggregate demand could create 95 million new jobs.

The global economy witnessed a lackluster 2016. With uncertainties surrounding the policy stance of the new administrations in countries like US, UK, and France, 2017 is expected to be a year of moderate growth too. The huge opportunity created by fintech start-ups has the potential to jumpstart the global economy, creating a win-win situation for financial services businesses as well as emerging countries. The demand created by emerging markets, in turn, would be enough to fuel businesses worldwide. Traditional Banking and Financial Services firms are now beginning to take note of this. Investment Banking behemoth Goldman Sachs, for the first time in its 147-year history, has entered into the world of retail lending by building a technology infrastructure called Marcus by Goldman Sachs, a new online personal lending platform, where credit-worthy borrowers can apply for fixed rate, no fee personal loans up to US$ 30,000 for periods of two to six years.

While this is an unprecedented chance for the fintech start-up community to impact every life across the globe, there is also the risk of handling exponential amounts of sensitive personal and financial data pertaining to individuals and businesses. Especially when financial institutions and/or governments are involved, this may well turn out to be a double-edged sword. While competition may be tough, making margins wafer thin, investing in top-notch security infrastructure may eventually turn out to be a greater differentiator than innovativeness alone. Following established industry practices such as performing KYC, due diligence and AML checks along with fair interest rates will ensure healthy growth for this sector. Fintech startups must remain wary of going down the microfinance route, which started with great promise but faced issues due to lack of transparency, poor governance, coercive recovery practices and high lending rates. This opportunity can only turn into a remarkable success story if fintech startups stay close to their core competence: accessibility, ease of use, low cost and innovation.

Decoding the Term Sheet – Types of Funding

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For many founders, one of the most important stages in the life-cycle of a startup is to produce and validate a commercially viable product or service – a much advanced stage than just an idea. The next and probably the toughest stage is - how to arrange initial capital to support the development of the company further. Lack of early stage financing is why 94% of startups fail in India. If you have a great startup idea or even if you have progressed further, in this blog, we will walk you through the diverse types of funding available for the startups. 

Moneybags is an Indian startup founded by Aditya Bansal, an engineer who is looking to build a credit scoring model. Through his startup, he envisions, he will be able to provide loans to those who are not found eligible by banks and other formal lending institutions. Moneybags will determine creditworthiness based on Aadhar based authentication and credit history of customer along with a few other predictive variables.

Aditya quit his job and is now looking to fund his idea. It is imperative that he chooses the right form of funding based on the type of his business and his future goals. Let’s consider the types of funding available to him:

BOOTSTRAPPING

Personal finance or bootstrapping is not funding in the strictest sense, but a means to survive before receiving Seed Funding – often considered as the first round of funding in the start-up world. Aditya can utilize his personal savings to build a working model or prototype (commonly known as a MVP- Minimum Viable Product) of his solution. He can utilize earnings from this to streamline his business plan and develop the full-fledged features of his product. For Aditya, this can be a basis to prepare for more formal funding sources.

Crowdfunding is another way of funding which is raising a storm online. If Aditya believes his business idea is rock solid and is ready to campaign online for funds, competing with other businesses and grabbing the attention of consumers who could give him money, he can garner funds through this route. Successful crowdfunding campaigns have been very few in recent history and most businesses remain unfunded despite campaigning aggressively. It has different models – incentive based or equity based.

Companies like Kickstarter and Indiegogo provide a platform to creative startups to raise money from the crowd in lieu of incentives or recognitions. For many companies, such campaigns also play out to be a great early sales route and/ or Public Relations (PR) stories. Smart watch company Pebble is one such example where it started a campaign to raise $100,000 and ended up raising $10 million in the first campaign and $20 million in second campaign. It was the third highest funded project on Kickstarter.

Companies like CrowdCube in the UK provide platform to raise money from crowd in exchange for equity (shares) of the companies. There are many companies including CrowdCube itself which have raised money through this model; the biggest success story being BrewDog which raised £10,000,000 via a bond issue. Equity based crowdfunding is not permitted in India yet, but government is looking into this matter actively.

EQUITY INVESTMENT

In common parlance, equity represents ownership or stake in a venture. Aditya can receive funding in exchange for issuing shares of his stock. The only difference is that Aditya would own common stock while his investors may receive a different class of stock with or without some preferred rights, these stocks/ shares are commonly known as preferred stock. Preferred stockholders have preferential rights in terms of protection of their investment, higher returns and control. ¬¬¬¬¬¬In the event of liquidation of a company, preferred shareholders may be paid before the latter based upon the preferences associated to their class of shares. Equity funding may consist of several rounds:

SEED FUNDING

Since his business is still in the concept stage, Aditya could raise a small amount of capital required to cover his expenses till he starts earning revenue. This is called the Seed funding stage where funds are raised from 3Fs or Angel Investors. 3Fs are Friends, Family or Fools – as they will invest in Aditya and may not necessarily understand his idea, product or business – but would like to support him. Next seed round comes from Angel investors who are successful entrepreneurs, high net-worth individuals or HNIs who are willing to invest in many companies to build a decent portfolio for future returns. They are motivated by joining initial rounds of the companies so they can get a better value for the money they invest.

SERIES A

This is the first stage of financing where stock is offered to investors and usually intended to aid a company build its business from product development to building a team. Investors could be Angel investors or Venture Capitalists(VCs). VCs are professional investors or investment companies that offer investment and become part of the Board of Directors. Subsequent rounds after this are designated incrementally with the letters B, C etc. and so on. Series A, B, C etc. differ from each other in terms of the life-stage of the business and the purpose for which funds are being raised. Later stage funding involves more sophisticated investors like VCs. A, B or C also differ in the value of the investment but interestingly, in every region, these numbers differ as well – so what is considered as an A round in India may be the equivalent of a seed round in the UK.

DEBT INVESTMENT


Aditya is wondering if he could just borrow some cash i.e. take a loan. A loan is, to put it simply, a transfer of funds with the obligation to repay in equated instalments and periodic intervals. Typically, there is a rate of interest and some collateral associated with the loan. In the startup world, debt funding from banks or lending institutions is not very common due to obvious uncertainty and lack of collateral. In countries like the United Kingdom, the government offers loans that are given to the startups on the guarantees of the founders – In India such schemes are either non-existent or not popular.

Convertible debt is a widely-used instrument in early stage rounds which Aditya may find useful. It simply means that the debt can be exchanged for equity upon the lenders’ decision or the borrower’s offer. The lender may receive a discount on the price of the future round. The primary reason, why many investors go for convertible debt is because at an early stage, it is difficult to determine the value of a company based on just an idea, product or prototype. Deferring the valuation for a later round when it has grown further and more investors are involved, is more likely to result in a fair valuation. Founders can take this route to save time, money and a lot of heartburn of arriving at a valuation number with investors at an early stage. So by the way of convertible note – investors and founders agree that a decent and realistic equity will be allocated to the investor (often on a discount) when a big equity round will take place in future.

Consider this example:


Moneybags receives seed funding from an Angel investor (Angel) worth Rs. 4,00,000 for 20% discount on future round with 2 years’ timeline and 20,00,000 valuation cap – this means any conversion on 20% discount should not have a valuation more than Rs. 20,00,000. Now in Series A, he raises Rs. 10,00,000 at post money valuation of Rs.20,00,000 – where the new investor will get 50% of the company for his 10,00,000 investment at 20,00,000 valuation – Angel investors investment will be converted to the equity of 20% discount i.e. 16,00,000. So, the Angel will get 25% of the company for his investment of the company for his 4,00,000 investment at 16,00,000 (20% discounted from 20,00,000) post money valuation.

Convertible debentures are a type of debt which are mostly unsecured by collateral or physical assets. In the event of liquidation, they are paid before anyone as a creditor (based on their priority ranking), before common stockholders and are a hybrid of equity and debt. Investors are usually willing to accept a lower rate of interest in exchange for the liberty to convert to equity.

Debt funding is exceedingly becoming the instrument of choice for investors since it is cheaper than equity, especially in India. Indian investors are often found to be inclined towards debt funding where they see short term return via interest payments than waiting for long for a higher return, albeit risky, through equity financing. With a lower risk appetite, Indian markets therefore, act very different from their global counterparts.

Now that Aditya is aware of the many ways he can fund his business, he starts identifying the developmental milestones for his company. Based on the nature of his business and the requisite milestones, Aditya is now able to calculate the amount of money he would need and the most suitable funding type. Armed with this knowledge and his Business Plan, he sets out to solicit funding for Moneybags.

Authors:

Atal Malviya


Atal Malviya is the Chief Executive Officer of Spark10.com – India’s first European Accelerator. Atal is a successful entrepreneur and an angel investor based out of London. He has founded and exited VC funded technology startups and invested in handful of technology startups in Europe and India. He writes and speaks about Tech Startups, Startups investment, Accelerators and Incubators, Tech innovations and Big data analytics.

Swati Suramya

She is Content Manager at Spark10.com. Swati has joined Spark10 Blore last month from Goldman Sachs.

PS: This article is for information purposes only and meant for tech startup founders or aspiring entrepreneurs. Examples used are fictitious. Please take professional advice when you make your funding decisions and Spark10 will not be responsible for any decision that you take or conclusion you draw from, based on this article.

A Startup for Startups – Helping Others Manage Their Businesses Better

 

In this cohort, we have a startup that wants to address a market segment that most others ignore – the startups. While everyone lauds startups and entrepreneurs these days, none of their products or pricing really help the entrepreneurs get the best of tools and systems. Well, there are exceptions. Sales Neuron (www.salesneuron.com) is one of those exceptions.

 

Sales Neuron is a business management SAAS solution that is developed especially for startups to manage their growing businesses with flair and efficiency. Founded by Arvind Uttam Chand, Sales Neuron wants to help other startups get the best of management tools that have so long been ignored by entrepreneurs for the lack of a similar solution in the market.

 

Imagine that you are a startup (if you already are, then you would relate to the problem below), and you have recently got some funding to take your business to the next stage of its growth. You hire a sales person or team with stellar attitude and credentials. Months pass by, but you realize that there seems to be no steady output in terms of productivity or efficiency. Your sales team puts in more hours and yet doesn’t yield the accounts you want. Moreover, you see that your competitor signing up the same guys you wanted to on-board. What the *beep* is going on?

 

Well, chances are that you are leaking potential customers because of mismanagement. Customers like it when you know who they are and love it when you pick up the conversation from where they left it. They appreciate that you know their details and don’t ask them, “Can I have your official email address to send you our e-brochure?” And they are relieved to be approached and handled by one person rather than being shunted between various sales team members.

 

Got you worried, didn’t we? Well, don’t be! Cause, Sales Neuron (SN) promises to have your back. With SN, you and the entire organization can now keep track of customers, their conversations, needs and irks. SN also helps you manage and track other stakeholders like investors, vendors, partners and service providers. Curious to know what else SN’s CRM+ can do for you?

Here’s just a partial list that Arvind managed to get out before he ran out of breath:

  • Manage the smallest of details for every person or organization you deal with,
  • Run targeted marketing campaigns directly from the product,
  • Create, send and manage quotations, invoices, and payments,
  • Manage your assets or inventory,
  • Customize or create modules that you use
  • Integrate with third-party applications and processes

 

Arvind has developed Sales Neuron into an intuitive, integrated & an industry focussed business software. Application Studio, its built-in customization platform enables end-users to customize the complete software to adapt to their specific business processes and changing requirements at no additional cost. Its drag-and-drop feature makes customization so simple, it requires no technical support to personalize the software to the business.

 

Spark10 is giving away 10 early bird offers to Sales Neuron with a 40% discount in pricing for the next 6 months. Go ahead and sign up your startup here – www.salesneuron.com/signup 

 

 

THE HUSYS STORY – An Indian start-up’s transformation to a Listed Company

 

If you are a start-up founder, chances are, right at this moment, you are thinking of getting your start-up idea funded. In all likelihood, you will get funded soon if your idea has a value proposition impressive enough, a credible team to execute, a market big enough with a bit of luck thrown in. Contrast this with the environment in the year 2002 in India. Start-ups were looked upon suspiciously, banks wouldn’t lend, investors wouldn’t invest and to put it mildly, the business and regulatory environments were not conducive. That’s when G R Reddy quit his job as Head – HR, Intelligroup, to start his own company. That he wanted to build a start-up on his own was a novel idea in itself; the fact that he desired to build India’s first Human Resources (HR) function Management Company was revolutionary, to say the least.

 

That said, Reddy never once doubted his vision of the company he wanted to build. He marshaled all his resources and started Husys in 2002 with funds withdrawn from his provident fund account. A sum of Rs. 30,000 may seem paltry today but at that time, it was enough to lay the foundation of India’s first fully integrated HR functions management company which would go on to help small- and medium-sized enterprises in managing their HR functions effectively. Later on, when a friend helped him with a sum of Rs. 25,000, Reddy devised an ingenious way of funding himself by starting ‘Mission HR,’ a three-month paid training program for fresh-out-of-college HR graduates. Based on their performance, these graduates were hired on a full-time basis and deployed at client locations when their training period ended.

 

After a few years, Reddy received debt funds from a leading public sector bank by pledging land he owned as collateral and used this line of credit for nearly 10 years to further Husys’ operations. The funds were utilized mainly to build technology infrastructure, expand bandwidth and structure cloud-based HR solutions for clients. He received the first round of funding in 2015 through the capital markets route and finally, Husys became a listed company on the NSE in 2016. Again, around the time when he was gearing up to complete the listing procedures, Reddy received a Rs. 70 lakh funding from seven of his friends, each of who gave him Rs. 10 lakhs.

 

Reddy’s success story is nothing short of a miracle. He never found an angel investor who would believe in his company: traditionally, investors believe in investing in straitjacketed categories – technology or manufacturing. Anything in between is not considered worthy. He was always clear in his vision of what his company was and what it could do. On his part and to his credit, Reddy built strategic partnerships with global players like Career Star Group, iWorkGlobal and Nina E Woodard Associates, Inc. to expand Husys’ footprint across 70 countries.

 

Talking to G R Reddy is like reading a handbook for start-ups. No B-school or formal degree can teach you what experience does. The Husys story, therefore, offers several valuable lessons for start-ups. GR Reddy has almost three decades of experience in the HR domain. He is the founder of Husys Consulting Limited, India’s 1st HR Company to be listed on the National Stock Exchange (NSE). He has previously worked for Satyam, Intergraph, Blue Dart and Intelligroup among others.

 

BUILD TO LAST

Reddy built a company that was sustainable and could be scaled up. Founders have a responsibility to build a robust company with a clear business plan that can provide lasting value to shareholders, employees and founders themselves. Building a successful product requires judicious investment in the right talent and cutting edge technology. Therefore, when it comes to arranging capital, founders may decide whether to raise Venture Capital (VC), sell the company for a greater ROI or go public to raise funds.

 

FUNDING IS NOT A MILESTONE

Start-up founders often think once they have a start-up idea, getting funded is the next milestone in building a company. This is not really accurate; funding is only an enabler in building a company. The first milestone is figuring out how to make something that people want i.e. giving a concrete definition to your idea, what your product/service will be like. After you decide who and what you are, then comes the question of how to get there. Funding should be leveraged at this stage.

 

FIND ALTERNATIVE WAYS OF BUILDING COMPETENCE

Reddy recommends that founders should think of various ways to leverage available resources or low-cost solutions like utilizing the infrastructure of colleges and institutions for building tech start-ups than waiting for a big round of funding. Founders could offer to teach at such academic institutions and avail their infrastructure in turn.

 

COLLABORATE, COLLABORATE, COLLABORATE

Rather than competing, working in collaboration with similar or complementary organizations is more likely to create a win-win situation for everyone. In the start-up world, if complementary companies come together and build an ecosystem where they leverage their synergies, they will have the power to collectively negotiate a better deal for themselves.

 

SPREAD THE RISK

Reddy found that 40% of the workforce in India worked for small- or mid-sized companies. He saw untapped potential there and built his company to cater to them. He also found it wiser to have a large number of SME clients than having one big client. This way, if he lost a client, he was never at risk. While this isn’t a comprehensive list of dos and don’ts for start-ups, it definitely is a list that has the potential to help start-up founders navigate the world of business while continuing to pursue their vision. Husys got listed in 2016 and it was the first HR function outsourcing/management company in India to achieve this distinction. A company built on strong fundamentals alone can achieve such heights. It is now poised for greater growth as it plans to acquire smaller HR firms and also roll out a franchise network which will service SME clients.

 

PS: Atal Malviya, CEO of Spark10 is one of the Directors of Husys. Atal joined the Husys board with Professor Biju Varkkey of IIM Ahmedabad and Ms. Nina E Woodard of Nina E Woodard Associates before Husys was listed on the NSE.

Not So Risky Business

Mike Patel is a leading medical practitioner in the suburbs of London and works with NHS. His parents are migrants from a village near Amritsar, India. Patel saves £100,000 a year and wishes to invest the money where he gets assured returns at no risk. So he buys a house with the savings he built over the last 5 years. Unfortunately the real estate market crashed suddenly, when he decided to sell the house. What he had perceived as a risk free investment, ended up giving him virtually no returns. Buying a house in UK is a good investment since rents turn out to be higher than monthly mortgage payments. However investing further in a second home whether in UK or India may not be considered as wise as the benefits are few and real estate market is facing volatility in both regions. Also, there is no hedge for risks in this market.  On the other hand, if he had invested the same funds in his ISA, after offsetting for inflation, the returns would have been negligible again.

Contrast this with Lakshmi Narayan Reddy’s decision to invest his savings in some early stage startups. Reddy is a Senior Consultant in a leading Information Technology Firm and does a great deal of research before making an investment decision.  Under the UK Government’s tax break measures EIS/SEIS, investment in an early stage startup leads to a 50% tax relief. He invested £50,000 in startups ‘A’, ‘B’ and ‘C'. Each of these companies had less than 50 member staff and £200,000 gross assets. Being a smart and savvy investor, he received £25,000 tax relief on his income tax bill for the year. Startup A yielded him 60% profit on his investment, while B ended up failing and C remained flat in terms of growth.

  • If he continues to hold his shares in company A for 3 years, his gains from the investment is free of capital gains tax.
  • Reddy can claim loss relief against other income, for the amount invested in company B. While losses are not completely recovered, according to estimates, almost 80% of the money can be written off as loss.

In the UK, real estate has been the preferred vehicle of investment for Non-resident Indians. However, the sector is witnessing sluggishness in growth since the past year. According to the Guardian, the annual growth rate for house prices has slowed down to 6.9% in October, versus 9.3% in June 2016. Experts opine that this is largely due to two factors:

  • Effect of Stamp duty changes introduced 2 years ago are playing out now
  • The uncertainty triggered by the EU referendum result.

Similarly, in India, the real estate industry has been witnessing a slowdown for the past 3 years. The effect of demonetization has dried up demand and prices are expected to fall by 20% till mid-2017. The crackdown on black money and benami property has further sucked out liquidity from the market contributing the decline.

A slight uptick in risk appetite can fetch high returns. Therefore, the expat community in UK has now started investing in technology startups and SEIS/EIS is a never before opportunity which has unraveled itself at the right time.


 

Risk Warning: This article is for information purposes only and targeted exclusively at investors who are sophisticated to understand the risks and make their own investment choices. Examples used here may not be of real people. Pitches for investments are not offers to the public. Spark10 does not provide investment advice and is not regulated by the Financial Conduct Authority.

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