How Community Banks Are Fueling The Growth Of Fintech

OBSERVATIONS FROM THE FINTECH SNARK TANK

Fintech startups looking for funding in 2023 are finding that it wasn’t as easy as it was a few years ago.

According to CB Insights, fintech funding in the US totaled $3.9 billion in Q4 2022, down 79% from Q4 2021. The total number of deals funded dropped from 423 in Q4 2021 to 342 in Q4 2022, representing a 73% decline in the average funding amount per raise from $43 million down to $11.4 million.

Not all venture capitalists (or VCs) are cutting back on investing, however.

Community Banks as Venture Capitalists

In fact, not all providers of venture capital are venture capitalists. Increasingly, banks are filling the void created by VCs. And not just the large megabanks.

According to Cornerstone Advisors’ What’s Going On in Banking 2023 study, there are about 500 community banks and credit unions making direct investments into fintech startups.

Among community banks investing in fintech startups, the average investment was nearly $3 million per bank in 2022. That figure is expected to grow by about a third to roughly $4 million in 2023.

Overall, Cornerstone Advisors estimates that community banks and credit unions will pump about $1.5 billion in capital into fintech startups in 2023.

Banks are Fueling the Enterprise Fintech Category

Banks aren’t necessarily investing in all categories of fintechs, however.

Most investments are in a segment of fintechs called “enterprise fintech” which Blackrock defines as:

“Software and platforms for financial institutions that streamline and/or automate operational and business processes.”

In other words, fintechs whose products and services can help financial institutions—not disrupt or displace them.

Deloitte estimated that this category of fintechs attracted $1.9 billion in funding in 2022, down from $4.3 billion in 2021.

In 2023, community banks alone will account for two-thirds to three-quarters of the total 2022 funding for the enterprise fintech category.

The VCs Helping Banks Become VCs

Many of the banks making fintech investments are doing so organizations specifically designed to help the institutions identify and vet potential investment candidates, and to manage their investments including:

• Alloy Labs. This consortium of 80 mid-size community banks has made 13 seed to Series A investments that focus on “the edge of money versus the center of transaction.” Current portfolio companies include Dapi, Moov, Atmos and The Bean.
• BankTech Ventures. Since launching in November 2021, more than 100 banks have joined the BankTech Ventures Fund which has invested in eight fintechs including Fintel Connect, ZSuite Technologies, and PortX. BTV includes its banks in the entire innovation process from strategy and thesis development, prioritization, technical relevance and business case validation.
• JAM Fintop. Investing in banktech and blockchain companies that develop solutions that allow financial institutions to more effectively compete and serve their customers, the 90 banks in JAM Fintop have 33 active investments with more than $700 million in committed capital.

Doing Fintech Investing Right (If You’re a Bank)

Banks should follow a number of best practices when making fintech investments:

1) Have a business strategy focus. Banks need to be clear about their business objectives for investing and what they expect in return—which is more than just a return on investment. It might be to explore a new segment, build a new product or deepen a relationship. Jason Henrichs, CEO of Alloy Labs Alliance cautions, however:

“Don’t expect investing to solve your strategic problems. The investment extends beyond the checks written—the board needs to invest significant energy into defining the objectives, the senior leadership team needs to create an investment strategy, and the operational team needs to build the infrastructure to extract strategic value.”

Carey Ransom, Managing Director of BankTech Ventures, adds:

“Banks need to start with a vision of what it will look like in a few years, what ‘community’ (not necessarily a geographic community) they can best serve, and what capabilities they need to invest in and develop. Much of the change will involve fintech investments, and a culture and team that understands how this will best serve their customers and the bank’s business.”

2) Define investing parameters. According to Henrichs, banks as VCs need to define: a) which segments or deal profiles they’ll focus on; b) how much they plan to invest over a defined time period; c) their comfort level with losses; d) how many startups will be in their portfolio; and e) what stage(s) they want to invest in.

3) Establish operational responsibilities. Where will deals come from? Who will do due diligence? Who makes the investment decision? Who’s responsible for ensuring that strategic objectives are met? Joe Maxwell, Managing Partner at JAM Fintop counsels banks that they need to define a point person for the fintechs to interact with. In addition, Maxwell warns banks that:

“The board of directors and senior leadership team must have tech savvy folks—it’s an imperative. It’s hard to support a VC approach if the board and executive team can’t articulate the ‘why’ behind the investments.”

4) Assess technology capabilities. Maxwell believes that bank that are “honest about their technology stack and operational costs make better investment decisions because they chase fewer shiny objects, can better articulate their pain, and better identify a technology fit.”

Lastly, there’s strong consensus (unsurprisingly) from the experts that banks shouldn’t lead deals, but, instead, bring in a partner VC firm to put together the pricing and deal structure and do the due diligence. It might sound self-serving, but at BankTech Venture’s Ransom says:

“Knowing how startups work and how to invest in them are specialized skills and knowledge that are typically achieved through a lot of learned experience, so tend to naturally lend themselves to partnership from a bank’s perspective.”

---

For a complimentary copy of Cornerstone Advisors’ 2023 What’s Going On In Banking study, click here.