It’s been quite an eventful year. Fintech has fallen a long way from the highs of 2021, and while 2022 was largely about the reset of the funding environment, 2023 is going to be a year of recalibration for fintech companies.
The great news is that large enterprise and midmarket companies care more than ever about bottom-line impact. As revenue growth slows down, cost savings and efficiency have become critical. Larger companies are more likely to cut back on internal innovation efforts and technology investments that are not core to the business.
This opens the door for fintechs that can deliver real improvements to the bottom line by eliminating manual processes and saving their customers money.
First, let’s take a look at the sectors likely to be most challenging: lenders, neobanks and fintechs that serve SMBs.
Online lenders
Lending is going to be hit hard. Lenders have to manage three big tailwinds in today’s market:
- Rising delinquency rates and charge-offs.
- Higher cost of capital for the debt they lend.
- Decreasing demand from customers because of higher interest rates.
Focus on how technology can solve hard problems, and don’t worry as much about finding what’s cutting edge in fintech.
The rise in delinquency rates and charge-offs from non-paying customers will be tough to manage for newer fintechs that have been operating for less than five years. These younger companies don’t have the models fully built out to predict which customers are likelier to default.
Managing risk during a downturn can be brutal, and lenders will feel this most acutely.
Neobanks
Neobanks transformed the customer experience of traditional banks by offering better digital products and lower costs. While big players, like Chime, who raised large amounts of capital will be fine, expect to see consolidation among the smaller neobanks.
The reality is that many neobanks have customers with small average deposit balances, and deposits are critical to banking business models in the long term. Neobanks will also be downstream victims of layoffs — if any of their customers are laid off, the banks will see their direct deposit flows diminishing.
Fintechs serving SMBs
Small businesses are more likely to shut shop during a recession. In turn, fintechs that serve SMBs rather than larger midmarket and enterprise customers are more likely to lose their SMB customers. This is why you already see businesses like Brex moving away from serving SMBs.
What’s hot
The opportunities for fintechs in 2023 lie in the “boring” areas like fraud, compliance, payment operations, taxes and infrastructure. CFOs will be more focused than ever on bottom-line impact. Fintechs that are able to demonstrate a measurable improvement in payment authorization and reconciliation rates or a reduction in fraud will be able to weather the downturn and grow.
Here’s more detail on the sectors with the most potential:
Fraud and identity
Fraud rates don’t decrease during a downturn. In fact, the number of bad actors attempting to create fake identities or launder money actually goes up.
Every major bank in the U.S. has been impacted by fraud, and every financial services entity has to verify the identity of its customers to prevent money laundering.
We have seen such a significant uptick that fraud prevention companies are thriving through the downturn of 2022 and will continue to do so in 2023.
Compliance
In the wake of the crypto meltdown, regulation is likely to be solidified and scrutiny might increase. This creates a need for platforms that guide fintechs through compliance and regulatory requirements to deliver financial products the right way. While not the most exciting area, regulation has been long overdue.
Taxes
There has been little innovation in tax. I can count the number of fintech tax startups with revenue traction on my hands. It is hard to build solutions for taxes in a way that is compliant with state and federal filing requirements and get go-to-market traction, especially given Intuit’s market share.
The layoffs at tech companies will drive more people to work on hard problems like taxes. People will also start consulting businesses that require Schedule C and self-employment tax filings, which are incredibly cumbersome today.
This will see more invention in the tax space, such as more startups that automate self-employment taxes.
Procurement
We tend to see innovation in sectors that have seen large PE exits. Thoma Bravo’s acquisition of Coupa will create more opportunities in the procurement ecosystem, which intersects with multiple other trends around ESG and the automation of vendor management and payments.
Payments
Like tax, payments and payment operations are massive markets with significant opportunities to slash costs and improve the delivery and accuracy of many functions. There are many opportunities in areas such as automating reconciliation, improving acceptance rates, reducing fraud in B2B payments and cross-border payments.
This sector has seen tremendous innovation with giants like Stripe and Ayden, but we still see a lot of opportunity in the payments ecosystem.
Treasury management
Treasury management — including financial operations and back-office functions — is one of the big areas of financial services that has not yet been transformed by innovation. Relatively little VC funding has been invested here compared to other sectors of fintech.
Expect to see more innovation in this space to drive real efficiencies in treasury management and financial operations functions.
Founders working in fintech today need to think like CFOs. Examine the areas of financial services that have the largest amounts of money flowing through them but involve manual processes and major inefficiencies. Focus on how technology can solve those hard problems, and don’t worry as much about finding what’s cutting edge in fintech.