Understanding the risks and benefits of investing in fintech startups (2024)

Fintech startups are often the first movers in disruptive technologies, fashioned to address an unmet need or to introduce a novel product, positioning them at the forefront of these rapidly growing markets.

Investing in these startups can lend the opportunity to get in on the ground floor of these emerging markets and cash in on the significant growth that can ensue as the industry or technology develops. Additionally, because fintech startups are typically small, they may be able to move more quickly and effectively than established firms, enabling them to capture market share and establish themselves as dominant players.

Fintechs typically have smaller balance sheets, fewer employees, and less physical infrastructure than traditional financial institutions and face less onerous regulatory requirements. These startups can pivot more quickly than incumbents and rapidly create and deploy novel products. Their ability to use technology to automate compliance processes and reduce their regulatory burden allows them to focus on innovation and meeting the needs of customers, rather than being bogged down by regulatory red tape.

Investors, however, need to place a greater emphasis -- compared to other startups -- on the fintech startup’s ability to solve customer problems and add value to their offerings. The apparent disregard for these fundamental analyses by several fintechs, including those dealing with blockchain, is a cause for concern. Despite boasting technically advanced products, many fintech startups struggle to identify issues that their products can address, raising apprehensions about whether customers would be willing to switch to their products.

One of the foremost problems plaguing many fintech firms is their lack of a viable strategy. While rapid product rollouts, a sleek user interface, or advanced technology may seem like significant competitive advantages, these elements alone do not constitute a strategy. Nor is simply lowering costs a feasible game, as competitors can readily undercut prices and drive down returns. Innumerable fintech startups have failed due to their inability to break away from the throttlehold of competition.

Assessing the potential for customer adoption is another key factor in determining the success of fintech startups. The ability to acquire and retain customers can have a long-term impact on the startup's profitability and success; it is imperative to evaluate the user experience and customer acquisition strategy of the fintech startup before investing.

Investors also need to assess the startup's ability to go the distance without collapsing under pressure. Without the right mix of strategy and judgement, a startup's chances of scaling up successfully can be as slim as a penguin's chance of taking flight. Intellectual property and collaborations are key aspects to evaluate here; patents, trademarks, and proprietary technology can greatly impact its competitiveness and its potential for innovation. Furthermore, parsing a fintech’s partnerships and collaborations is akin to evaluating its entourage - they can either boost or bust its performance. Strategic partnerships and collaborations can offer the essential resources to expand and achieve sustained success, or they can hold it back from achieving its full potential.

Investors also need to adopt a forward-thinking mindset. It can take several years for a fintech to mature and generate profits. Moreover, it is essential to evaluate the probability of successful exit strategies, such as mergers, acquisitions, or initial public offerings, when analysing investment prospects. Investors need to thoroughly evaluate the startup's funding history, burn rate and valuation, given the considerable amount of funding required to scale and achieve profitability.

These startups face significant competition from traditional financial institutions and other startups. Here, it’s important to recognize that fintechs operate in a swiftly evolving landscape, with ground-breaking technologies and innovative business models emerging constantly, which necessitate a deep understanding of the startup's product roadmap, a good handle on the competitive landscape and the startup's ability to build a "moat" around its business