Banks should NOT invest in FinTech startups – they should acquire them

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fintech insurtech wealthtech regtech ai cybertech esg news

If banks want to remain market leaders they need to start acquiring technology companies, according to Paul Cuatrecasas of Aquaa Partners, in a research interview with FinTech Global.

Banks need to follow the example of tech giants

The behemoths of the banking world – from Goldman Sachs to JP Morgan to Deutsche Bank – are now technology companies. The rise of FinTech nibbling away at their bottom lines means companies across the financial services industry are shifting to place technology front-and-centre of every decision in an effort to maintain their hold over the market

From his experience as CEO of Aquaa Partners, a technology M&A advisory firm, Cuatrescasas believes that to bring in the talent and culture capable of driving significant innovation and really shift the needle, banks need to start acquiring more FinTech startups.

“Banks are under more pressure today than they’ve ever been,” he said, “the time has come for them to take a deep breath on whether they need to make acquisitions or not in areas they maybe haven’t made acquisitions before.”

Leading tech businesses such as Google, Amazon and Cisco have made acquisitions a key driver of their development through the years. Many of these have been less-than-revolutionary for the company, but some have proved hugely influential in defining the businesses’ futures. Google paid just $50m for Android before turning it into the world’s most used mobile operating system while Amazon’s £200m purchase of Lovefilm helped pave the way for it to become a media powerhouse.

“They make hundreds of acquisitions because they know the game,” highlighted Cuatrecasas. “You need acquisitions to bring in fresh thinking, fresh talent, fresh products and challenge existing employees.” He compares these acquisition strategies to that of a VC fund where “they make 10 investments. Two or three might fail, five or six might be ok but it only takes one to make a 100-times return.”

With banks now positioning themselves as technology companies they need to be willing to take risks and adopt these types of strategies to keep pace with the startup disruptors targeting their customer bases. Some banks are already placing bets and the likes of BBVA and Groupe BPCE have made notable acquisitions of challenger banks Simple and Fidor, respectively.

The banks’ long-established brands and loyal customers means they are well positioned to react to changes in consumers’ expectations and Cuatrecasas pointed out “these banks will not easily lose customers until things get really bad but because of these startup disruptors things might get bad much more quickly than they think.”

“The market leaders understand how it is moving and are basing their whole strategic vision on that,” he added. “If the leaders are doing it then all the other players need to start thinking about this and considering if they can do it organically or not.”

Acquisitions can act as driving forces to overhaul talent and culture

An adventurous technology acquisition strategy that allows sometimes risky bets on businesses that can drastically change how a bank functions, or how customers experience its brand, have the potential to propel institutions into market leadership positions for the next decade. What’s the key reason these can be so transformative? Talent.

Cuatrecasas suggested the personnel that can really “turbo-charge” banks is “talent that is technology minded – not necessarily coders, but executives who understand the digital world as well as the customer experience, not just the user experience on a screen.” The challenge, however, is attracting these rare and valuable individuals and teams who can demand hefty salaries and be selective about how, where and with whom they work.

Cuatrecasas said these top-tier individuals will “seek out cultures that cherish their skills”. This is not something banks, insurance firms or any traditional businesses where tech plays more of a back-office role have a reputation for, compared to companies such as software makers.

By acquiring talent, rather than attempting to poach it, a bank can also bring in a cultural shift needed to help innovation flourish and enable it to compete in the changing finance landscape. “If they are joining as a result of a larger acquisition they get to stay with their current culture and the bank gets to buy some time,” Cuatrecasas claimed. “It gets a grace period in which they have an opportunity to ensure the transition, from a cultural perspective, is executed successfully.”

FinTech moves too fast to test the water so banks need to start acquiring startups

One of the primary ways traditional financial institutions are engaging with the FinTech space at present is through investment. Corporate VC gives them the opportunity to build ties with companies, learn from them and understand if they might be a good fit for the bank as a partner or buy-out target. If an acquisition is the bank’s end goal, however, a minority VC investment is an inefficient method. As Cuatrecasas explained, “A bank, on average, would take a 20% or 30% strategic stake before acquiring the company. If the target is really returning value for the bank’s 20% stake and the bank acquires the rest of the company later then it is paying a lot for its own value-add.”

While different companies need to adopt strategies that suit them best, it is better to take the plunge and acquire the businesses that will really make a difference, rather than delay and test out the water first. “When banks, insurance companies or traditional technology companies make technology investments it seems like they’re dipping their toe in the water,” he said. “Sometimes that works but things are moving so fast today that if you want to dip your toe in the water and wait a year or two things might have changed completely and then your minority investment hasn’t mattered so much – it hasn’t changed your business at all and hasn’t really moved the needle.”

Full acquisitions also create a greater level of commitment to the intended purpose of the deal. It encourages traditional institutions to leverage the greatest value for themselves and the target company. This raises the importance of proper due diligence on the part of the acquirer to ensure it knows what it’s getting itself into. “If you do your homework right and acquire the whole company, or at least acquire a majority,” said Cuatrecasas, “It enables you to bring it on board and become full and true partners and execute on a mission which should be transformative in some way.”

Leadership teams must be prepared to take risks

How well institutions adapt to this need for a long-term vision that goes beyond reactions to short term stock-price fluctuations will inevitably come down to its leadership team. The game-changing acquisitions that the future market leaders will seek out need the involvement of executive-level decision makers if they are to be effective. Banks that are unable to convince shareholders of the importance of this kind of expenditure on occasional risky bets will struggle to keep pace with the rest of the industry.

“Banks with leadership teams that are modern and forward thinking will be the ones that win. Banks that don’t will probably not do very well,” believes Cuatrecasas.

As with VC or any investment, there’s the very real possibility of failure and as the FinTech market matures and banking acquisitions become more frequent, high-profile failures will become more likely. This may deal a PR blow to banks but the reality is the money at stake in these acquisitions is small fry compared to, for example, what banks regularly dish out in fines. Cuatrecasas explained if a bank with “€20bn market cap buys a tech company for €200m and gets it wrong, it’s not the end of the world. It’s a loss, but that loss is not so different from some of the larger penalties that some of the banks are paying for irregularities over the past nine years.”

Convincing startups to come aboard requires the selling of a vision

The challenge for banks in developing a tech acquisition strategy, however, is not just in finding the talented teams capable of steering the company but also convincing them to sell their businesses to and to join the bank.  Cuatrecasas suggests that banks need to consider the aims of an acquisition rather than grabbing a startup with surrounding hype. He said institutions should take a “step back and really think about what is it the bank needs to transform its business over the next five years. Then find a target company that can help them.”

Developing a clear mission for an acquisition allows banks to present to startups the difference they can make in companies and the influence startups can have in the banks’ future and the way it serves its customers. “If a bank can propose that properly then that’s more than half the battle in persuading the talent,” claimed Cuatrecasas.

Starting the relationship off on the right foot is one thing but it’s the first 100 days, which Cuatrecasas calls the leveraging period, when the real effort is required in ensuring that companies are properly integrated and expectations are met. He commented: “it’s hard work and requires a lot of co-ordination. Like in any sport you tend not to win in a very competitive market unless you stay focused as a team.”

© 2017 FinTech Global & Investor Networks Ltd


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