Fintech, Fundraising, and The Future - Simon Taylor of Sardine.ai

Don: Good morning. Today is a special day. I'm joined here by Simon Taylor. Simon is the Head of Strategy and Content for Sardine.ai. Sardine enables all companies, whether big or small, to improve risk management by having the world's best API for fraud detection and compliance. Some of Sardine’s most notable customers include the likes of FTX, Relay, MoonPay, and Brex. For those who don't know, Simon is one of the most influential people in banking, insurance, and fintech. He's a founder, he led blockchain research and development at Barclays, and he's the co-host of both Fintech Insider and Blockchain Insider. In most episodes, you know we explore the journey of starting and scaling a company. While we'll certainly touch on some of that today, we'll spend the majority of our time together discussing macro trends in the banking and fintech space and diving into the weeds of the technology that's changing the fintech ecosystem. Thanks for coming on the podcast with me, Simon. - Simon: Thanks for having me. Excited to be here. ➢ Don: Great. Let's dive right in. The first question we ask all of our guests is in five words or less, who is Simon Taylor? - Simon: Fintech nerd. - Don: Love it. What is Sardine? - Simon: The world's best fraud team you hire as an API. ➢ Don: Who is your biggest inspiration? - Simon: I don't think the question is who but what's next? Everything. I'm omni-curious. It'll pop up in front of me, and I'm going to love it. Content, somebody builds something, writes something, and does something, and I just find it exciting. I have no idea why. That's why I call myself a fintech nerd and a crypto nerd. I find this stuff exciting genuinely. What are you doing when you're standing in line waiting to get on an airplane? Because I'm scrolling Twitter reading about fintech and crypto. In those little moments of boredom, you can tell what your true passion is. For a lot of people, it's sports, lifestyle, family, or something else. Sorry to my wife and baby daughter who I love dearly, but the first thing I do is reach out to Twitter. - Don: Any particular tweet today that caught your eye ahead of this podcast? - Simon: Yeah. There was one by ZeroHedge. I don't know if you follow the account or know those guys. They're a very opinionated, anonymous blog that talks about macro. They covered the Bank of America results. BofA was talking about their lending averages FICO scores being in the almost 800 regions across all of their product range, but that's an anomaly. It looks like they've done amazingly well, but have they, and was it a point in time? Was it pandemic-related? One tweet can tell a thousand stories once you dig beneath the surface. That's what I love. ➢ Don: Awesome. That's actually a really great segue. Normally, at this point in the conversation on Startup Growth Stories, we'd get right into the thick of it understanding people's companies and talking about the founding story, but since this is a special episode and we're lucky to have you here on the call, we actually want to pick your brain on—for the first half the conversation—the experience you have in fintech and better understand what the hell is going on in the macro. - We talk a lot about fed rates and rate hikes, how that's impacting the cost of capital, and the impact on startup valuations. I'm wondering if you can share your perspective on what's going on with the macroeconomy as it relates to rising interest rates, startup valuations, and the broader fundraising environment inside and outside of fintech. - Simon: I guess it depends on how far you want to zoom out. In 1929, it's oh, sound money, Bretton Woods, the gold standard, Volcker, and everything else. - Let's not do that. Let's talk about the pandemic. In 2020, we see the market crisis. Fintech companies initially struggled for funding and the whole tech market just had a quiet period. Then, it inverted. The stimulus came, but that stimulus was sitting on top of two decades of all-time low interest rates going back to Greenspan. There was a lot of money flowing toward VCs because there was no other asset class that was delivering a return. Investors were searching for a yield. They had to risk to get that yield. - Everything went to venture. Equity started to look like debt was something that the capital markets guys used to say where it was just low risk, it's going to give you a return, and you might as well look there. But of course, this was a temporary 20 years of history that doesn't look like anything else apart from maybe the Weimar Republic in Germany. - It's a really weird point in time. There are all of these charts that you guys may have seen in the past two or three weeks about, oh my God, quarter over quarter or year over year, funding is cratered. It's down 70%. But if you actually draw a line to where it was before the pandemic, it's about the same. We've reverted to the mean in terms of VC funding. - I don't know if you've seen but VCs, in the last 12–18 months, raised all-time high rounds. [...] and Sequoia raised billions upon billions. There's no way they can possibly deploy all of that at Series A. They're going to have to deploy some of it, and some of it is committed to deploy at Series A. - They're out of the market temporarily, but that's allowing time for prices to reset just enough to historic norms and to revert to the mean because let's face it, seed 1000X revenue, Series A 100X revenue, Series B 150X revenue. I picked it up somewhere or I did the napkin math. Do you remember fast.com? - Don: Yeah, of course. - Simon: Those values appeared quickly and disappeared just as quickly. Based on the revenue and ARR they had, they were valued at 166X revenues. There was no business and long-term contract. Great at marketing, amazing story for how you do get attention and build an almost consumer awareness brand. There was a lot to like there, but maybe things did get a bit silly. It's unfortunate now that founders and builders today are feeling that, but really, we never had it so good for a while. That's correcting, and it was meant to happen. - Don: I'm hearing a couple of different things there and I want to double-click. One, it seems like ventures raised a lot of capital, they're sitting on a lot of dry powder, and they need somewhere to put that capital. To me, that would save the market and it will come back. One question for you is when will the pain stop? When should founders think about their next round? What should we expect looking into 2023? - Simon: That's a really good question. I think great businesses that are starting to show traction will never have a problem raising if they need to, but beware of the terms and conditions, beware of the liquidation preferences, and beware of all of that kind of stuff that gets thrown in because even flat rounds aren't really flattening more if you start really looking at how some of these term sheets are getting constructed. - Reset your valuation expectations, reset your growth expectations, have a conviction that you can grow top-line revenue, and stop telling a revenue story. In consumer, everybody wanted to talk about a user growth story and a customer growth story. That's not wrong, but it needs to be a revenue story. - I think there's a barbell here. There's the public perception or what everybody says out loud which is, oh, it's about profitability. Then, there's the opposite end which is user growth, SoftBank, doesn't matter how much it costs, we'll just pull capital on it, doesn't work. What we're really talking about is revenue growth and the Rule of 40 growth. Rule of 40, as many of you will know, is when you add up profits and revenues, that should equal 40 as a growth percent. ➢ Don: So 2020–2021, the mantra was to grow at all costs, show traction and user growth, high BPR, and no big, flashy rounds at large lofty valuations that sometimes didn't necessarily translate to fundamentals of the business. What do you view as what's most important in 2022? It's Rule of 40 which to me is gross profit and revenue growth taken hand in hand. - How important is getting to default alive, cash flow positive, and efficient operating expenses? What do you think about the full top to bottom P&L? Then, specifically for fintech where fintechs have had some of the largest valuations and some of the lowest margins relative to their B2B SaaS peers, how should a fintech founder think about valuation and fundraising? What's most important in going into that next [...] environment? - Simon: A fintech founder is not one thing. A fintech founder of what? An infrastructure company, a fintech founder of a consumer, or a neobank? Of what? - If we avoid that rabbit hole for a second, there's a conversation that it's just good practice to not burn insanely quickly on the assumption that the next round is coming and to be showing a positive unit economic trajectory over time. Just do that anyway. The best founders always did, the ones that were either their growth was so good that it just was trending the right way, or they were getting so much traction that they could trend it the right way quite easily. - I don't think it's just be wildly efficient default alive. You're still going to want to grow because you're in venture after all. You've founded a venture business. Don't forget growth out, but it's revenue growth, not user growth. It's growth you can afford. It's not growth with terrible economics. - I'm focused on the top line plus the economics of that new customer. What does that mean for your pricing? What does that mean for your cost of goods sold? What does that mean for your underlying provider base? What does that mean for the consolidation? - Sure, I just used that API and plugged it into that thing because it was easy, but actually, is that worth another look? Do I need to think about my operating model, OD, and talent strategy? Especially for businesses that have been through layoffs, how do I keep the culture going and pointing the right way and get people really energized and excited about running through walls with this thing that's streamlined? - Really hard to answer that in general. It's kind of like the question, how should I improve my health? It's like, well, there's good advice that works for everybody. Is that going to work for you? I don't know. Can you have diet discipline? Can you get up early? There's a bunch of stuff. ➢ Don: That's all incredibly insightful. Simon, who's to blame here for what we experienced in 2021? A lot of the founders that I talked to feel like they've been retreated by the equity markets. In 2021, it was growth at all costs. It was building a big team, hiring the best, most expensive engineers in the valley, building a huge amount of opex, and burning through cash that investors gave them at a large valuation. - Now, they're getting in trouble looking into 2022 where they can't raise at those same prices and well beyond cash out date to grow into their multiple. Is it the Fed with the zero interest rate environment that drove up asset prices, is it the venture capital investors who chase these prices to the top, or is it the founders themselves that were irresponsible, overinvesting, and overspending capital? Do you have an opinion there? - Simon: It's a curse on all of your hands ultimately. A responsible serial entrepreneur who's built multiple businesses would go, this is weird, it's never been so easy to raise money. I don't like the valuation and these term sheets. They clearly don't care about my business, and I don't have any level of conviction that I can hit profitability given what I've seen in the past. But somebody who's a lot younger wouldn't have that experience. - Then, the Fed sure raised rates and they used to cut rates, but they didn't print the money. The stimulus checks and a lot of that were government policy. That was responding to a pandemic. What, there's a virus that we're going to blame? That was responding to a global financial crisis and that was responding all the way down. - Ultimately, I can be angry, old man yells at a cloud, or I can take some level of personal responsibility and learn the lessons. Always the key thing here is nobody duped you, but they would have pushed things and sold things based on realities that were true in the time, but that's always the case. Hopefully, people learn the lessons from this. - I don't really feel for anybody that's (a) having been laid off but (b) you think being laid off hurts, and it does and it has real consequences. Try laying people off and dealing with that in your conscience. That's an insanely hard thing to do, so I have a mad respect for anybody that has to do that and has to go through that, but this is insanely character-building and it will make you stronger. The businesses that get through this will be so much stronger. The lessons you learn will be stronger. - I hate to say this, but there were a lot of things getting funded that probably shouldn't have. There were a lot of things that were features, not products and a lot of things were products, not businesses. There were 16 things in the category that all look the same that all reached massive valuations. - That's not sustainable. The market always wins. The real question is where does conviction come from when reality smacks you in the face? Macro reality could get a lot, lot worse. ➢ Don: That's incredibly insightful. Actually, one of the reasons that we launched Startup Growth Stories in the first place is really to help founders weather the storm together, understand that we're going through similar problems, and then meet with experts like yourself who can actually provide insight and perspective to help us get through these challenging times. - What tangentially related question I had for you, you've mentioned in the past how public markets have diverged from private markets, is that still the case? What are you seeing in private markets? Have multiples finally permeated down to Series B and Series A startups? - Simon: I'd say there's still a difference between the two. Public multiples for fintech now are anywhere between 1X and at a top-end maybe 8X revenues if it's the [...]. Consumer fintech is somewhere between 2X and 3X revenues. You're in that ballpark, which is not a million miles off historic norms as well. That's a good ballpark really. - But then Walmart has a market cap where it's $460 billion, but it trades at 0.6X revenue. Your revenue multiple doesn't mean you are or aren't successful once you hit public markets depending on how old you are. - There's a really good piece by Morgan Stanley that I covered on Fintech Brain Food. Some of them are delivering rule of 40 growth in the public markets. Those are the ones that are typically at the higher end of that. The market still likes growth on some level. It still lets you stand out versus your peers versus things that might have spiked into the public market and then really are struggling for revenue and good unit economics. It always, always comes back to the fundamentals. - On the private side, I have no history in VC, and my desk is not crossed with thousands of deals per week falling from it. The noise I'm hearing looks and feels like 2019 and 2020, but it's not far from reverting to the mean. The interesting question is does that go further given, as you say, the VC dry powder and given the macro is still trending negative for quite some time? ➢ Don: Makes a ton of sense. Time will tell. The question is are we going to revert to the mean or are we going to crash straight through it and need the pendulum to swing back up before we get there? - Simon: [...] a hypothesis as well speaking of the macro. A lot of the things I've said are all just my opinion. The confidence level on this next statement, I'm closer to 60%–65%. It's not 100% confident, but there is a real probability that in hiking rates so fast, something breaks. The Fed will end up probably breaking the bond markets. When they do, they'll start easing but won't call it easing. The market will know what's up, things should start to even out on the pricing scale a little bit, and then we'll see what the real mean is and what the market really thinks rather than going completely risk-off and staying away from anything that looks like a risk. - The correction so far has brought us back to the middle of the long-term range rather than toward the bottom of it. The pricing pressure could come down a little bit more, but we saw this happen in the UK. The UK wasn't raising rates particularly quickly, and they broke the gilts market and nearly sent a bunch of pension funds under in the process. - Part of that has to do with structural issues in how the capital markets work and all of that stuff, but those issues won't be fixed quickly and the US has its own quirks and foibles in that sense. There's a chance we get to see early next year that the mood music changes in pricing and market even as the real economy starts to feel the real, real pain as inflation hits, as rentals hit, and as all of the impact of these rate rises start to hit the real economy. ➢ Don: It's really interesting. For credit-focused fintech where access to capital is existential, capital market strategy is obviously essential. In this capital market environment, how should fintech startups who are credit-focused think about their next move and access to capital? Is it getting more expensive? Should they wait to raise their next warehouse facility? Should they consider TOPCO financing? How are you seeing the trends that you just mentioned in this environment impacting credit-focused fintechs? - Simon: The balance sheet power matters and the banks are back, my friend, where it used to be much more over the counter and much more go find those buyers and find those specialists. The banks are really in the best place. They're extremely well-capitalized, they have the relationships, and they've been paying attention to fintech, but they didn't stand out and deploy. - They're the ones that can now deploy because they're in this different position. They are designed by their structure to be counter-cyclical, and that's exactly what they're able to do. As I speak to bankers, in particular, they're licking their lips. They're off to the races when it comes to that side. If you don't have the relationships, then I would start thinking about who those folks to start building them with depending on how your desk is structured and what your sources of capital have been historically. - But that's just a mood music piece. I don't have empirical data on that. I've spoken to four or five bankers who were saying, we're getting a lot more attention, the aggression and pricing has gone away a little bit more, the focus on underwriting has definitely appeared, and the risk committees that weren't letting them win deals before suddenly are the ones that have left them in good shape to be the ones that can write deals now. ➢ Don: When you say banks, you're referring to the multi-hundred-billion-dollar publicly listed offline financial institutions that have dominated the landscape for the last couple hundred years. I'm curious if you have a point of view—and I know you do because I read your newsletter—on the emergence of this BaaS ecosystem and the emergence of digitally native challenger banks perhaps on the consumer side, but also I'm curious if you have a point of view on the business banking side as well. Where does that all fit in here? - Simon: Partner banks have done an amazing job in unlocking consumer and B2B fintech in an amazing way. They provided access when nobody else would. If you look at some of the biggest fintech companies you can name, generally, you can find a tiny partner bank underneath it, that sub-$10 billion in assets. - That goes back to the Dodd-Frank Act of 2010 and something called the Durbin Amendment which essentially was designed to reduce the swipe fees that merchants had to pay. You walk into a store with your credit and the small business gets hit with a 2.5% fee for that transaction. What the Durbin Amendment said is that's not okay for the big banks, but we'll leave it there for the small banks. Hopefully, that means that the small banks get to survive and thrive but small businesses also win. - The unintended consequence of that was that the small banks discovered that there was a new type of partnership they could do with these fintech companies. Because they could revenue-share the swipe fees, there was so much more to go around and that would be if those organizations went to one of the bigger banks. - I'm Square, Chime, or somebody like that, and I want to go do a debit card. If I go do that with one of these smaller partner banks, I can actually make a material amount of revenue out of that. That absolutely takes off. - The problem was these tiny organizations were designed to serve a local community. They weren't designed to serve tens of millions of customers via somebody else. Now, a lot of the big, sophisticated fintech companies have put in lots of operational controls, fraud controls, and everything else, but these tiny banks are still quite small, so the regulators are coming in starting to really say, hey, we're not so sure that all of you have got your act together. Of course, some have. But there's that regulatory pressure coming there. - There was also a generation of intermediary infrastructure providers that popped up, the so-called banking as a service provider. They all look a little bit different. A lot of things are actually very different businesses get lumped together, but if you're not familiar with fintech businesses that might stand out or companies like Unit, Synapse, Bond, and Treasury Prime, people will name Marqeta and Galileo, but they're actually a different thing. But that aside, all of those businesses get named. They're a part of this mix where you take this really tiny bank, you take an infrastructure provider in the middle, you take a consumer brand at the top, and you have this entirely new distribution model for finance where you're using a debit card and you're using an app that feels a bit like your bank's app, but it's not really a bank. We call these things neobanks. - Regulators went, hmm, we're not so sure about that. What happens if something goes wrong? Then, that becomes a whole rabbit hole of questions. I don't think the partner banks as they exist today with the operating model they have will necessarily be the same. They're going to have a lot more competition from the big banks who now see the opportunity and are coming towards winning that business and they're also going to have a lot more regulatory scrutiny. Some will succeed and some will do extremely well, but not all will. It’s going to be interesting to see how it shakes out. ➢ Don: That's really helpful. What is it that has unlocked this opportunity for these digital banks? Why has this product taken off? What's been the gap that they're serving in the market? Simon: I think a couple of things. One was that banks have quite a high bar. Especially if you're time-poor and low-income, you have to go into a branch from 9:00 AM to 5:00 PM to open a bank account 10 years ago. It's no longer the case now, but it was for quite a lot of banks 10 years ago. - They also couldn't do basic things like move money in real-time. Then, Cash App comes along and says, well, if you want to just send that money right now, you need to pay somebody, or you need to get paid, push a button that will cost you $2, and you'll get that money right now. Same with Chime, they introduced the get paid two days early. All of these little things that nobody in the banking industry had bothered to do but were entirely possible to do become these killer features, these standout reasons why you need to use that app. Yes, it was a better experience, but it was also a financial innovation. It was product innovation that made the difference. - Then, those apps expanded from there. There was (1) solving a consumer pain point, but (2) it was a revenue model baked in which is the Durbin Amendment and the revenue share, which is if I'm growing users and I'm getting revenue through the door, my unit economics may not be great, but I can expand that and I can launch other products. I have a way to get to market. I'm solving a consumer problem. - What's happened in the years since is a lot of the banks have copy pasted a lot of those features, but now, the consumers, instead of having their primary bank, have five or six fintech apps where they might have Robinhood, Cash App, and Venmo. They also sometimes use Zelle. This is a much more complex world the consumer finds themselves in. ➢ Don: It's really insightful. Do you view consolidation, these super apps, or apps that have multiple features that solve multiple customer pain points as a trend you're seeing in the market? - Simon: Yeah. It's the circle of life. As companies reach a level of maturity, that growth has to come from somewhere. Some will be specialists and stay niche, and that limits their long-term top-line growth. But Cash App is becoming a different monster over time. PayPal can do just about anything. Venmo is going wider. - I do think that's somewhat inevitable as these things start to chase revenue and reach a certain maturity. The interesting question to me is how may I start to look to get charters and get into lending. Some will stay away from it, but getting a full banking charter is hard, expensive, and slow. Getting the charter is hard, keeping it is harder. - Just look at Vero right now. It has 2 million-plus users. It's an organization that has got its charter, but it's going through the growing pains of putting in all the structures it needs to get efficient to be able to lend you as a bank now, not as what it was, which was a neobank. You've seen this elsewhere. We saw it in the UK with the likes of Monzo who went through something similar. They were a neobank that became a bank, had about two years where they just paused product development more or less just to fix all of the stuff they had to do to be a bank, and now they're slowly starting to get into lending, deploying lending, and so on, but it's not their natural skill set. Their great skill set is being a great UX, UI, and everyday-spend card. Can they get into lending and do they have that DNA? - You've got these things that used to be neobanks that become banks which is one route to go. Then, you have the other one which is things that don't ever want to be a bank but actually re-bundle things, the fintech super app as you call it. Probably, the closest again is your PayPal and Cash App, although [...] has an industrial loan charter. - The other one would be Revolut in Europe. They do everything from stock trading, to crypto, you name it, they've got the thing that does it. Underneath the hood, it's a thousand different partnerships. Maybe one day, even the Apple Card heads that way. They're becoming this underneath the hood, it's 15 different providers, but to you, it looks like 1 rather than doing all the manufacturing. - That's the fintech super app thesis. It's interesting, but again, regulators raise an eyebrow at that approach, so it's going to be interesting to watch what plays out in the next couple of years. ➢ Don: Thanks for sharing all these insights. There are so many takeaways here. In the last segment, I want to switch gears just a little bit. Our listeners are founders, operators, at seed, bootstrapped through Series C SaaS, and fintech startups. We know that building a fintech company is very complex. By comparison, the regulatory considerations and access to credit, maybe SaaS sounds a little bit less intimidating. I'm curious if there's any advice you have for first-time fintech founders and whether that is different for first-time SaaS founders as they navigate this evolving macro environment. - Simon: I think my TLDR in fintech is that payments are easy, edge cases are hard, and payments are absolutely full of edge cases. You need to understand those critically or hire somebody who does. - Secondly, lending is easy, getting paid back is hard. - Thirdly, everything is compliance. If you figure that out, it's almost backward. You don't have to be an expert in any of those. In fact, you probably shouldn't be, but you should know it, get into the weeds, grok it, and get into the details of it. That's going to be an absolute superpower. There are a lot of folks and operators out there that understand this stuff and there are a lot of folks who either just let go or have options in a startup where the valuation's underwater. - There's a lot of talent out there that might be looking for the next thing, and there's a lot of VC dry powder out there. Your timing could be really good if you understand the macro, you understand where the market's going, and you are humble enough to say, okay, I don't know everything, but I'm going to try my hardest to learn it. Also, if you have conviction in your idea and you can keep pushing, there are a lot of things that drive by and traditional financial services will tell you can't be done and absolutely can be done. You just got to find it. - I come back to Chime. The get paid two days early could always be done. A lot of people in financial services would say, oh, but it's too risky. Is it though, or is it now a killer feature, it's become the norm, and everybody's adding it? That would be the balance I'd hope to try and bring. ➢ Don: Excellent. You've come a long way in your journey. You've accomplished a lot. For those of us who are earlier in our careers, can you share one pivotal moment in your life, career, or entrepreneurial journey that changed your ultimate trajectory? - Simon: I worked for a payments company. In fact, I'll go back before that. I left school at 16. I worked for a telco for eight years as a software engineer and I was just coasting along. Eight years is a long time. I was actually getting testicular cancer and I was forced to really stand back and evaluate what I want from life and what I wanted to do. I was just a big fan of technology. I knew I had to get closer to it. I've done software engineering, but I wasn't good at it. That's when I started down the journey of trying to found a couple of businesses and kind of moved on from there. - I eventually had to get a job. The company I got a job for—this is how long ago it is—I'd be scrolling on my BlackBerry reading TechCrunch. I saw something about the founder of Twitter, Jack Dorsey, stepping down to build a new startup called Squirrel. It did not end up being called Squirrel. It ended up being called Square. - I emailed that to the leadership of the company I worked at and instead of telling me off, they created a job for me as the head of innovation, and the rest took off from there. Follow your instinct, follow your gut, and sometimes, setbacks can be the most important things for you. - Don: Incredible. Simon, we'll call it there. Thank you so much for joining us today. Really insightful conversation. We're excited to share this story with all of our listeners in the world. Appreciate you joining Startup Growth Stories and looking forward to staying in touch. - Simon: Thanks for having me. - Don: Thanks a lot.