This first appeared in the monthly a16z fintech newsletter. Subscribe to stay on top of the latest fintech news.
We are entering a new age of ownership, one where investing is increasingly distributed and accessible to retail investors. Public markets are notoriously going through monumental shifts, and retail investors are incrementally getting access through fractional shares and pre-IPO allocations. But the rise of retail investors is not limited to public markets. Regulatory changes have expanded the frameworks for private companies to raise money from retail investors, and a new wave of startups — Republic, Party Round, Otis, Masterworks, OpenSea — have given more retail investors the platform and tools to have a stake in private markets and alternative markets, such as wine, cars, and art (including NFTs) that were traditionally available only to the ultra wealthy.
For startups, the rise of retail investing represents an opportunity to narrow the gap between being a user/customer and becoming an investor/owner. The next-generation of consumers want to be rewarded for being loyal customers and want a path to ownership in the places they shop, eat, and consume. So, how do platforms marry this interest in getting ownership in private, public, or alternative markets with the interests of their consumers?
From a pure product and customer experience perspective, startups can embed into their experiences to transform users into owners. Stock-back programs — popularized by Stash — are one example. Whenever a customer uses a product or shops at a particular store, they get a fraction of stock back, creating further company loyalty. With modern product-first programs, fintechs can similarly incentivize consumers to swipe, invest, and engage with platforms and reward those that engage the most with shares. Additionally, companies could solicit better product feedback from customers through ownership incentive as a way to get more actionable product feedback so that the best customers feel closer to the company and help them build better functioning products.
When it comes to customer acquisition, companies who give customers and advocates shares instead of pouring marketing dollars into Facebook and Google should see lower CACs. Finally, on the fundraising side, founders are starting leverage their user base. Airbnb set up a host endowment fund to give equity to their hosts when the company went public. More recently, Clubhouse and Gumroad raised money from their users and communities. As more consumers and investors continue to ask for a seat at the table, the companies and organizations that reward their advocates with a piece of the pie will ultimately be the ones with a significant competitive advantage.
Consumers haven’t loved their banks for decades, but it is only in the past decade that real “neobank” challengers have emerged. While the incumbent banks don’t necessarily have beloved products, they do have a distribution advantage — the top 15 U.S. banks own more than 50% of deposit market share in the U.S. To combat this advantage, early neobank challengers have leveraged inflection points — a trigger event in a person’s life, whether it’s a milestone (e.g., graduation), a point in time (e.g., immigrating to the U.S.), or even a micro-moment (e.g., making a first huge purchase) — to reduce the cost of customer acquisition by targeting a particular type of user at a particular time when they were more likely to change their banking services.
The next wave of customer acquisition (and product) strategies were to remove hated fees or other anachronisms as beacons for consumer attention: free checking (practically non-existent if you couldn’t keep a balance over $1000); no overdraft fees ($12B paid last year, most by the financially vulnerable); and the ability to get a paycheck 2 days early! With these wedges, several fintech companies have grown to scale with millions of customers.
All of this has put pressure on traditional banks to dramatically cut fees of existing offerings in order to compete with neobank challengers. This past month, Ally eliminated overdraft for all consumers, Capital One joined Fifth Third in offering early direct deposit. It’s not yet clear if these fee eliminations will be enough to retain existing customers — not to mention gain new ones. What is clear is that in the competition between neobanks and traditional banks, consumers are the real winners, with fewer fees, more choices, and better financial services.
Financial services, when embedded effectively, can improve liquidity for marketplaces — creating better experiences for market participants and enabling marketplaces to capture more value per transaction. For instance, Opendoor uses debt capital to create instant liquidity for homeowners and reduce the friction homeowners face when selling their home. Airbnb unlocked a massive amount of latent supply with their embedded insurance product, which was key to providing hosts with peace of mind when listing their homes.
Both Airbnb and Opendoor built these embedded financial solutions in-house, but there is an opportunity for financial infrastructure companies to thrive by focusing specifically on unlocking latent supply or reducing friction on the demand side. On the supply side, know-your-customer (KYC) providers, such as Checkr, Mati, and Jumio, are working with marketplaces around the world to better verify gig-workers, and companies like Parafin and Resolve provide lending solutions to enable sellers to access the capital they need to be active participants in their respective marketplaces.
On the demand side, lending-as-a-service companies, like Wisetack, allow contractors on platforms like Joist and HoneyBook to offer point-of-sale financing to their end customers, increasing conversion rates. And in B2B marketplaces, Faire offers retailers net 60 terms directly on the platform, allowing them to buy the optimal amount of inventory for their store and try new products risk-free.
With Faire’s model as inspiration, B2B marketplaces should offer free, vertical specific tools to gain adoption and then monetize via financial services. Combine this new mechanism to unlock growth and monetization with a structural shift in the penetration of digital payments due to COVID and you get a market dynamic that makes B2B marketplaces an attractive category to build in.
Active investing is on the rise — we are on track for more new institutional hedge funds in 2021 as well as an increase in smaller emerging fund managers that span investing strategies, from traditional long-short equity to foreign exchange to crypto. With this rise, there is the opportunity for supporting software to help a rising crop of emerging fund managers launch and manage their fund.
On the launch side, the process is fairly standard in terms of boilerplate legal documentation, regulatory approvals, and registration, but requires expensive and time consuming back and forth with lawyers and regulators. Software could streamline this process and cut down the costs. After launch, software could help with the laundry list of back and middle office tasks around fund administration, order and trade management, and reporting software. Limited partner communication and management could be handled via the platform. Finally, software could provide connectivity into — or even natively provide — the brokerage services to execute trades.
Together, the back and middle office software could combine something like Interactive Brokers on the brokerage side, with a modern version of SS&C or SEIC, into one platform that scales down to serve micro and smaller funds, and eventually scales up to serve larger funds over time. As the system of record, this software platform could be deceptively large by serving as a means to the front office as well. It could power a marketplace to match fund managers with limited partner investors and help with the fund marketing side. And it could plug in data feeds and analytical tools that sit on top. While we’re still in early innings of the creation of this market, the signs point to a potentially very large business to be built at the intersection of two significant tailwinds — creator tools, which will increasingly become vertical specific, and the rise of active investing.