Building the Backbone of Tomorrow’s Financial System

At BACKED, we back the bold — investing in founders building frontier technology at seed in Europe.

In Autumn 2024, we opened up our thinking with the publication of our Blockchain investment thesis, followed by our Stablecoin thesis in Winter 24.

Today, our fintech investor, David Linsey, puts pen to his approach to Fintech. Founders, if this resonates with you, this is your calling card —let’s talk. Follow us on LinkedIn for latest investment news.

 

Why do we need a fintech thesis? By David Linsey.

It is hard to believe that the seed investors in today’s generational companies had a thesis which exactly aligned with what those companies were building. Yet, when the time came, they were able to pull the trigger. So, how does a thesis prepare us do the same?

The key determinants in investing are to 1) see the most relevant deals, and 2) have a prepared mind to select the best deals. A thesis is useless if it does not serve at least one of these two goals, and can even be destructive by blinkering investors from opportunities that are good investments but don’t ‘fit the thesis’.

The purpose of our thesis is therefore twofold: to make our thinking public so that relevant founders may find us, and to help us orient our own investment decisions by way of a clear framework to evaluate startups, and a relevant knowledge base built from deep research.

This document makes mentions of areas we find particularly interesting and where we will spending our time researching, but it is NOT a comprehensive list of what we are investing in. If we knew exactly what needed to be built, we would just go do it!

What is fintech today?

Before investing in fintech, we must be able to define it. I define “fintech” as “when monetising flows of money is a significant chunk of the core business”, or as software directly serving this demographic. The three main categories I see in this space:

1. pure ‘finance’ companies (e.g. digital bank, such as a deal we are about to announce in February 2025)
2. SaaS companies with an integrated fintech component (e.g. Amenitiz)
3. SaaS marketed at financial enterprises (e.g. Thought Machine)

 

Beyond this simple definition, I find it useful to separate fintech into two categories: the augmenting and the replacing. Augmenting technologies sell into existing financial institutions, while replacing technologies compete directly against these institutions. The very largest opportunities are in the replacing category, but the huge size of the financial services market makes for compelling augmentation business cases. We will go into further detail on how we will invest in each in the ‘areas of interest’ section.

Why is fintech (still) exciting?

There have been notions among investors that fintech has somehow been ‘done’. Yet looking inside any financial institution demonstrates that this is not the case. The processes that financial institutions use to lend, issue, and comply with regulations bring to mind images of pre-CAD era engineers designing complex systems on paper. There’s a long way to go.

1. The most attractive element of fintech is the sheer scale of the financial sector, and the need for a new generation of efficient financial entities.
2. The second is the number of slow and inefficient processes and software present in today’s financial institutions, with billions in efficiency gains to unlock, and clearly demonstrable ROI.
3. The third is the expansion of fintech models into businesses that would not normally be called ‘fintech’.

 

We are also excited for novel business models and will keep an open mind for ideas that are scaleable, profitable, and defensible.

Getting to Conviction: How do we invest in fintech?

The highest-confidence way to achieve returns as a VC, is to invest in companies that will generate large cash flows at scale, and will be valued based on these cash flows at exit. Strategic acquisitions are an added bonus, but at Backed we invest in fintech for the sector’s greatest appeal – high profitability at scale.

To invest effectively, we must have a clear idea about what will get us to conviction in a company. The sections below highlight a few key heuristics:

1.0 Is a business worth building?

Will this company generate fund-returning levels of cashflow at scale?

• Take rate
  • Unit economics are key, and take rate (the percentage of a transaction that a company captures) is the key driver of unit profitability. There are of course variations between different types of fintech, but the key points are that 1) companies which expand take rates for their sector are desirable and 2) sectors with higher take rates can allow scaling while bleeding less cash and so taking less dilution. Take rate directly relates to how large a company has to be to return our fund, and one of the most common failure modes in fintech is failing to scale to positive unit economics. We will not set ourselves up for failure by investing in businesses that will be unit economic negative for an extended period of time.
• Relevancy
  • Is there any incentive from customers to disintermediate/ graduate from this company? If so, we will not invest. We do not want to invest in companies which provide limited functionality above the base layer on which they are building. We want to think carefully about which players will dominate a market over the decade for which we are tied into an investment, and make sure that their incentives align with the existence and growth of this company. A well-known example of this not being thought through is the struggling crop of investments in the banking-as-a-service space.
• Timing
  • Are we going to be the best startup in the space?
    • We do not want to follow ‘waves’. This runs the risk of missing the winners and getting the second tier followers. We look for the next wave instead.
    • For this reason we are not looking to invest in European D2C wealth management/consumer banking plays, payment orchestration, or similar areas which have been very ‘hot’ in the past cycle.

2.0 Can it be built?

This depends primarily on the founder, but is heavily influenced by the market’s desire and willingness to pay. Our founder focus derives from our human centric approach at BACKED. It’s one of our core values to “Put People First” which means we back founders over markets every time.

• Experience
  • The era of low-hanging fruit in fintech is likely over, and we want to back experienced founders. The least competitive spaces in fintech are those that are most difficult to understand, and we think that experience is vital when it comes to building and selling financial infrastructure. There are still large untapped markets (see areas of interest), but they are non obvious. The beauty of investing in fintech is that financial services is such a large industry that even seemingly niche products such as index issuing are billion+ dollar markets, but these markets require detailed insider knowledge of market problems and dynamics.
  • We believe that experience matters more for augmenting technology than for replacing. This is because augmenters must understand complex dynamics of selling to incumbents, while those building new financial institutions have greater freedom to innovate.
• Sales Dynamics & Market Demand
  • CAC dynamics and sales cycles are key. How efficient is a company’s growth machine? To scale to a fund returning outcome, there must be a high ROI distribution strategy which will not falter as the company grows.

  In consumer fintech we look for CAC-LTV ratios of at least 5-1, and for CAC to be repaid upon the first transaction (this is why take rates are so important).

  In SaaS, we much prefer larger contracts, even with slower sales cycles. This presents advantages in both customer acquisition and revenue retention. First, we believe that effort does not scale linearly with contract size (for example, it’s not 10x harder and more expensive to sell a 1M contract than to sell a 100k contract. Secondly, larger orgaisations provide more fertile ground for product expansion.

  We look for signs of problems that are essential, rather than nice, to solve. A strong heuristic is to look for things that customers have tried to build in-house and failed at, or heavily overspent on.

• Licensing and regulatory requirements
  • We do not want to take regulatory risk at seed. The delta in valuations before and after acquiring licenses has not proven to be significant enough to justify the risk. The worst time to invest is when a product is built but unlicensed: we are paying the price for a product, but are uncertain and cash-burning while we wait for licenses.
  • The only time we will invest pre-license is at an occasional pre-seed early exposure deal, where increased ownership compensates for the elevated risk.

What are we Looking For?

• New infrastructure Software: what processes are being conducted inefficiently in large organisations? This covers processes for which there is currently no incumbent full-stack software, and which are done largely manually.
  • Examples we have seen include the index issuing space (long, undigitised, and expensive processes), and the mid and smaller end of the supply chain finance market (it has not been worth many banks’ efforts to take on smaller clients, as the effort involved in onboarding them can cost more than the profits from the deal.)
• Replacement infrastructure software: what software is no longer fit for purpose? This covers processes for which incumbent software is outdated and overpriced.
  • Areas we are looking at include next-gen software for wealth managers to onboard and manage clients, and next-gen KYC and identification systems. A key investment for us in this space was Thought Machine, which represented a significant upgrade from legacy banking software.
  • Can we innovate on pricing models? How can products be priced in a way such as that the ROI to the customer is clear, and the provider is incentivised to provide the best possible service? For example, [a fintech still in stealth] are incentivised to be accurate in their forecasts because they are responsible for credit commitments, whereas SaaS based incumbents are not.
• Vertical SaaS with the ability to capture payment flows for the industry.
  • A new crop of vertical SaaS companies are likely to emerge as a result of AI, and these new companies can integrate fintech products from day 1. Accepting payments is at the core of most industries, and integrating payments into vertical software can give a significant revenue uplift.
  • Payments are just the beginning. Packaging insurance, lending, and other financial services within SaaS could markedly improve unit economics, especially if companies can take a percentage of revenue as they have with payments.
  • Portfolio examples include Amenitiz (Amenitiz Pay) and Travizory (who intend to hold flows of money in their treasury before paying them out to governments, and who may be able to process visa payments going forward).
• Consumer products where the customer experience is poor:
  • When Revolut started, the average user experience of interacting with a European bank was awful. It is now excellent, but there are many consumer finance touchpoints which still fall into either the awful or inadequate categories. Much of consumer credit is still this way – serviced by non-specialist institutions operating on age-old software. In the same way that vertical SaaS has come to dominate the SaaS industry, we believe that vertical consumer fintechs can make the space both more profitable and much better served.
  • The insurance industry is often cited as an example of a sector ripe for disruption. There have been some inroads such as Cuvva, but the space remains relatively Jurassic. We have not yet come across a winning approach for insurance, but we are looking.
• The unexpected!
  • As addressed at the start of this document, the most novel and innovative companies are by definition impossible to predict. While we can hone our expertise and understanding of the areas above, we must keep our mind open to completely new ways of doing things. If something sounds crazy, we will still make our decision from first principles. The ultimate investment is the winner who was obvious in retrospect but unloved on day 1. The best impact we can have is to fund a company that truly wouldn’t have been possible without us.

Let’s build together.

The financial services sector remains vast, complex, and ripe for innovation. While the first wave of fintech disrupted the customer-facing experience, the next generation of startups will rebuild the industry from the ground up. At BACKED, we’re here to back those visionary founders making it happen.

With our deep sector expertise and commitment to founder-first partnerships, we’re uniquely positioned to help these companies thrive. We build communities for our founders above and beyond our regular Founder Experience progrmaming. We also run a quarterly dinner series called Capital Table, for London’s fintech investors (pictured at the top is our Growth stage dinner which we co-hosted with Andrew Davis from Goodwin Procter and Claire Mitchell from HSBC Innovation Banking). And finally, we have recently established our fintech angel community.

If you’re a founder building in any of the spaces above, or have an entirely new idea about the future of finance, please get in touch with David.

We’ll keep sharing insights through our investor lens this year, as well as announcing some of our recent investments – the first coming very very soon! 👀  Stay tuned on LinkedIn.