The Venture Investing Road Less Traveled: Funding Enablers, Not Challengers

It may seem like the age of tech flameouts, where disruptors themselves have been disrupted, and where once-fabled and high-flying unicorns have fallen to earth. WeWork’s dramatic fall from grace tops the bill, perhaps, where a firm that promised to disrupt commercial real estate now finds itself on the edge of bankruptcy after an initial public offering (IPO) that never came to pass.

Other companies have seen their IPOs go bust, trading well below their offer prices even as they seek to change their chosen verticals, such as ride-hailing and food delivery, and notching top-line growth while operating losses seem to be on the long-term horizon. Uber and Lyft might be the poster children here.

The marquee name that stands out for having lost big on bets for disruptors is SoftBank’s Vision Fund. SoftBank launched a $100 billion fund in 2017 that took multibillion-dollar stakes in these (and other) companies. As a result, last month, the company reported a $6.5 billion quarterly loss, and wrote down the value of several holdings.

As Founder Masayoshi Son has said, the goal may be to build a company that can grow 300 years down the road, banking on game-changing technologies, such as artificial intelligence. Then again, looking that far into the future may overlook some of the challenges — and opportunities — that lie in the here and now in the payments space, amid a venture capital landscape that has changed markedly over the last few years.

In the latest Monday Conversation, Dan Rosen, venture capitalist and founder of Commerce Ventures, told Karen Webster that eyeing the new tech enablers of payments (those that provide the software, hardware and platforms that streamline the heavy lifting to the digital age for the more traditional players), and not the disruptors, can pay off handsomely. It’s a strategy, he acknowledged, that flies in the face of what has been a hallmark of the past few years: a tech industry dominated by the U word — that would be “unicorn,” of course.

Rosen said that through the last few years, many of the larger tech startups (with eyes on displacing those that sit in the Fortune 500 today) have taken venture funds as a way to accelerate a path toward IPOs, or perhaps even to avoid IPOs — and sometimes the governance mandated as a public company. In the face of such funding, it has become difficult for the ecosystem at large to separate tech innovators from those that are but a next-generation façade of a traditional business model.

“That’s been at the heart of this WeWork question,” he said.

His comments came on the heels of a recent Commerce Ventures capital raise for a new, $60 million fund aimed at the retail and financial services sector. The new fund’s partners are strategic individuals who have run some of the largest companies in the retail, payments, banking and insurance industries — and who want a front-row seat in the hunt for tech innovators that can accelerate their own digital payment ambitions.

First Enable, Then Disrupt

Rosen said Commerce Venture’s approach was borne out of the reality that there’s a continuous need for the more-entrenched financial services and payment players to keep up with best-in-class user experiences, processes and interfaces. It’s not a one-sided relationship, though.

There’s a continuous need, too, for tech innovators to find distribution. They can capture that distribution by aligning with incumbents who can leverage enablers’ innovations. With critical infrastructure in place, they can fast-track new products and services, and work with the likes of Visa and Mastercard to transform payment ecosystems.

It’s a principle that Rosen said has become even more important, as payments have moved well past retail and toward enabling a better, more secure online user experience. The payments landscape has evolved over the past few years to embrace other flows across consumer-to-business (C2B), healthcare and business-to-business (B2B) use cases — and open up investment opportunities for those with great tech, but no way to scale it.

Commerce Ventures, he said, has thus focused on those platforms and tech innovators, funding roughly four dozen investments, with 19 companies valued at more than $100 million, and two firms valued at more than $1 billion — including stakes in firms such as Marqeta, Bill.com, MX, Narvar and Forter, among others.

“Even from early on, our strategy has been decidedly different from that of Silicon Valley’s, or of the broader venture capital community,” he told Webster, “which has been primarily focused on the challengers or disruptors of the incumbency of large financial institutions.”

There’s a benefit to these enablers landing incumbent players as customers, he added, as they provide critical infrastructure. As Rosen noted, these incumbent firms traditionally have deep pockets, and their business is recurring, with high margins — eventually leading to predictable financial performance for the enablers, and possibly, down the road.

The Opportunities Ahead

Looking ahead, he said Commerce Ventures will continue to seek opportunities at the intersection of payments and financial services, across a variety of different industry verticals. Chief among those verticals will be healthcare, with particular attention paid to integrated and embedded payments functionality on offer from software providers.

“Payments is a big headache in the space, especially as the volume of payments that [come] out of consumer payments continues to go up very rapidly as healthcare costs go up,” he told Webster, “and employers and insurers just won’t absorb as much of that increase.”

Commercial payment firms will continue to attract investor dollars, he added, as the space is so large, and there is still so much manual work tied to spreadsheets that can be automated.

Neobanks: Overcapitalized?

The discussion turned to “hot” areas that have attracted venture capital dollars, but may not deliver on the hype. One of those areas, Rosen remarked, is the Neobank opportunity — one that he said is overfunded, and where venture capitalists have chased a significant number of firms with billions of dollars.

“And it’s not overfunded by a little bit,” he told Webster of challenger banks. “It’s overfunded by a lot.”

That’s especially true in the consumer lending and demand deposit account (DDA) startups. He also nodded to stock investments and the asset management space as being overfunded niches within financial services, as the space becomes increasingly digitized.

When it comes to raising venture capital to build a regulated business that competes with a depository institution (in one of the core areas in which depository institutions operate), Rosen said, it’s nearly impossible to build a successful challenger in that space that can sustain a multibillion-dollar valuation over time as an independent public company.

Going through the lengthy and onerous process of becoming a chartered financial institution does not guarantee a pot of gold at the end of the investing rainbow, he added.

Alternative credit has also become a popular vertical, noted Webster, marked by a plethora of point-of-sale credit providers that many have said could find themselves tested when the economy takes a downturn. Rosen stated that the rush of firms into alternative lending means they are only competing on one thing: the cost of capital.

“Not everything that makes sense to other people makes sense to me,” he said.

With a nod toward Commerce Ventures’ continuing investment principles, Rosen added: “I don’t look at a lot of the venture-funded, successful payments startups as challengers as much as new providers of infrastructure. There is money to be made with these enablers, who are, at their core, technology businesses.”