Where are US fintech’s next billion-dollar startups?

As fintech investments soar to new heights, investors are looking at the bottom and top levels of the services stack to find the next billion-dollar startups.

That’s the word from seasoned investors like Andreessen Horowitz’s managing director, Angela Strange, who has invested in a number of successful financial services technology companies. For Strange and Chris Britt, co-founder and chief executive of financial services startup Chime Bank, the best opportunities are in customer-facing financial services and specific infrastructure opportunities that can support those  businesses.

For many large companies, financial services are already entering a twilight period. Markets like consumer and student lending, banking and financial management and business lending are becoming more crowded, and companies like Affirm, Betterment, Brex, Chime Bank, CommonBond, Kabbage, Robinhood, SoFi, Wealthfront and many others have raised hundreds of millions so they can take on established players in banking and finance.

Investments into financial technology companies in the U.S. exploded in 2019 with at least $12.7 billion flowing in the first half of the year alone. That figure — a 60% jump in dollars committed — came even as the number of deals remained relatively steady, according to data from Accenture.

Increasing capital commitments were even more pronounced in Europe and the United Kingdom, where a fintech boom has nearly doubled the amount of money committed to startups over the first half of 2019 from a year-ago period.

Though still lagging behind the U.S., investments in the U.K. climbed to $2.6 billion in the first half of the year (where deals jumped by 25%). Challenger banks were the big attraction in Europe: Monzo raised $144 million; Starling Bank pulled in $211 million and TransferWise raked in $292 million. The first half of the year closed out with a $175 million investment for WorldRemit in June.

“There’s been a lot of interest and demand from consumers for new fintech propositions, particularly in the U.K. and elsewhere in Europe, which helps explain the big jump in investments there,” said Julian Skan, a senior managing director in Accenture’s Financial Services practice, in a statement. “Fundraising is also moving to support the scaling up of challenger and collaborative fintech, which will cause lumpiness in some rounds as we get to the business end of the investment cycle where investors look for returns based on a sustainable bottom line, rather than another buyer. However, the question is: How long can that last? Fundraising is likely to reach a plateau soon and will most likely dip going forward.”

Strange is more sanguine about future opportunities for emerging financial technology startups, in part because of the legacy technology stacks that service them. Existing services were not built with modern technology in mind; their architecture is inflexible and is difficult to adapt to new applications that modern consumers demand.

Selling “picks and shovels” to new fintech companies and incumbents is one of the biggest opportunities in fintech right now, Strange said. “These legacy systems have been around for decades and [customers] don’t love them, either. They’re high cost. You can’t update them. And so there are now starting to be large companies that just pick off what can seem like a small piece of the back end, but really isn’t.”

Strange pointed to the portfolio company, Synapse, which has raised $50 million to overhaul and modernize the connections between banks and new financial services companies. “They will make sure that you’re compliant, that you pass all of the bank’s rules.”

Examples of valuable businesses servicing consumer-facing fintech companies abound — just look at Galileo Financial Technologies, which recently raised $77 million in a round of funding from Accel Partners. The nearly 20-year-old company made a mint providing the API layer linking banks with the startups providing debit cards, credit cards and alternative spending and savings accounts. Some of the biggest names in fintech including Monzo, Robinhood, Chime, Revolut, and TransferWise use the company’s services.

Galileo expects to hit a whopping $26 billion in annual payment volume for the year, according to founder and chief executive Clay Wilkes.

At Chime, Britt uses startups like Socure to comply with know your customer (KYC) regulations and Persona to enhance those existing features. “There are lots and lots of cool companies that we can partner with,” said Britt.

I think of it as almost…offering any sort of financial services product as a module to these fintech companies,” said Accel partner, John Locke, who is taking a seat on the Galileo board. “I think with Galileo as that infrastructure layer… with that infrastructure layer in place fintech companies are more about how do you stitch these products together in a unified customer experience.”

That aligns with Strange’s thinking on the subject. “Now, ‘Act Two’ in financial services is to pick a super strong wedge that’s going to enable you to acquire customers. But then think about how do you use that to become more of a platform and bundle on more services,” she said.

These wedges are typically new promotional services that encourage users to switch from existing checking or savings accounts to an alternative payment provider or savings service. Ultimately, the goal is to create a financial service that will have an almost daily use case, said Strange.

Chime’s billion-dollar-valued challenger bank is a good example of that thesis — even if no investors believed in the company’s value proposition when it launched seven years ago.

“In the early days… every VC we pitched, they’d say, why are you trying to get people to put their direct deposit or their deposit with you? Why don’t you give them money? That’s a way better business model,” Britt said.  “And those businesses are fine. But you know, here we are in 2019. It seems like every fintech is launching checking accounts, right? We were a little ahead of the curve on that front.”

Chime’s features also helped. Offering no-fee advances on paychecks and waiving overdraft charges for customers were early features that drew in new users by the bucketload, Britt said.

“There’s… like 42 banks that are over $10 billion in assets right now,” said Strange. “And think of the number of new neo-banks that have cropped up in the U.S.? Like we’re nowhere close to that, right? And so how could you segment the population in different ways and provide them different services. There’s opportunities for large companies.”

One market that’s been underserved when it comes to better access to financial services tools, is the underbanked and unbanked in the U.S., she said.

“There’s two banking systems in the U.S. There’s one that probably most of us are in. We get credit card offers all the time in the mail. We’re totally bombarded. We don’t love our bank, but we don’t think about it all that much,” said Strange.  “Then there is solidly 50% of America or even more that often live paycheck-to-paycheck. They don’t have a lot of savings. They would name their financial institutions as none of the primary banks… They have fewer options.”

Those customers have a pressing need for modern financial tools that don’t charge predatory rates for their services and represent several billions of dollars in spending every year, said Strange.

“There still hasn’t been enough new companies and innovation started there,” she said.