Analysis Featured

How to grow a fintech company, the 3 phases

(Frank Rotman, the author of this paper,  is a Founding Partner of QED Investors. QED Investors is an early investor in Avant, Circle Up, Credit Karma, Fundera, Klarna, LendUp, Orchard, Prosper, SoFi, Zopa, and more)

To put it simply, there are usually three phases of growth and each has its own characteristics and cadence.

Phase 1: Test, learn and burn

Phase 2: Revenue your way into scale

Phase 3: Cost your way into a healthy business

In Phase 1, every iota of energy needs to be focused on figuring out product/market fit and if the unit economics of the product make sense.   It’s about maniacally executing a well designed learning agenda.  It’s about interpreting early market/test results.  It’s about figuring out which levers matter and how hard they should be pulled.

Phase 1 is also about burning cash.  There’s no way around it because at this stage the business by definition has very few customers and revenue can’t overcome the fixed costs of supporting the product.  While every dollar matters for all the obvious reasons, the goal should be to maximize learnings rather than minimize burn.  Test, learn and burn.

In Phase 2, a business should be focused on scaling aggressively in order to build market relevance and overcome fixed costs.  But, aggressive scaling doesn’t mean mashing the accelerator with no constraints.  Decisions should be made based on the learnings from Phase 1 and not be speculative in nature.  In the formative days of Capital One we used to talk about how this phase of a product’s life felt like cheating because we learned enough in Phase I to know what the results were going to be in advance of spending our marketing dollars.  Cha-Ching!

Phase 2 is also about building out the capabilities of the team and operational processes such that the results are repeatable.  Selling widgets starts with making consistent widgets to sell, and this is a piece of the growth story that’s routinely being overlooked by today’s hyper-growth lending start-ups.  My observation is that many lending companies that I’ve diligenced over the years grew or are growing faster than they should.  It’s not uncommon for a hyper-growth lending company to tap pockets of customer demand at the margin, and it’s precisely these marginal customers that have less robust economics and more volatility associated with them.  Increasing repeatability and reducing volatility is almost always more important than an extra 10%, 20% or even 50% growth rate.  Volatile revenue is garbage and nine times out of ten will destroy value and create distracting fire drills.  Do the work and analyze what the last 10% or 20% is actually contributing.  It’s not an easy exercise but ALWAYS worth the time and effort.  Revenue your way into scale is a good mantra to espouse but only if the revenue is stable and robust revenue.

The transition from Phase 2 to Phase 3 is really interesting because it usually comes as a wake-up call vs. a choice.  Most successful businesses grow at a 45 degree angle straight up until the day that they suddenly hit a wall.  WHAM!  Sometimes the wall is a direct result of a shock to the industry or the economy.  Sometimes the wall shows itself after an internal breakdown in processes or controls.  And sometimes the wall is erected by the competitive landscape and appears as a slowdown in the growth rate of the business.  Welcome to Phase 3!

The Phase 3 playbook is usually quite obvious but not without pain and suffering.  The leverage in this Phase typically comes from refinement vs. trail blazing.  It comes from ripping costs out of the system and jettisoning marginal projects, tests and even people.  It comes from renegotiating contracts and focusing on cost-efficient-widget-making.  Costing your way into a healthy business is almost always an inevitable stop on the way to greatness, so when it arrives embrace it, deal with it, and move past it.  I wrote a few posts  earlier in the year that lightly touch on this topic: Thriving, Surviving or Dying and What Happens When The Cash Runs Out.

So how does this tie to my earlier comments about being in “remember when” mode?  It ties to my comments because I find myself sharing stories (both good and bad) and lessons from the past with less experienced operators.  I find myself remembering back to a time when being great meant growing top line at 20-40% a year with 20%+ ROEs for 10 years in a row.  I remember when hyper-growth was punished and consistency was rewarded.  I remember when the resilience and quality of revenue mattered more than raw growth numbers.

Don’t get me wrong, early stage lending companies need to grow at 2-3X a year in order to achieve relevance and overcome fixed costs.  But, my lamentation is around the growth advice that some investors are giving to entrepreneurs and that many entrepreneurs are glomming onto.  Grow, grow, grow!  More is better!

In many cases there doesn’t seem to be an appetite for discussing the right growth rate if it’s sub-100%.  In many cases unit economics take a back seat to top line revenue growth and vertical economics.  And in many cases the hard work around attacking costs is replaced with a view that “we can grow our way into our cost structure”.

My advice is simple.  Learn first.  Grow when you’re ready.  Become operationally excellent.  Embrace the inevitability of a wall.  Build a great business by attacking costs and improving the bottom line.  Rinse and repeat.  And don’t let anyone fool you into thinking that building a lending business is a land grab (as justification for their growth advice).  We live in a consumerist society so the opportunity to lend money will be there tomorrow if it’s there today.  Patience you must have my young Padawan.  Patience.

(Article originally published by Frank Rotman on his blog Fintech Junkie)

About the author

George Popescu

Serial entrepreneur.

George sold and exited his most successful company, Boston Technologies (BT) group, in 2014. BT was a technology, market maker, high-frequency trading and inter-broker broker-dealer in the FX Spot, precious metals and CFDs space company. George was the Founder and CEO and he boot-strapped from $0 to a $20+ million in revenue without any equity investment. BT has been #1 fastest growing company in Boston in 2011 according to the Boston Business Journal and the only company being in top 10 fastest in 2012-13 as it was #5 in 2012. BT has been on the Inc. 500/5000 list of fastest growing companies in the US for 4 years in a row ( #143, #373, #897 and #1270). After the company sale in July 2014 until February 2015 George was Head-of-Strategy for Currency Mountain ( www.currencymountain.com ), a USD 100 million+ holding company focused on retail and medium institutional currencies, precious metals, stocks, fixed income and commodities businesses.

• Over the last 10 years, George founded 10 companies in online lending, craft beer brewery, exotic sports car rental space, hedge funds, peer-reviewed scientific journal ( Journal of Cellular and Molecular medicine…) and more. George advised 30+ early stage start-ups in different fields. George was also a mentor at MIT’s Venture Mentoring Services and Techstar Fintech in NY.

• Previously George obtained 3 Master's Degrees: a Master's of Science from MIT working on 3D printing, a Master’s in Electrical Engineering and Computer Science from Supelec, France and a Master's in Nanosciences from Paris XI University. Previously he worked as a visiting scientist at MIT in Bio-engineering for 2 years. George had 3 undergrad majors: Maths, Physics and Chemistry. His scientific career led to about 10 publications and patents.

• On the business side, Boston Business Journal has named me in the top 40 under 40 in 2012 in recognition of his business achievements.

• George is originally from Romania and grew up in Paris, France.

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