10 Implications for Fintech of the SVB Collapse

The sudden collapse of SVB continues to send reverberations throughout not just the fintech ecosystem, but also the broader financial markets.

While in many ways it feels too early to look back on what happened, and events are unfolding live, we can nonetheless draw some conclusions about how the world has changed and how it will continue to change in the near future.

Here are ten implications of the new world we live in:

1. The ending of the forty year bull market in bonds will be a turbulent transition:

A lot has been written about the end of the forty year bull market in bonds that started in the early 1980s. A big driver behind this bull market was the macro economic impact of the demographic bubble represented by the baby boomers. Born right after the Second World War, this generation started entering their mid-thirties by the early 1980s, at which point they started accumulating capital at pace, which gradually but inevitably started putting downward pressure on real rates. Baby boomers are now entering their mid-seventies, and rather than accumulating capital, they are now decumulating it.

This was clearly not the only driver behind low rates – globalisation, technological improvements, and the emergence of developing countries all played major roles.

Whatever the causes, the bull market is now coming to an end, and as the SVB example painfully illustrated, the transition will be anything but smooth. They got caught on the wrong side of rate movements, and as confidence in their balance sheet collapsed, so did the bank, in a matter of hours.

Beyond SVB, considering debt to GDP ratios for sovereign countries also brings home the magnitude of the challenge that lies ahead. If a country has a debt to GDP ratio of 200%, a one percentage rise in interest rates, corresponds to 2% of GDP. As more income is diverted to debt service, budgets and consumption will shrink, with monumental consequences.

2. The perception of bonds will change:

As rates go up, bond prices decline. And the longer the duration of the bond, the more severe the reduction. We will now start to adjust to a world where bonds are not necessarily seen as safe havens, or more specifically, will only be seen as safe havens in cases where they can be held to maturity.

For example, a bond with a 1% coupon and thirty year maturity, has a duration of about 25, which means that if the rates rise by 1%, the price of the bond would go down by about 25%.

As rates rise, the reality of this simple math will reverberate through world of finance.

3. The narrative around how to allocate your pensions will change:

Over the last forty years, bonds yielded positive returns to holders as rates were going down. As this changes, bonds may very well return to more historical norms of close to zero real returns, or negative returns over short periods of time when rates increase rapidly.

This will have implications for how portfolios are constructed for the purposes of retirement and pensions.

Very likely, bonds will increasing be come to seen as a hedge against inflation, as opposed to a strategy for generating real returns. Inflation linked bonds that can lock in a real rate of return may also become more popular.

4. Banks will not be able to rely on income from bond portfolios the way they used to:

As the SVB example illustrates, bonds will likely have lower real returns, and hence become a less reliable tool for generating excess income, on bank balance sheets or elsewhere.

As a result, banks will likely start favouring lending where they can pass rate rises onto consumers, and make excess returns.

5. Lending platforms that can pass on cost of debt and manage risk effectively will become more valuable:

It follows from the above point that lending platforms that can generate low risk, high yield assets in a predictable and low yield fashion will become more valuable, and banks may in fact be willing to pay a premium to acquire such assets.

Clearly, in the very near term, there will be a lot of turbulence, and the natural tendency for banks will be to pull back and retrench. But as the dust settles, they will likely look to bolster their lending capabilities.

6. The Fed will have to make difficult trade-offs between inflation, financial stability, and unemployment and there may be no easy paths forward:

The Fed will have very difficult trade-offs to make in the coming months, and will very likely have to choose between reducing inflation or creating more market volatility. It is impossible to say which way they will act, but there will likely be a stark trade-off between reducing inflation vs. avoiding future events akin to the SVB failure.

Predictions are hard here, but one very possible outcome is that the Fed may end up raising its inflation target. This would have the added benefit (from the Fed’s perspective) of inflating away the debt burden.

7. Protectionism and the roll-back of globalisation may be a political response in many countries that ultimately has negative growth consequences:

Times of turmoil lead to simple narratives, and unfortunately, many of those simple narratives involve protectionism and anti-immigrant sentiments, just to name a few.

Ironically, globalisation, immigration, and trade are all forces that drive economic growth, and to the extent these are rolled back, growth will suffer further, potentially creating new challenges and reducing dynamism in the economy.

8. Bank consolidation will only gather pace:

Flight to quality in deposits will likely be a real thing, and this, along will all prior forces around economies of scale, will continue to drive bank consolidation.

9. Modern finance is faster:

The run on SVB happened at the speed Silicon Valley is used to, and it is fair to assume that this is the new gear modern finance will now operate at this moment henceforth.

Regulators will have to keep up with these challenges, and it is likely that the bank regulators globally will find ways to adapt, including the introduction of digital currencies.

10. Fintech is here to stay:

Finally, all this change means that the impetus for innovation in financial services will only increase.

To adapt to this new world, we will need visionary and skilled entrepreneurs along with expert venture capitalists willing to back them in order to help solve the new challenges presented by the brave new world of tomorrow.

SVB, the Power of Math, and World Pi Day

As the fintech and start-up community leaves a tumultuous weekend behind, we can now collectively take a deep breath and reflect on what transpired.

There will undoubtedly be a lot written about why SVB failed, what could have been done differently, and who should shoulder the blame.

The human psyche favours simple answers, and this tends to lead to a tendency where we want to find one primary cause for a big event. Reality, of course, is much more nuanced. When something big like a bank failure happens, there are a confluence of factors that come together, but our brains still crave that simple narrative.

If we look at SVB, the list of causes is long indeed: the fractional banking system has an inherent tendency towards bank runs, a very small percentage of the deposit base was protected by FDIC insurance which is designed to prevent such runs, the interest rate exposure on either side of the balance sheet was misaligned, they were very concentrated in one niche customer segment, the venture community can exhibit herd like behaviour, all moving at the speed of Twitter, they had a high Beta footloose deposit base, and so the list goes on.

But looking at that list there is one particular cause that is worth highlighting, especially in light of the fact that March 14th was World Pi Day (3.14), as this particular cause demonstrates the awesome power of simple math. That is the concept of bond duration, and what that did to their bond portfolio.

While there was a lot of publicity around the $1.8bn loss SVB realized when selling $21bn of bonds, there was another and bigger ticking time bomb on their balance sheet, which was the Held to Maturity (HTM) bond portfolio. As of September 2022, SVB had a bond portfolio in excess of $90bn, and the mark to market losses on that portfolio were a staggering $15.9bn, greater than their $11.5bn in tangible equity at that point in time, as was reported in their financial statements.

In other words, if SVB had been forced to sell its entire bond portfolio, the losses on that would have wiped out its entire equity book value plus some! But how is this possible – after all, bonds are supposed to be safe right? How can a bond portfolio crystalize such big losses?

It is very important to note here that there is nothing wrong with holding a bond portfolio to maturity, and in fact if one does so, there is no credit risk. And no loss would have crystalized. The bond does what it says on the label and you get the returns promised, it would just take many many years. The problem occurred because they had to sell today because of the run, and that laid bare the interest rate risk as explained below.

Let’s look at this interest rate risk, which brings us back to the power of math and the concept of bond duration which is fundamentally all about discounted cash flows and net present value. Here is a simple illustration.

If you buy a one-year maturity bond, with a 1% nominal coupon, when interest rates are also at 1%, that bond is worth par at your time of purchase. So you would pay $1,000, expect to get a $10 coupon plus the principal in one year’s time, discount that cash flow into the present with the 1% discount rate, and arrive at a $1,000 value. In other words, par.

Now, imagine that interest rates increase to 2% the instant you bought the above bond. Instead of discounting your expected $1,010 return on the bond by 1% to get $1,000, you would have to discount it by 2%, getting $990.19. Your bond is trading at a discount, and you just lost some money on your safe bond. Of course, if you hold your bond to maturity, you will still collect the $1,010 in one year’s time, but that money is only worth $990 today because we discount it at a higher rate. That is how bond math works.

But this was a one-year maturity bond, which incidentally has a duration of 1 (or close to it, depending on when the coupon gets paid) so the math was pretty simple.

If this had been a thirty-year maturity bond, we would first need to formulaically calculate the exact duration of the bond which is a measure how sensitive a bond’s price is to changes in interest rates. If we think of the cash flows flowing from the bond (the annual coupons and principal payment at the end) as bags of money positioned on a lever, the duration is the fulcrum point that balances this lever.

With a one-year bond that only pays one coupon at the end along with the principal, this fulcrum point is exactly 1. With a thirty-year bond that has a 1% coupon, it turns out that the fulcrum point is closer to 25 years.  

As a general rule, for every 1% increase or decrease in interest rates, a bond’s price will change approximately 1% in the opposite direction for every year of duration. So if we bought a thirty year bond, and rates went from 1% to 2% the day after we bought it, we would expect our bond to lose about 25% of its value, going from $1,000 to $750. So much for bonds being safe!

Now, clearly the folks that did this at SVB were aware of bond duration, and they had some sort of rate hedges and other instruments in place. However, the fact remains that they took on interest rate risk, and the duration math (as well as the rate environment) moved against them, and fast.

The fact that the Dodd-Frank rollback in the US (which happened in 2018) also reduced the buffer of shareholder funds needed to absorb such losses at banks did not help, and SVB was just under the $250bn threshold that would have come with more regulatory oversight and interest rate sensitivity stress testing.

While there are many learnings and insights from what happened, one is clearly to always work from first principles and be aware that the conventional wisdom around you may not necessarily be correct. As we just saw, bonds are safe only when held to maturity, and if you have to sell a long maturity bond early, math and markets can catch up with you.

When in doubt, always do the math. Much like Pi is a constant in math, make math a constant in your life.

A Guide to Local European Fintech Ecosystems: Top Five Impressions from Istanbul

As we continue to tour local European fintech ecosystems, we will share our top five impressions and highlights from each trip in order to give our followers a better sense of the rich and diverse fintech communities that are rapidly emerging across Europe.

The first in this “top five impressions” series will be Istanbul, which my partner at QED Investors Matt Burton and I visited in early January 2023.

Impression #1: While there is a lot of noise around inflation and politics, the Turkish economy remains very large and dynamic, albeit not without huge risks and imbalances.

The Turkish economy is currently getting most of its press in the Western media around the fact that inflation is running high at around 80% per annum. While this is true, and inflation has caused a lot of disruption for consumers and companies alike, a very striking fact upon visiting Turkey is how large and dynamic the economy is.

The population of 85 million in 2022 is now higher than any other country in Europe, and despite the inflation, the Istanbul stock market was up close to 100% in USD terms in 2022, with house prices having seen a similar rise with the influx of a lot of hot money from the region.

Having said that, the economy and the currency remain volatile, and Turkey is undoubtedly high on the macro risk index, especially if put into a European context.

Above: Trump Towers in Istanbul adds a certain color, diversity, and pizzazz to an already bustling business culture

Impression #2: There is a rapidly developing fintech ecosystem, with niche industries such as agricultural fintech developing rapidly.

Turkey has had its share of fintech exits (e.g. Naspers-owned PayU acquiring iyizico in 2019) and the current banking system is competitive, with high card as well as digital penetration putting Turkey on par with many Western economies. As an example, card penetration in 2019 was relatively high at 2.4 cards per capita according to a JPMorgan research report.

And while there is a lot of general fintech activity in Turkey, certain interesting sub-sectors such as agricultural fintech and logistics with an element of embedded fintech stand out the most. As an example, Tarfin, a fintech that has been operating in the market for close to five years, has pioneered innovative ways to fund farmers, both when they purchase seeds, fertilizers, and other factor inputs into agriculture.

Above: Turkey is a top three global producer in more than 20 fruit categories, and this richness can have big consumer benefits.

Impression #3: Istanbul’s historical role as a bridge between continents and cultures continues to be an asset.

Dating back to the East Roman Empire, which was later referred to as Byzantium and onwards to the Ottoman Empire, Istanbul has set at a crossroads of cultures and commerce. This is widely evident today in Istanbul, with a big influx of people from all surrounding regions be it Eastern Europe, Central Asia, Middle East, or Africa.

From a fintech perspective, this gives Turkey a very unique role to play especially in cross border trade, supply chain finance, and international remittance. As a result, there are many interesting fintech players emerging in these areas, such as Figo Para that is active in invoice discounting and supply chain finance.

Impression #4: Turkey is one of the top five crypto markets in the world.

Given the inflation and amount of cross border commerce, it is perhaps not surprising that Turkey is one of the largest crypto markets in the world in terms of user penetration. In fact, according to the website Analytics Insight, Turkey has the fourth largest crypto user penetration globally, at 18.6% (or around eight million users). Other countries with high user penetration include Argentina and Nigeria, which tend to be countries defined by frictions around dollar scarcity.

Above: This is not a food blog, but if we continue visiting Istanbul we may well turn it into one.

Impression #5: Elections are coming, and will be main story in the first half of the year.

Making political predictions in Turkey is not easy, and when asking locals to tell us what will happen in the upcoming elections, the divergence and implied uncertainty that is revealed by the answers is notable. What is clear is that these elections will clearly dominate headlines, while also adding an incremental amount of uncertainty into the existing mix.

No matter the outcome, we think that the fintech ecosystem in Turkey will continue to develop, with notable activity in payments, crypto, cross border commerce, and e-commerce enablement to name just a few.

In our next instalment in the local ecosystem top five series, we will turn slightly North West, and staying in the Balkans will look at the rapidly developing fintech ecosystem in Sofia, Bulgaria where QED led the Series A of Payhawk.

Five valuation formulas in finance that everybody needs to know

What are the five most important formulas in finance for company valuation? And how can you apply them to your everyday life, whether you are in the venture community or not?

1. The Time Value of Money:

Or, “a dollar today is worth more than a dollar tomorrow”.

The formula:

Present Value = Future Value / (1+r)^n, where “r” is your discount rate, and “n” is the number of periods.

Today’s inflation makes this clear:

Price of milk is increasing by 10% every year, so a gallon of milk that costs $1.00 today will cost $1.10 next year.

And $1.21 the following year. That $10 bill in your pocket buys you 10 gallons today, but only 8.2 gallons in two years!

The “r” in the formula is the discount rate at which we discount future profit.

$1 in the next period is only worth 1/(1+r) today.

And $1 in three periods is only worth 1/(1+r)^3. The further out the future cash flow, the exponentially smaller its value today.

It is also important to note that “r” takes not only inflation, but also risk into account. If your neighbor tells you they will give your $10 in two years, not only does that buy you less milk, but they may move house and never pay you.

Given the risk, you may want $5 today vs. $10 in two years!

So how can you apply time value of money to your life?

Be aware that with 10% inflation and 0% interest on your $9,000 savings account, you are $900 poorer at the end of the year. Congratulations, you just paid the inflation tax!!

Invest your money (wisely) and don’t let it melt away!

2. The value of a constant growth annuity:

Or, “even an infinite cash flow has finite value”.

The formula: Present Value = Perpetual Cash Payment / (r – g)

In this formula, “g” is the constant growth rate, and “r” the discount rate from Formula #1.

The simpler version of this formula is the No Growth Perpetuity – a cash flow forever that does not grow.

That formula is: Present Value = Perpetual Cash Payment / r

If “r” is 10% and you win the lottery to receive $1,000 every year that is worth $10,000 in today’s dollars.

You can apply this formula to value mature companies quickly:

If a company will only grow 5% over the foreseeable future, and is earning $10 million in after-tax profits, and your “r” is 15%;

The company is worth $100 million today.

$10mn / (15% – 5%) => 10mn / 0.10 => 100mn

There are many implications of this formula.

i.) companies & cash flows have finite value, driven by math

ii.) growth increases the value of future cash flows

iii.) risk & inflation decrease value

iv.) predictability decreases risk

You can see why “predictable growth” is something of a home run in valuation terms!

3. The Black-Scholes formula:

Or, “options have value”.

The Black-Scholes is a bit too complex mathematically to get into here.

But the implications of Black-Scholes are simple and valuable!

The implications:

i.) Options have value; never give one for free unless you are getting something in return

ii.) Value of options increase w/ volatility & duration

In risky times, (or if you are wise enough, before the risky times come knocking at your door), secure options.

Flexibility has value as it lets you pursue more options.

Value flexibility.

4. Enterprise Value vs. Equity Value

Or, “debt is never free”.

The formula:

Equity Value = Enterprise Value – Net Debt.

The best way to think of this is in terms of your house.

Your house may be worth $300,000. But you have a $250,000 mortgage – debt to the bank.

Your equity in your house is only $50,000.

The same concept applies to a company valuation. So in a situation where a company has taken on debt, we need to think of two concepts.

Enterprise Value: The analog to the value of the house from above.

Equity Value: The analog to “equity in your house”, or what is left when the debt is paid off.

If your valuation is based on net income, this is not an issue.

100% of net income is for equity holders, & is net of debt service.

But if your valuation is based on revenue or EBITDA you need to look at how much debt there is.

And subtract it from the Enterprise Value.


i.) Debt gets paid of first. When enterprise value goes down, equity value gets wiped out first. Be aware.

ii.) Do not confuse enterprise cash flows (revenue, EBITDA), with equity holder cash flows (Net Income)

iii.) There are things that don’t look like debt, but are

iv.) When you are referring to a company’s value, especially in private markets, know if you are talking about enterprise value or equity value.

v.) Public markets do not have this confusion: All stocks are traded based on equity value.

vi.) Take on debt judiciously

5. The Capital Asset Pricing Model (CAPM)

Or, “return expectations are driven by inflation as well as a risk premium”

The formula:

Expected Return = Risk Free Rate + Risk Premium

The Risk Free Rate is measured by a safe asset such as a short dated U.S. T-bill.

This is what investors can earn without taking risk.

In the long run, this is very correlated with inflation.

In the short term there can be lots of deviations we need not get into here.

The Risk Premium is derived from:

– The overall risk appetite in markets (equity risk premium). This can go up and down based on the macro situation.

– The systemic risk of the security (also known as Beta, it is a measure of how much risk a security contributes to a portfolio).


i.) Higher inflation => higher risk free rate, higher “r”

ii.) Macro uncertainty => higher equity risk premium, higher “r”

iii.) A risky venture => higher Beta, higher risk premium, higher “r”

More macro risk & more inflation, is not great for venture valuations!

In summary:

Pass on inflation into your net profits if you can. Predictability of growth will reduce your investors’ “r” &  increase valuation. Take on debt judiciously. We are in a new reality with valuations, get used to it, and accept it. Things will change, but only as the macro situation and the inflation outlook improves.

Back to School Part II: The Value of Options

As if we need a reminder that we live in volatile times, the global currency markets gave us a bone-rattling jolt over the last week as the British pound hit a historic (or arguably hysteric) all-time low against the U.S. dollar, prompting abundant commentary and an avalanche of new memes in social media. While a lot of what happened was idiosyncratic issues related to Britain, the U.K. is certainly no island when it comes to being exposed to the vagaries of global markets.

In fact, in our last blog we had covered the precipitous drop in tech valuations and how we could make use of simple discounted cash flow formulas to estimate what a company may be worth fundamentally. After all, in a world where markets seem to be prone to changing their minds by an order of magnitude over short periods, we all need something solid to hold on to. Mathematic formulas certainly seem to be as good as any place to get some comfort.

While discounted cash flows are a big part of modern finance, as promised, there is one other big area that we had not yet covered – the realm of options and how to price them.

Stated simply, an option contract gives the holder the right to buy, sell or use an asset at a pre-determined price at some point in the future. While many people think that option contracts came into existence along with the Chicago Board Options Exchange (CBOE) on January 1st, 1973, they have existed for much longer.

In fact, the first record of financial options in history date back to the fourth century B.C. when the ancient Greek philosopher Thales of Miletus decided to take a break from the rigors of philosophy in order to profit from his prediction that the forthcoming season would bring with it a record olive harvest. Not having the funds to buy olive oil presses at scale, Thales instead gave a smaller sum of money to each press operator in Miletus, securing the right to use them during harvest season. And when his prediction came true, Thales sold the right to use these presses (for a considerable profit) to all the olive producers who were eager to convert their record harvest into oil.

Of course, the modern option contracts that were written at the CBOE in 1973 have come a long way over the ensuing millennia. More importantly, the way options are valued has evolved just as dramatically.

Specifically (and not entirely coincidentally), 1973 was also the year in which Robert C. Merton published his seminal paper “The Pricing of Options and Corporate Liabilities” in the Journal of Political Economy. This paper was revolutionary as it was the first to expand the mathematical understanding of a formula which had been under development by Fischer Black and Myron Scholes since 1968. Calling it the “Black-Scholes option pricing model” the formula revolutionized modern finance and provided scientific legitimacy to the CBOE and other options markets around the world, and ultimately resulting in Robert Merton and Myron Scholes receiving the Nobel Prize in Economics in 1997.

The formula itself is based on a parabolic partial differential equation, and can look quite intimidating to those not well versed in post graduate levels of math and physics.

However, there are several practical implications of options pricing that are relevant for the start-up and early stage investing world.

First and foremost, as Black-Scholes tells us, options have value. Hence, if you are giving somebody an option, you are giving something of value and vice versa. As an early-stage founder, if you can incorporate free options into your business, you should always look to do so. These can take the form of distribution agreements, supply contracts, or even a built-in feature to take your product in a certain new direction in the future. So keep your options open whenever it is practical to do so. Conversely, when you are asked to give somebody an option, for example a bank asking to do a proof of concept with an option to extend the contract, know that you are giving away something of value.

This actually brings us to the world of real options, which is the right to make (or else abandon) some choice or course of action that is available to the founders and managers of a startup. There is a whole host of literature that is focused on using real options to value startups since using a discounted cash flow can be so tricky given how uncertain the future can be. In this view of the world, the value of a startup goes up in proportion to the number of options it has to go after big market opportunities as new information flows in.

Speaking of uncertainty, one of the key takeaways from Black-Scholes is that the higher future expected volatility is, the more valuable an option becomes. So in volatile environments, and the startup world would certainly qualify as such, options become even more valuable. Similarly, the longer a period the option is valid for, the more valuable it becomes.

There are also implications here for your organizational design and the kind of people you recruit to your company in the early days. The more flexible your organization is, the more it would be capable of rapidly persecuting different courses of action, thus taking advantage of various embedded real options.

Hence, for an early-stage company, having a culture and organizational structure that enables rapidly tacking or jibing as the business environment changes is not just valuable – it can mean the difference between winning or losing in a volatile world.

Back to School on Valuation

As the warm and fuzzy memories of summertime fade into the distant past, it is once again time to start setting the alarm clocks, buying new textbooks, and catching up with our friends we have not seen over the break. In other words, it is back to school time.

While I used to think that the year starts on January the first, I have now come to the realization that much like the English Premier League, the year really starts in late August and goes with a frantic and exciting pace all the way to the next summer. So welcome to the 2022 – 2023 season! I hope that it will be one filled with excitement, lots of goals, and most importantly, fair play.

As we think back to the second half of the 2021 – 2022 fintech season that we left behind, the defining feature was of course a momentous shift in company valuations. On the public side, there was no hiding from this painful reality, whereas on the private side it seems like many people are still coming to terms with it. Our more practical minded Swedish friends such as Klarna seem to have accepted the fact, dealt with it, and moved on, while others that are living in a sort of denial can still be found.

Lots of good pieces have subsequently been written on valuation over the summer, some dealing with the relationship between EBITDA and revenue, and translating revenue multiples into the context of future growth expectations, etc.

Those have all been good to read, but in the spirit of back to school time, it would be good to look at company valuations from a very rudimentary perspective. Specifically, let’s look at four simple principles that can be used to create a valuation framework for companies – profits, time value of money, growth, and risk.

Let’s start with profits. To put it very simply, companies are ultimately only valuable if they can generate net income that can then be distributed back to investors as a dividend. If I told you that I had a company that will never generate a single dollar of profit in its lifetime, or there was one where all pre-tax profits would be swept up by an evil troll (no, I am not talking about the IRS here) at the end of the day such that they can never dividend out any profits, the answer to what those companies are worth would be very simple. Zero.

Now that we know we need profits (one would hope we really didn’t need a reminder), let’s look at a way to value those future profits. This takes us to our second principle, the time value of money. Stated simply, this principle tells us that a dollar today is worth more than a dollar tomorrow. The current inflationary environment illustrates this fact very clearly. If a tomato costs $1.00 today, but will cost $1.25 next year, my $10.00 buys me ten tomatoes today, but only eight tomatoes next year.

Hence, $10.00 to be received next year is only worth $8.00 today if measured in tomatoes. The rate at which we discount the future cash flows (25% in our tomato example) is denoted as “r” in finance, and is called the discount rate, interest rate, or cost of capital depending on the context. Hence, $1 in the next period is only worth 1/(1+r) today which is one of the three key formulas you’ll ever need in finance.

The second formula you’ll need (and with these two you can derive other more complex looking formulas) is a mechanism for valuing an annuity. An annuity is a constant but perpetual cash flow, and is the other basic building block for valuing cash flows over time.

For example, let’s assume we have a company that will generate exactly $100 million of dividendable net income per year, from now until the end of time. What is this company worth? I will give you a hint – it is not infinite!

To answer the question, let’s assume that the cost of capital, or “r” from above, is 10% – in other words, investors can put their money in an equally risky venture and earn a 10% return. So what is the answer?  

While many people get this question wrong, the simple answer is that it is a unicorn – worth $1 billion! The formula for valuing an annuity is simply to multiply the annuity (in this case the $100 million) with 1/r. Put simply, 1/10% = 1/0.10 = 10, so multiplying $100 million by 10, we get to a billion.

A convenient way to keep this formula in mind (and also to prove it to be correct mathematically) is to ask the reverse question. If I could earn a 10% annual return on my capital in perpetuity, how much would I need to set aside today to generate $100 million year after year? The answer is $1 billion – just put it to work and clip that 10% coupon – not a bad way to earn $100 million per year!

While these two formulas are all you need to derive other time value related formulas in finance, they leave out one important fact we in the venture capital world care dearly about – growth. A cash flow that grows is obviously worth more than a cash flow that does not, and our annuity example above related to a zero growth, constant cash flow.

So how does the growth rate, usually denoted as “g”, impact the value of an annuity? The answer is that the value of an annuity becomes 1/(r-g), so if we assume a 5% perpetual growth rate, the unicorn in our prior example suddenly doubles its value to become worth $2 billion ($100mn/(10%-5%) = 100mn/5% = 100mn/.05 = $2bn).

[A note to those who want to geek out a little bit: As promised, this seemingly new formula is derived from the prior two formulas under time value of money. Follow the proof & derivation from this link: https://en.wikipedia.org/wiki/Dividend_discount_model

However, there is one more important insight around growth that we need to keep in mind while valuing companies. In the long run, nothing can grow faster than GDP. Think of this as the speed limit of the universe – nothing can travel faster than the speed of light. Taking Apple as an example, after they have produced billions and billions of phones and computers, at some point they will have saturated their addressable market, and their growth will be bound by how fast GDP can grow. If this were not the case, at some point Apple would literally take over the world.

So if you want to value Apple, one way to do it would be to model out the growth in profits year by year until they reach that “end state”, then come up with a terminal value based on the constant growth annuity formula from above, and then time value all those cash flows into the present. Sounds simple, right? No wonder stock prices can be volatile!

But the point is that the problem is not one of lacking the necessary math – it is actually one around the difficulty of forecasting how fast exactly Apple will grow, what their competitors and regulators will do, etc.

Which finally brings us to our fourth and last principle, risk. In simple terms, the more difficult it is to forecast and rely on those future cash flows, the higher the risk, which in turn means the higher the “r” you need to use to discount your cash flows. And vice versa.

To summarize, our unicorn from above, that has $100 million in net profits, and will grow at 5% until eternity, is worth $2 billion if our cost of capital is 10%. If they manage to grow faster, they will be worth more, but they cannot grow faster than GDP in perpetuity. If our cost of capital (i.e. risk) goes up beyond 10%, they will be worth less.

So sharpen your pencils, take out your calculators, and get to work – there are many companies to value out there, and don’t worry about running out of interesting subjects – we’re creating new ones every day!

Plug and Play Finance

This article was originally published in Business Age on 6th July 2022

Plug and Play (PnP) Finance is a new term, but it has been a long time in the making. It has its roots in the world of embedded finance, which refers to financial products becoming so ingrained in our everyday applications and experiences that they become virtually invisible.

However, there are important differences between embedded finance and PnP Finance.

Firstly, embedded finance is a result and can be achieved in a number of different ways. Some of those ways can be quite hard and costly to implement. For example, a marketplace may be able to facilitate payments on its platform, which are then embedded, but the marketplace in question may have to deal with a lot of thorny issues around customer onboarding, KYC, payment flows, settlements, etc. This requires a lot of work for the marketplace, both in terms of developing software, as well as dealing with the implementation and management of regulated products.

Conversely, Plug and Play Finance refers to the means by which one achieves that same embedded result. And in the case of PnP Finance, the solution is already modularized and implementing it takes weeks, not months. So one way of thinking about plug and play finance is that it is a subset of embedded finance, but a particular subset that is much more easy for businesses to use and integrate.

PnP solutions are easier to implement because they contain all the elements needed to on-board customers, provision financial instruments, and conduct financial activity without innovators (the businesses using PnP solutions, such as the marketplace in the above example) having to get into the details themselves.

Specifically, onboarding is easier because the plug and play finance provider takes on the risks and responsibilities associated with onboarding customers such as KYC and other AML requirements. This in turn is possible because the PnP provider tokenizes sensitive customer data, and the innovator hence never has to handle this data in its raw form, which saves them the burden of being subject to more regulation.

Similarly, the provisioning of financial instruments such as cards, accounts, insurance policies etc. is all done by the PnP provider, and the innovator using the plug and play services does not need to get into the details of doing any of that. On the other hand, a customer that wants to simply embed a financial service may have to get into a lot of nitty gritty detail around the specifics of each product. PnP Finance means that the business just gets ready to consume modules where all key decisions and parameters have already been taken care of.

A good example of such a plug and play finance solution in the market today is Stripe Connect, Bolt, or Weavr where the innovator is taking the financial solution as is. Big tech is also moving into this space one giant step at a time. For example, Apple, who had entered the payments space with Apple Pay has now taken one step further by announcing it will let its users in the United States benefit from a buy now pay later service to split their purchases into instalments.

So what of the future? What will come next?

The next step in this evolution will be the emergence of PnP platform providers. Most PnP solution providers today only offer one solution. For example, Klarna delivers one solution around Buy Now Pay Later (BNPL) that can be integrated into an online checkout experience, Stripe Connect delivers a PnP solution for marketplace payments, etc. PnP Finance platform providers will enable the creation of multiple PnP solutions in one place from one vendor.

Another likely outcome in the not-too-distant future is that financial institutions will realise that providing an embedded finance solution such as Banking-As-A-Service (BaaS) is difficult because it requires a very high level of supervision of the innovator and their end customers. They may then start migrating to a more PnP approach, where parameters and use cases are pre-determined, any sensitive data is tokenized and hence not accessible to the innovator.

Finally, Because PnP Finance is easier to implement, it will become a driving force for more and more products and services having financial modules ingrained inside them.

While these new developments clearly come with significant customer and societal benefits by making commerce even more friction free and ubiquitous, there are nonetheless significant risks and warnings to which one needs to pay careful attention.

Warning one is that we are at an inflection point today, and the rules we set in place will reverberate well into the future, magnifying in significance and scale over time. Regulatory bodies such as the FCA cannot ignore the implications of these developments and need to think carefully about how concepts like customer outcomes, affordability, and competition translate into this new world. For example, is Apple offering BNPL good or bad for competition? How much bargaining power will merchants have? How does one define regulatory jurisdictions? The key here is to find the right balance of letting the market develop while intervening in the key areas.

Warning two is to do your homework carefully when using a plug and play finance service provider. If you are a business owner or manager looking to reap the benefits of plug and play finance, be mindful that all is not always as advertised. Do your diligence carefully before choosing your PnP provider. Reach out to those who know the space well to ask their views on which providers to use. Hold your service provider accountable. Many companies have a nasty habit of over-promising and under-delivering.

Warning three, and perhaps the most important one, is to not get left behind. Innovators that successfully embrace the full potential of PnP Finance will be able to offer embedded finance solutions faster, with better user experiences, and by taking on less regulatory risk. It stands to reason to think that these businesses will leapfrog those that are slower or do not offer embedded finance solutions in the first place.

Whether it be making payments or providing any other financial service, we need to keep up with the latest developments as business owners, managers, regulators, or law makers. The world is moving forward at ever increasing speed, and the future of finance belongs to those that adapt the fastest.


From multibillion-dollar valuations to regulatory scrutiny, and Apple now boldly entering the space, it seems we don’t go a day without reading some story about Buy-Now-Pay-Later, or BNPL as it is commonly known.

Amidst all this noise, activity, and chaos, it seems prudent to take a big step back and ask a simple question. What is BNPL? What exactly makes a loan BNPL – and consequently, when is BNPL not really BNPL but just plain lending?

After all, I could call any loan, such as my house loan, BNPL as well. I buy my house now, and pay it off later, over thirty years to be precise. But as we all know, that is not called BNPL, it is called a mortgage.

While there is no official definition out there yet (yes, the regulators in various jurisdictions are working on it) there are a few specific things that make BNPL what it is, and work as it should.

When all these specific attributes are in place, BNPL can create very favorable consumer outcomes. However, as one deviates from these pillars, a sort of cascading failure takes place where the various components that all rest on each other stop working, and what could have been a BNPL starts morphing into something else such as “mere” point of sale finance, a.k.a. POS finance.

So let’s take a look at the eight key attributes that make BNPL work as it is meant to, and why they all simultaneously need to be in place.

1. BNPL is free

POS finance, as alluded to above, has existed for a long time, and you can always go into a retailer and apply for a loan once you have bought your couch or your bicycle (the latter being a better idea if you want to work on your figure).

This usually involves a loan application which can feel like a proctology exam in the worst case and involve filling out some quick forms in the best case. The loan is then approved or declined, and the borrower goes on to pay interest over a pre-determined period of time.  

BNPL on the other hand is free, meaning that if the bike cost me nine hundred dollars, I can pay for it in three installments of three hundred dollars each over three months. Given the concept of time value of money (money today is more valuable than money tomorrow, all else being equal), this is an NPV positive proposition for the consumer and as such has great appeal.

2. In BNPL, the merchant pays a discount rate

As economists often like to point out, there is no such thing as a free lunch, and since the consumer is not paying for the loan, somebody else has to. In BNPL, this is the merchant, and they pay for it with what is called the merchant discount rate.

In simple terms, this means that if the dress we bought cost one hundred dollars, the merchant only gets something like ninety-seven dollars for selling it. The BNPL provider gets the remaining discount rate. In this example we used three percent, but in reality, this can range from something as high as eight percent to a low of less than two percent.

But why is the merchant willing to pay this discount rate? This brings us to the third attribute of BNPL.

Big tech is now entering BNPL as well

3. BNPL results in higher sales conversion for the merchant

Yes, the merchant is only willing to pay the discount rate because they can sell more goods and services if they use BNPL.

Especially for bigger purchases, being able to spread the payments over several months lightens the burden on the consumer’s cash flows, and a result they end up buying more. The merchant, who is after all in the business of selling goods, likes this, and is hence willing to pay for it. They would rather sell eight dresses and collect ninety-seven dollars per dress than selling five dresses and collecting a hundred dollars per dress.

Even so, how much of a discount the merchant is willing to pay depends on several other factors as well. Which now brings us to the fourth attribute.

4. BNPL works best when the purchase is discretionary

If my boiler breaks down, the merchant that comes to my home knows I will need to get it fixed very soon unless I am particularly keen on cold showers in the frosty London mornings. Hence, these merchants knows that their “sale” is easy to make and will likely be less interested in offering BNPL. They know that the consumer will pay for the new boiler whether BNPL is offered or not. Nobody likes cold showers, except perhaps Wim Hoff and his followers.

If, on the other hand, I am contemplating buying new windows, that is a discretionary purchase. It is nice to have more modern windows installed, but I can always do it next year. In fact, in London many people seem to wait about a century before contemplating putting in new windows.

The merchants who are in the business of selling new windows are aware of this, and if they can make the purchase easier by offering BNPL, they know they can get a much higher conversion. Hence, it is no surprise that these merchants like BNPL. In fact GreenSky, a QED investment that was recently acquired by Goldman Sachs for something close to $2.2bn built their multibillion dollar business on this very insight.

Of course much more is needed to build the ideal BNPL business. Which brings us to:

5. BNPL works best with good credit quality customers

The discount the merchant is willing to pay is not infinite, so whether it is three percent or eight percent, the BNPL provider needs to fit their entire unit economic equation inside that discount.

And the BNPL provider has many costs such as operational and salary costs, but also very importantly, credit losses. If a consumer does not pay back, the BNPL needs to foot the bill, and still make money from the merchant discount they get.

So let’s assume that in a simple example, the merchant discount is three percent, the BNPL now has to pay for its own cost of finance (which cannot really be much less than two percent), its operational costs (which even at scale will be tens of basis points), and the credit losses.

If the credit losses go to two percent in the example above, the BNPL provider suddenly starts losing money. What’s worse, if losses go up, the banks and capital markets that fund the BNPL provider start charging a higher borrowing rate.

A cascading failure or death spiral can very quickly set in, so watching the loss rate is existentially important for the BNPL provider, and the key to that is good underwriting and having an underlying population of positively selected high credit quality consumers.

If not, the BNPL may have to start charging interest and fees to covers its losses, and the whole thing then starts to morph into POS Finance as we saw earlier.

Having a high credit quality population is also important for insuring the sixth element of BNPL, conversion.

6. BNPL has high conversion

If the merchant offers BNPL to one hundred customers, it is important that at least seventy-five, but ideally something close to eighty percent plus of these consumers are approved for the BNPL product.

This is because customers that apply and get declined tend to not take it so well, and the merchant does not want to lose their sale or otherwise annoy their customer because they were declined, which can be embarrassing.

This particular point illustrates how all these attributes rest on each other. In order to have high approval rates, yet low losses, point number five from above, good credit         quality once again reveals itself as a crucial component of an ideal BNPL equation.

Again, this does not mean that lending would not work in a general or high risk population – but to have the purest form of BNPL you need to control your losses with a combination of superior underwriting and a positively selected population. Otherwise your BNPL proposition can quickly start to morph into something else.

7. BNPL is frictionless

The seventh component is that in order to avoid the merchant worrying about customer friction, the BNPL process itself has to be tech driven, seamless, and embedded for the end user.

Again, this also drives high conversion as well positive selection, illustrating once again how all these pillars rest on each other.

The best BNPL providers employ technology to its very fullest to achieve this goal.

8. BNPL has good customer outcomes

Finally, and perhaps most importantly, BNPL need to have good customer outcomes. This means that the BNPL provider has to focus very closely on affordability – can the consumer afford to pay back the installments over the agreed time period?

If the customer ends up buying too much, and becomes unable to pay back the installments, credit losses go up, the BNPL unit economics stop working, and everybody loses.

However, when assembled correctly, these eight pillars can support a win-win-win outcome where the merchant, the customer, and the BNPL provider all have great outcomes and are better off for using the model.

Five Fintech Predictions for 2022

2021 was such a roller coaster that making predictions for 2022 feels somewhat daunting. But as venture capitalists our jobs is to make bets on the future, so here it goes. Key predictions for 2022:

#1 Unit economics come back into fashion: 2021 saw frenzied deal volume and unprecedented valuations. A lot of this was driven by changes that took place so rapidly (sky rocketing e-commerce adoption, remote working, etc.) that many funds went into full FOMO. Our prediction is that 2022 will see investors sharpening their pencils on valuations, and hence we are unlikely to see the meteoric growth in valuations we saw in 2021.

The best case outcome for valuations is that any adjustment happens gradually, and in the context of sustainable economic models. No matter what happens, it is as important as ever for founders to keep in mind that the best immunity to market volatility is gained by the vaccine of solid unit economics.

#2 Embedded fintech in reverse: In 2021 we saw lots of non-fintech players using embedded finance to monetize their customer bases. A classic example of this would be a non-fintech company, such as a marketplace, using embedded finance to create lending or buy-now-pay-later solutions. Another example is a company like Shopify making a lot of its revenue from payments, etc.

A new trend we are expecting to see more of in 2022 is the reverse of this – companies going fintech first, and then building non-fintech businesses on top of this. One such example would be a company using fintech tools to initially attract customers, and then building marketplaces (or other non-fintech business models) on top of those customers. 

It is also worth noting that these trends in many cases can intertwine in many cycles. So in the first cycle, a company can start with some legal tech to attract a customer base. Then, in the second cycle, the company can enrich their customer proposition and monetization by adding embedded finance such as payments, currency exchange, or mortgages. This then deepens customer engagement and attracts new customers that value these tools. And finally, in the third cycle, having achieved stronger customer acquisition momentum and higher monetization, the company can develop a marketplace proposition, where the customers start trading with each other, creating a strong competitive moat in the process.

#3 War for talent heats up: Many of the top startups and growth companies are now flush with cash after having gone through a landmark year, and they need to deliver results. Expect the war for talent to turn into a battle royale!

Being able to attract top talent was the key differentiating advantage in 2021, and this trend will only get amplified in 2022. There are of course a lot of implications for this. For example, many companies will increasingly start looking across international borders, and companies that provide the infrastructure for such remote hiring and remote working will continue to benefit. Another beneficiary will be companies whose culture is better adapted to the ways of working that are quickly emerging. So expect to see a lot of continued innovation in work cultures and the “future of work”.

#4 More regulation and polarization in crypto: The crypto world will start to increasingly bifurcate, with some countries and regulators becoming increasingly more crypto friendly, and some increasing their level of regulation. Expect lots of continued debate within developed economies on how crypto should be treated and what exactly is and is not permissible.

#5 Big brother steps in: While developed countries will look to regulate crypto more on the one hand, we will also see Western central banks more openly committing to creating their own digital currencies. UK, Sweden, the ECB and many others are working on this frantically as Covid accelerated the disappearance of cash, and central banks need a currency they can control directly. 

As those of you familiar with the banking system know, central banks basically control the money supply indirectly via the banks that they regulate with all the monetary policy tools they have, while controlling it directly via the actual money they print. Even before Covid struck, cash was increasingly disappearing from developed economies (especially in places like Sweden), and hence that one part of the money supply that central banks used to control directly was becoming less and less relevant as a policy transmission tool.

As a result, central bankers will want to have a digital currency they have total control over, and we can expect lots of new announcements around this in 2022. This will make lots of new monetary policy innovations possible – for example when stimulus is needed it will be much easier for central banks to create more money supply by simply transferring new digital currency into the accounts of all eligible citizens.

Interestingly, this will also make things like highly negative interest rates and very strong consumption incentives much more easier. One example that has been talked about is that central banks would be able to hand out a digital currency that “expires” if not spent within a certain timeframe, thus creating a very strong stimulus for demand.

Undoubtedly, 2022 will continue seeing us living in interesting times. No matter what the future has in store for us, I wish a healthy and peaceful new year to everybody.

2021: A Cyber Space Odyssey

It has been fifty-three years since Stanley Kubrick’s landmark film “2001: A Space Odyssey” was first released, and exactly two decades since that particular year went from being fiction to history. While talking AIs in the form of Alexa, Siri and others have now become part of human history as well, we can all feel ever so slightly relieved that the antics of HAL 9000 still belong in the realm of fiction. 

Having said that, traveling recently on a London tube carriage with my daughter, she pointed out to me that every single passenger bar none was sitting, head bent at a forty-five degree angle, face fixated on the cool glow from their smart phones, totally lost to the outside world as the aforementioned AIs were busy stimulating the dopamine receptors in their respective brains. So while HAL 9000 may not have become reality, perhaps William Gibson’s dystopian vision from the Neuromancer trilogy very much has.     

In any case, turning back to the history and fiction of fintech, 2021 was a landmark year in many regards, and those of us who lived through it are left feeling dizzy, excited, and exhilarated. While it is hard to summarize a year in a few words, here are some of the key trends of this year.

  1. Valuations went sky high. 2021 was a year of record valuations, and records were being broken at such a rapid pace, that it was difficult to keep track of what a “market valuation” for a start up should really be. Many of us in the fintech community found themselves going back and forth between the extremes of struggling with the valuations of new deals, to celebrating the successes and progress of our portfolio companies as a result. 
  1. Invisible fintech becomes real. Embedded finance is now mainstream, and we now see more and more non-fintech businesses using embedded finance and fintech as their monetization routes. Your core business may not be fintech, but fintech increasingly became the route by which companies were looking to monetize their user bases. And we started seeing more and more proof that even the big tech giants will increasingly turn to fintech for monetization.
  1. A tale of two cities. In the rapidly evolving world of e-commerce, it was the best of times and it was the worst of times. While demand for e-commerce went through the roof, the supply side got so disrupted, it was simultaneously the best time and the worst time to be an e-commerce player. Fintechs that were funding and enabling payments for e-commerce merchants went through a similar roller coaster, and the best of them were able to capitalise on the volatility and turn it into a huge opportunity. 
  1. Everybody is now invited to the fintech party, and hedge funds were no exception. This was the year of the likes of Tiger Global and Coatue coming out in force, and becoming king makers and game changers, acting fast, decisively, and with big bazookas. Very few funding rounds went by where the stance of the big hedge funds turned growth investors were not a big topic of discussion. 
  1. Crypto goes boom. While crypto has always been a big part of fintech, this was the year where investments into crypto changed by an order of magnitude. Oh, and a sovereign country adapted bitcoin as legal tender. There was in fact a quantitative shift in the amount of money that flowed into crypto related start ups, and 
  1. Web 3.0 and Metaverse were big trends in the tech world, and their reflection in the fintech universe were NFTs that went right to the heart of this question: What does it mean to own something that only exists in the digital world? In the art world, Beeple was at the forefront of tackling this question, and profited handsomely, becoming multimillionaire overnight. In a world where so much content only exists digitally, the fintech world started tackling the questions of ownership and value attribution in earnest. One can only hope that this will continue to benefit the digital artists and creators out there. 
  1. Hiring is the ultimate competitive advantage: Forget proprietary tech or other moats around your business. Those that managed to hire top talent in this market had an edge nobody else could match. This was perhaps not surprising, since after record funding rounds, all these start ups and growth companies had to deliver on their ambitious plans, and AI or not, it turns out we all still very much need fellow humans.

So looking back at all these trends, 2021 was in many ways a year of extremes and contradictions, and this was very much reflected in our world of fintech as well. 

Next up will be predictions for 2022, so stay tuned, stay healthy, and keep your seat belts fastened!