The key aspects investors look for in RegTech firms (Part 2)

In the first part of this article we looked at the investment landscape in the RegTech sector and why it makes sense to invest in RegTechs developing regulatory solutions. In the second part, we will now look at the most important aspects of a RegTech investment, what investors look for, how they valuate an investment opportunity and what founders and executives of RegTech firms need to know.

The key questions to answer

What are the important aspects then for investors in RegTech? What do they look for, how do they valuate an investment opportunity and what do founders and executives of RegTech firms need to know? Well, similar to other areas in start-up and tech investing you find common themes, but there are also a couple of aspects that are quite peculiar. 

The Team

The most important one, in my opinion, first: the team behind the company. It’s the same as in all start-ups: the idea or technology can be as good as it gets, but if you don’t have the right people in your team, it’s simply not worth much. Execution is key for a start-up, so the questions I ask are about the team members, how long do they know each other, obviously the longer the better, but more so what have they experienced together. E.g. have they already weathered some storms and came out alive on the other side? Examples of achievements are good indicators in respect of the likelihood that a team will be able to execute an idea/plan. And what is even better if they already have a successful track record of launching a company in the past.

The Financials

Obviously, you cannot disregard the financial situation and projections of an investment target. What is true in the general world of start-up investing is all the more important in the RegTech universe. While it can be easy and cheap to build a payments app or a lending platform, RegTech solutions on the other hand can be costly and time consuming. For example, the CtC period – from Contacting a potential client to the signing of the Contract – often takes a year and more and investors will want to know how you expect to cover the bills, in particular as trials that prove the worth of a solution may be required and can ramp up costs quickly.

On the subject of numbers, one of the reasons someone invests in a RegTech obviously is that they want to make money. So, an investor will want to understand what the likely profit is. Therefore it is important to have a pretty good understanding of the market size. We already referred to cost of compliance above, but in reality the actual target market is likely to be significantly smaller than the overall size for compliance and regulatory tools. Since most RegTech solutions only focus on parts of it, the real market size might be significantly smaller, but still a great opportunity if executed well.

The many pieces of the RegTech investment puzzle

While it is clear that the financials aren’t always an exact science – after all, many of the numbers are based on estimates – it is still important to have a very good take on it as ignorance will tarnish the credibility of firms seeking to raise funds. In the end, investors trust you with their money and if you give them the idea that you’re not going to handle it cautiously or have no real idea what to do with it, they are unlikely to write you that cheque. So make sure you know your numbers including projections of how much money and financing rounds it may take to get to an exit, how that is envisaged, i.e. takeover or public listing, as well as how equity is and will be distributed.

The Product

RegTech solutions needs to solve the problem and not indulge in a flight of fancy. Many financial institutions complain that when they talk to RegTech firms they are often left with the feeling that they don’t understand the problem these organisations have to deal with. Regardless at what stage you are in the development and deployment of your product, make sure that you do not loose touch. This will not only help you to find clients but also save you from spending you could have avoided.

The same is true for the use of innovative technologies to build interest in a solution that does not serve the purpose. For instance, Blockchain in KYC has been hyped to solve a massive problem, but it also faces significant practical obstacles. If you can build it and make it work, great! But don’t add something fancy just for the sake of it.

Having a functioning, useful product differentiates a RegTech from other investment opportunities and particular in times where ICOs raise millions sometimes with a vague idea only.

For the product as well as for the overall company it is helpful to have a roadmap of milestones – realistic achievements in the near and mid-term future with regard to product and business development. If you already have traction, make sure to show and evidence it. Few things show value like customers telling the investor you have value.

The relationship between Investor and RegTech firm

So, someone has offered to put money in your RegTech firm, but that doesn’t necessary mean you should take it. Why? To make sure that the story doesn’t end in tears, the relationship has to work on more levels than just the investor has money to spend and the RegTech needs it now. If the interests of both parties aren’t aligned it is likely to cause friction further down the line that can easily result in very stressful arguments and potentially costly lawsuits. Make sure that all the pieces of the puzzle fit: is the company at the right stage for the kind of investment the investors seeks to make? For instance, if there are different views about the time it may take to reach a certain point, the investor might not have the patience necessary for the execution of the business plan. Has the investor experience that is relevant for the industry or the particular firm he or she wants to invest in? If not, it might be difficult to understand specifics and problems that could occur along the line. At the same time, a RegTech firm should look beyond the money an investor has to offer. Finding an investor that contribute by making connections and introductions, help with certain issues a start-up encounters during its development and its strategy could be more valuable than the capital they bring in the long run. Having someone sharing the same ideas can lead to invaluable contributions and when (more likely than if) further money is needed at some point in the future this investor might be more willing to put more money into the firm.

Sure, if you’re in dire straits you might not be in a situation to be picky. But bearing these aspects in mind, it is likely to help creating a fruitful relationship between a RegTech firm and its investors.

In the end, every case is different but the above are, what I find, some helpful guidelines. If you want to know more about RegTech in general, check out the dedicated section at PlanetCompliance and feel free to drop me a line.

 


If you haven’t read the first part of this article where we looked at the investment landscape in the RegTech sector and why it makes sense to invest in firms developing regulatory solutions, you can find it here. If you have any questions or comments with regard to this article or RegTech in general, drop us a line at info@planetcompliance.com