Escape Velocity for a Mass Affluent Wealthtech Startup
The robo-advisory industry has massive market potential, which is measured in the trillions in assets under management (AUM) in the United States alone.
However, few tech startups will make it to the threshold I refer to as “escape velocity,” that is, building a large, independent company with over $100M in annual revenue and a sustainable competitive moat.
For a pure robo-advisory business to reach even the minimal cash flow break-even point, or to set itself up for massive ongoing growth, it needs one of the following:
(1) A managed account business with $10B+ AUM, in order to reach $30-50M+ ARR and still be able to grow from there
(2) Meaningful commission or other fee revenues and significant customer scale, typically with millions of customers
Note: In this article, I am referring specifically to robo-advisory startups for taxable accounts. However, to a lesser extent, these challenges increasingly apply to rollover-focused, 401k tech, and HNW advisory business models.
Motif’s Failure to Reach Escape Velocity
The latest robo-advisor to go out of business is Motif. Like many others that have tried and failed, the end result was not due to lack of funding or very smart team. In fact, Motif raised over $120M and had a highly thoughtful approach to product innovation.
In Motif’s case, they closed up shop with about $850M in AUM as the entire industry began a massive shift toward commission-free trading (a trend accelerated by Robinhood, Schwab and others).
While Motif is no longer around as a standalone entity, as Schwab purchased its tech and IP, the founding team should be commended for giving it a very thoughtful and creative go. This included their thoughtfulness regarding how to structure thematic motifs, pivot toward social impact investing, and branding.
Headwinds to Reach Escape Velocity
Regarding first principles, on a more basic level, the three most important headwinds facing mass- affluent-focused wealthtech companies are:
(1) Low LTVs, driven by:
(a) Typically low average account sizes. This is now accelerated by the COVID-19 pandemic and resulting economic situation.
(b) Managed account fee compression. Some companies, like Schwab, even offer free or near-free management, subsidized by other fees and float revenue. Others, like Vanguard, combine robo and remote advisory for 30 basis points.
(c) The death of commission-based revenue. This has been accelerated by Schwab, Robinhood, and others.
(2) High CACs and difficulty reaching scale driven by:
(a) Traditional incumbents with big marketing budgets. They typically skew heavily toward high-cost paid acquisition, due to a lack of ability to effectively grow organically.
(b) Tons of noise for consumers with often limited product differentiation. With many going to market with RIA models built on Apex, Hydrogen, DriveWealth, or similar platforms, it’s increasingly easier to go to market, but harder to provide a service that’s 10x better or cheaper. This also drives higher churn.
(c) Many launching with niche, highly targeted starting points. However, most ultimately migrate toward larger account sizes, better economics, and more customer volume.
Exacerbating this further is the challenge of servicing low-LTV accounts. It’s unclear to what extent the future will be shaped by hybrid human/robo advising models (e.g., Vanguard’s PAS), which offer automated portfolio management with limited (remote) human advisor discussions.
What We Will See With Existing Wealthtech Startups
I believe there will be limited opportunities for new wealth-tech entrants to reach scale in the US.
What we’ll likely see is:
(1) Increased consolidation among incumbents. Companies like Schwab will buy up others, thus combining and optimizing (read: cutting) opex, focusing heavily on branding, and spending a lot of money to acquire younger customers as their core customer base continues to age.
(2) A very small handful of robo-advisors reaching scale. My best bet is that Wealthfront will be uncompromisingly focused on an IPO, and Betterment may go public or be acquired by an incumbent. Others will get acquired for smaller sums or go out of business, unless they expand beyond wealthtech.
(3) A few non-advisory startups like Robinhood reaching scale. Creating a new Robinhood today is possible, but akin to winning the lottery. It’s exceedingly difficult to acquire millions of customers in a cost-effective manner, only to make money on non-management fees. Also, I’ve never been bullish on subscription-based advisory services reaching mass scale. Not enough people like to pay monthly fees; although they are usually lower costs than AUM fees, they’re more salient.
I believe the solution to reaching wealthtech escape velocity is actually counter-intuitive. It involves not actually building wealthtech companies from the ground up, but instead:
Build a company that serves your target customer’s financial needs.
So, what’s the future of new wealthtech startups? I believe the answer is, perhaps somewhat counter- intuitively, companies that don’t consider themselves wealthtech companies. Rather, they will be companies that serve the full financial needs of their customers, including their wealth management needs, when needed.
Case in Point: SoFi’s HENRY
SoFi is perhaps one of the best examples of this. The company’s early leadership is famous for their view that SoFi was not a student loan origination and refinancing company, but rather, a company that served the financial needs of their HENRY customer demographic (“High Earner Not Rich Yet” customers).
The resulting approach allowed them to stay close to their customers’ needs and expand to multiple areas, including wealthtech, mortgages, personal loans, and insurance, with some through direct offerings, and others through partnerships.
I’d venture to guess that in a world where SoFi and its pure student loan competitors go public, SoFi is likely to garner a much higher multiple given their multiple lines of business.
But perhaps more importantly, it’s clear how this approach of targeting the customer and not the product helps SoFi with regard to the headwinds facing the wealthtech space. They’re able to have higher LTVs as they expand across multiple products, and keep their CAC on a per product basis extremely low. They’re
essentially using their existing customer base to expand. Furthermore, they’re likely to have decreased churn with customers who utilize multiple products, assuming that their customer experience remains solid.
However, Danger Continues to Loom
The danger here, however, looms in just taking the obvious approach that sounds like it should make sense: being that one awesome company that does everything to meet customers’ financial needs.
The devil here is not in the end game, but the path there.
Companies can only succeed when they target and market the solution to a singular, burning need, to one customer at a time. People just can’t keep multiple financial products in their head simultaneously, and if you’re targeting mass-affluent America—not white glove HNW financial advisory—you’ll have to keep it simple.
Start with a burning problem. Solve it well. Then, move on to the next with existing customers.
The bad news here is that this too will become a commoditized approach. Companies like Flybits, for example, are helping even large incumbents figure out how to do this. Just like direct robo-advisory, it will be harder for customers to cut through the noise, as every company claims to help everyone do everything.
However, the good news here is that it comes down to execution, which is what almost all large companies, and most startups, fail at.
So, I’ll end with a bit of basic, often repeated wisdom. It’s simple but true: it all comes down to your customer. Companies that stay very close to the customer, truly understand their needs, and build products and experiences around this, will win. The key is that true product innovation requires creativity and vision, something your customer interviews can’t give you.
And if it all comes down to your customer and how wonderfully you solve their problems, hire a few amazing product people, make sure they stay deeply plugged into your customer’s lives and needs, and give them the space and resources to dream up a future that makes their lives better.
The answer isn’t another wealthtech startup, but something more elusive: good people focused on customer needs, with novel ways to solve validated problems, delivered one at a time.