July 1, 2020
This is the transcript of the third episode of MEDICI Studio's new video interview series "Weekend Wisdom: VCs Debunked & Demystified" led by Aditya Khurjekar, CEO and Founder of MEDICI. In this episode, watch Tilman Ehrbeck, Managing Partner at Flourish Ventures, answer questions about “FinTech with Purpose.”
Aditya Khurjekar: Welcome everyone to MEDICI Studio! This is our Weekend Wisdom series, where we talk with leading VCs and try to debunk & demystify the venture capital world. My guest today is Tilman Ehrbeck of Flourish Ventures. Tilman, thank you so much for taking the time.
Tilman Ehrbeck: Thank you for having me. It's the weekend; whether its wisdom, I’ll let you and your audience judge.
AK: We really appreciate you taking the time. I want to thank the audience here as well. We have this session being live-streamed on YouTube, LinkedIn, and Twitter Periscope, and you might also be watching this recorded on MEDICI Studio. All of these wonderful pearls of wisdom that we are collecting here in the Weekend Wisdom series have been opened up for all our FinTech audiences in these tough COVID-19 times so that people can benefit and learn as we get through this. So, Tilman, let's jump right into it. But before we do that, let’s make sure people are familiar with Omidyar Network. Your fund Flourish Ventures is relatively new, and of course, you have been in the space for decades. I would love to ask you to just introduce yourself, your fund, and your overall mission in your own words for our audience, please.
TE: I’m happy to do that. As you can probably tell from my accent, I grew up in Germany, started my professional life at the International Monetary Fund, so really macro, and very quickly realized that the action was really in the private sector, and in particular, with smaller enterprises and entrepreneurs who really wanted to change the world. After a detour with McKinsey, which brought me to India—by the way, Aditya, I spent five years in India between 2005 and 2010—I started working on financial services, in particular, for folks who, at the time, were outside the system, and that brought me to the Omidyar network, where I built up our financial services team and portfolio, and that was going relatively so well that we decided to spin it out. A year ago, we took the portfolio that we had built and the team with us, and we spun out under this new brand name of Flourish, keeping two key features in place in conversations with our source of capital, which is Pierre Omidyar, the founder of eBay. And these two features are: we have permanent capital, which gives us great degrees of freedom, and we do have a mission or a mandate if you will. And our mandate is to help households and small businesses improve their lives—their economic lives and access—and the ability to use financial services is a key component of that. So everything we do is through that lens. FinTech, which came up as a theme after we had started, is a means to an end in that context. So our main mandate and mission is backing entrepreneurs who use technology-led innovations to help improve the economic lives and financial lives of their customers.
AK: Now, on that point, people use these terms somewhat interchangeably, and I have myself been guilty of that sometimes, but I have also evolved my own views as to what it means when we say “financial inclusion, financial health, impact investing.” We chose to focus this conversation on, per your suggestion, “FinTech with Purpose,” so, how do all of these things come together? Are they all the same thing? Are they different? How would you explain this to the audience?
TE: Well, they are related, and they build on each other if you will. Many of your audiences in emerging markets will understand this particularly well. The starting point really was, for me, at least 10–12 years ago, the realization that literally half of the working-age adults globally were outside the formal financial system whatsoever. No bank account, no insurance coverage, nothing, and that didn't mean that they didn't use financial services. It meant that they used the age-old informal services: the moneylender, the pawnbroker, the informal remittances services, and the rotating savings club. They used them because they had no alternatives, but these services can be very, very expensive and very inconvenient, so there's a double unfairness in all of that. We have a relatively stable income, our cash flows are neatly aligned, and we have insurance coverage for unforeseen circumstances. When you're outside of all of that, you need these services more; when you don't have them, the informal alternatives are more expensive, so it is expensive to be poor. You have heard that expression before, and that's how it started with access and inclusion, but that's only an input.
Ultimately, we want people to have better lives. We realized we needed an outcome orientation in addition to the input orientation, and that's how financial health came about, and that's particularly relevant in highly advanced economies like the US where we operate. I should have said earlier that we operate in the US and in a large number of emerging markets, the big countries, such as India, Indonesia, and Bangladesh in Asia; Nigeria, Kenya in Africa, and in Brazil; and Mexico. So in emerging markets, access and inclusion were the starting point, and that problem has been solved in the US. The issue in the US is that many households essentially live paycheck to paycheck, and that is a middle America phenomenon as well. By some metrics, there could be up to two-thirds of Americans living paycheck to paycheck, and that is because they are not as well served by the incumbent financial services industry as they should, and that's where the opportunity lies. The orientation or the mandate in the US is much more financial health outcome-oriented.
Impact investing is this third concept that you mentioned. Again for us, that's a means to an end. When we make investments, we want our individual investments to help improve their customers’ lives. If they don't, then what's the point? So we start with that high-level impact lens, but then we want and need our portfolio investments to be wildly successful in their own right. Our entrepreneurs and our core investors expect that from us, but we also want them to demonstrate that this new approach is feasible and, in the ideal end-state, actually change the entire industry narrative. I can give you examples of that. But let me stop here. Does that make sense: inclusion, health, impact investing as a means to an end?
AK: I think that's a good way to frame it. So thank you for doing that because it's about the objective and the means, and it depends on how you look at it.
I want to ask you about something that—I'm hoping there is a happy answer here, but I don't want to assume—if we go back in time and look at, say, public markets, maybe a couple of decades back and the wave around double-bottom-line investments, or double-bottom-line portfolios—we started seeing funds that said we won't invest in tobacco and alcohol as an example. So that is kind of to stop the negative, but there were also movements in the public markets such as ESG. So the public markets have a different narrative around this, which seems to have evolved. In the private markets, where you play, and most of us play, it is what we just talked about. My question to you is: are you seeing the work that you do become more mainstream over time? Because if you look at the work that you do, which is focused on “FinTech with Purpose,” versus the work that says, another traditional FinTech investor would do, is that gap narrowing in your mind with regard to the last couple of decades?
TE: Yeah, I think so, in parallel to the public markets. The public markets, depending on how you count, are now at least 25% ESG oriented. If you read BlackRock CEO Larry Fink’s shareholder letter from, he would argue any and all of their investments ought to be impact-oriented. There has been a convergence in our space as well. So when we started, we had this mandate that I described earlier. We said tech-led innovation is a means to that end, and it's actually, frankly, the only means to that. That’s because the traditional cash brick-and-mortar models are simply too expensive to reach folks who transact very frequently but at teeny tiny ticket sizes. So because of that mandate that we have, we started from first principles. But increasingly other investors realize that if it's half of humanity at the base of the pyramid, there is a huge untapped opportunity. So these worlds have been converging. I would say in the current environment and now with a pandemic crisis and an economic crisis that has been triggered by the reaction, the lockdowns that we had to go through. This notion that you need to really do right by your customers and help them in very difficult circumstances is even more important than it used to be before. So yes, I do see a convergence, and I’ll give you an example. If you look at our investment themes for the last couple of years, one is in challenger banks. It really bugged us that in the US, the traditional banks slapped you with hidden fees and charges, you have an overdraft charge, and you pay $35 because you didn't pay attention.
From a technology perspective, this shouldn't even happen. The bank knows when I use my debit card, whether I have that balance or not, and so we said, “There is a better way to do this.” If a challenger bank that is app-based that has no branches, no physical infrastructure, it’s not hindered by the traditional legacy infrastructure; it just can provide better services faster and cheaper, and that's what they do. In the US, we have two investments of that type in the portfolio. They can provide a free transaction account, no hidden fees, because they have such a cost structure advantage, and customers love that. And in the current environment, their customers need them even more so because they have to shop from home. Nobody wants to go to a shop, have to touch that screen and all that type of stuff. So, yes, there has been convergence already, and it's even accelerating, I would argue now.
AK: That's great to hear, especially from someone like you who lives and breathes this and has been doing this for many decades. And for people like us who work in the industry without having that kind of “impact” label proactively, but we have that, as an understood, inherent, back-of-the-mind driver anyways; that’s a very comforting and encouraging thing to know. It does seem like we have come a long way even in the advanced markets like the US. I remember from 10 years ago, the biggest innovation at the time seemed to be prepaid card-based think— over-the-top innovations on prepaid cards. It always bothered me that the companies were making so much money on the high interchange of prepaid and the high fees for when there was breakage that with regard to the objective of helping people who are not financially well, how are you exactly helping them when you are hitting them with fees and high interchange? So it does seem like we have come a long way. Now, could we double-click a little bit on the differences? We always like to compare and contrast between what is FinTech innovation in emerging markets versus FinTech innovation in the so-called advanced markets, and I do have my views on “advanced” because it depends on how you define “advanced.” But if we were to keep it simplistic and maybe use some examples from your portfolio, how would you showcase some similarities and differences in your words?
TE: I’ll start with maybe the differences that used to exist, and then I will say that they are coming down, not at least because of the crisis that we are living through right now. But the historical difference, if you will, it's the obvious one. In emerging markets, large chunks of the economy are totally outside of the formal economy and outside of the formal financial system, so there’s really an ability to innovate into white space and in particular, innovate on top of the mobile phone revolution, initially the 2G feature phone, but then quickly, the smartphone, with an open-architecture-type environment. Frankly, emerging markets, as a result of that, have leapfrogged so-called advanced economies massively over the last decade. Initially, it was East Africa with mobile money, and then it was China with the closed-loop systems around Alipay and WeChat Pay. And more recently, it's been India with the investment in the public good, the open architecture, and digital infrastructure. Whereas in the West, and the traditionally more advanced economies, we had an incumbency industry structure. We had incumbency regulation in the US complicated by the fact that we have at least five federal regulators, and many financial services are actually subject to state regulation. Things were sort of easy enough. I mean, why improve over the credit card with a magnetic stripe? It was convenient enough for me as a middle or high-income consumer. I don't even bear the risk when there was fraud. Somebody took care of it, which is why we shifted much later in the US to the chip relative to other geographies, so it used to be quite different.
I do think there is now convergence in that, and that has to do with the features of the economy in the new normal that I could imagine. The online digital platforms will become more important in our lives. Finance will be more and more embedded in this, and so I do think that there will be consumer behaviors that will increasingly be the same globally. Nobody wants to go to a bank or an ATM and punch in their PIN number during COVID. So now you will see the US introducing QR codes, and you will, in the US, see more social commerce. Facebook and Shopify just announced their innovations here. So I actually think there's a convergence from an industry structure perspective as well, and the difference might well be what the regulatory environment allows or does not allow because financial services are, for a good reason, regulated, and they should be regulated.
AK: I think that is something we see in so many spheres. It sounds like a cliché that technology is a big equalizer, but I think we are seeing that in financial services very clearly. I mean, there is no reason for a rich person or a poor person to have a different expectation of their experience when they are shopping or when you're taking a shared taxi like Uber or Ola. You could live in an emerging market and be at the so-called bottom of the pyramid, but your expectation from your mobile app is exactly the same as an expectation from the mobile app if you are a rich person in New York City in Manhattan. So technology has really equalized expectations of experiences that people want, and the ecosystem has to cater to that. I think technology is an equalizer, but business models are obviously driven by the regulatory constraints that are different and availability of nationwide infrastructures, where again, the so-called emerging markets seem to have better nationwide infrastructure, like real-time payments. So it's fascinating to see this for sure. So I do want to ask you about the future because I feel like there is so much good that has happened already in the last couple of decades. We are seeing people truly learning from each other. You have lived in different parts of the world, so you have that first-hand view yourself. As you look at the future and as you look at how these experiences in payments and financial services are getting embedded because of platforms and other adjacencies being the front and center, are there any opportunities for entrepreneurs and founders that stand out? If you were to start a company from scratch today, what would be a few things that you would advise them to think about?
TE: I started hinting at the future from an industry perspective already. So let me riff on that a little bit, and then I'll come back to maybe more fundamental advice to founders. On the industry structure, I was supposed to give a keynote at Mumbai FinTech Festival in early March, and obviously, that got canceled, and I put together a presentation that I quite liked. So I was very bummed out that all that good work had gone to naught. Then a few weeks ago, I flipped through that again, and I realized that a lot of the trends I would have been talking about just have been accelerated or amplified by the COVID crisis. I have started mentioning some of those, so let me elaborate. I do think there's a trend towards digital platforms becoming more important in our lives—all of us. Which ones might be a bit different depending on my life circumstances, if I'm a retired grandfather, maybe it's Facebook WhatsApp because I want to communicate with my grandchildren and I want to send them a gift when they graduate. And if I'm a small business, it might be the social commerce platform. If I'm a gig economy worker, it's a gig economy platform.
For example, we have an investment in the US in a platform that matches opportunities in the gig economy space. It's called Steady, and it was already super important before the crisis. Now it's even more important because some of these gigs have fallen by the wayside, but new gigs are emerging, such as food delivery. So platforms are becoming more important in our lives for all of us, and they are the natural owners of some financial services, certainly the payments piece, because that's incorporated, but also capital—they could provide working capital for my small business, or at least they have the data to help underwrite that working capital need. They could provide, or at least they have the data to help underwrite insurance needs. So embedded finance was already a big trend before the crisis, and it will accelerate even more. So against that, there are opportunities to provide the plug-and-play product silos. The point-of-sale credit helps the merchants stimulate demand. But the merchant doesn't want to underwrite the credit; that's not their core competency. They need somebody to plug in the targeted insurance coverage. I buy a cell phone or a smartphone—it's really important to me because I'm a gig economy worker, and it's part of optimizing my earnings, and my livelihood. I want to insure that smartphone for screen breakage or whatever it might be, and there are specialist players who plug-in and do that.
We have made investments in all of these spaces. ZestMoney in India would be a credit plug-in, Koala in Indonesia would be an insurance plug-in, and Toffee in India is another one. So that's happening now. Then you could imagine there's a whole new question in this context in this new economy that we are talking about around the remainder of the plumbing—helping new players with a KYC component with fraud detection. If the world moves online, unfortunately, online fraud will rise probably, so there are B2B FinTech opportunities in this open API world that connects new platforms with regulated balance sheets at the back-end, and somebody has to connect all that—huge opportunities there.
I think there's a third set around data, so data was already and is now becoming more and more important. Who controls and owns that data? How do you make it available in the context of open API banking and banking data portability? There's probably a big role to be played for intermediaries that enjoy my trust as a consumer when it comes to my data, so there's a number of themes at the industry structure level.
As an entrepreneur, I would urge people very much to go back to the fundamentals and first principles and start by saying, “Is what I am doing fundamentally helping somebody improve their underlying situation? Be it as a household or be it as a small business, do I really create value? And in particular, do I create value by using technology data access, intelligent interpretation of all this new data? Do I create so much value that either the consumer is willing to pay or some third party is willing to pay? Is it viable for me as a startup? You need to have an understanding of your unit economics, and they need to be fundamentally positive. Otherwise, you don't have a business that can profitably scale and create the type of value that you, as an entrepreneur, would want to create. But it starts by innovating a value proposition that truly makes a difference for people.
AK: Thank you for that, Tilman. Is that something that you would somehow modulate for what people are now calling the “new normal?” Is there a new normal, you think? Is COVID 19 a blip that we will just come out of, and everything will be fine, or do you think that the world has changed fundamentally, and so our worlds have also, therefore, changed fundamentally? Is there in your mind, truly a new normal here?
TE: Yeah, I think so to some degree. But that goes beyond my competency. So everybody should listen to this with a grain of salt and form their own opinion, but it became very quickly clear that this will not be a V-shaped type event in the real economy—except stock markets, maybe because central banks around the world have pumped liquidity into stock markets. The stock markets are not good indicators of what's going on. Our common sense, our observations, and what we hear from others is frankly a better indicator. So what's going on? We have a pandemic crisis. It's unclear how we will get this under. It will last at least 18 to 24 months. Even if we find—I obviously hope that we do—find a vaccine relatively quickly, to manufacture that vaccine, and get it into the arms or wherever it needs to be shot into 80% percent of humanity globally—and that's what you need for herd immunity—that’s seven billion people. It is a huge logistics challenge. We are in unprecedented times from a public health perspective, and that's outside of my competency, but from all I've read, it seems it will take 18 to 24 months. I know what that means for the economy. The real economy will not recover in a V-shaped fashion, it will start, it will reopen with starts and fits because we might have to shut down again when there are second waves. Until and unless we have a vaccine, there will be no return to anything that is pre-normal, and I think that time frame is long enough for a number of things to change.
Consumer behavior will change. I've read somewhere that it takes 60 days to form a new habit. We all have been through 60 days, so new habits have been formed. Once people have done something differently and found it to be superior, cheaper, and safer, why return? This is very pertinent to payment behavior in these types of things. So consumer behaviors will change irreversibly. What constitutes a viable business model will change because even if a restaurant opens, if it has to operate at 50% capacity, that's just not viable because their margins were so thin in the first place. So yes, we are already in a new normal, and I very much hope that we pull together and make this a virtue out of the vice, and make this new normal work better for more people, cheaper, safer, more adequate.
AK: Tilman, on that note, I want to thank you again for sharing your thoughts. We really have an opportunity here for all of us, no matter which part of the ecosystem you are in, to take this time to get ready for that new normal and to upskill ourselves with learning and wisdom, and the weekend is the best place and the best time to become a little wiser. So thank you, Tilman, for making us a little wiser. I appreciate it.
TE: Thank you for having me, Aditya.
AK: I want to end this episode by just reminding our audience of the COVID 19 fund that MEDICI has launched. We are encouraging all of you to visit the page, make a donation, and take the time to think about how we can help—as privileged as we are—here in the ecosystem. There are so many people who don't even have hope. No contribution is too small. If we could take a moment to think about what we could do to help solo and small volunteers on the ground who are doing things in their own way, who do not have the infrastructure support of large organizations. This is about how we can help them to do something for people in need in the COVID 19 crisis. So thank you all again. And thank you, Tilman.
This is Weekend Wisdom on MEDICI Studio.
Watch the video interview on MEDICI Studio here