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Strategy Session: Frank Rotman Of Boutique Fintech VC QED Investors On Rebuilding Banking

QED Investors was set up in 2007 to invest in fintech, long before it became the leading sector it is today. In the 14 years since, Virginia-based QED has amassed a total of 19 unicorn companies in its portfolio, including  San Francisco-based Credit Karma, which it invested in at Series A and which was acquired last year by Intuit for $7.1 billion. 

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Frank Rotman, co-founder and partner at QED Investors

We recently spoke with Frank Rotman, one of the firm’s co-founders and previously an executive at banking and lending giant Capital One. Rotman co-founded QED with Nigel Morris, another former executive at Capital One.

QED’s first fund was a $30 million internal fund. Its most recent fund VI was announced in February 2020 and is its largest fund at $350 million. 

According to the firm, it has now invested $662 million to date in 142 portfolio companies with $2 billion under management. That includes its investments in Seattle-based Remitly and São Paulo-based Nubank at Series A. At Series B, the firm invested in Mexico City-based Bitso; and first at Series C, Stockholm-based Klarna. The firm invests in the U.S., U.K., Latin America and is starting to invest in Southeast Asia. Investing team members are based in Washington DC, San Francisco, New York, Mexico City and London.  

The team’s sweet spot, according to Rotman, is to “use our operating backgrounds to help crack the code on businesses that still have a lot to figure out.” Based on a Crunchbase News analysis of its investments, the firm appears to invest most often for its first investment at Series A, and then at the seed stage. 

“Venture capital is a very simple asset class that’s very difficult to do well,” Rotman said. We spoke with him further about QED’s investment approach, the fintech sector and more. 

The following was lightly edited for length and clarity.

What has changed in the last five years in fintech investing?

Rotman: There are some very, very large fintechs that kind of show the art of the possible, of what an at-scale player can actually achieve. And that fuels the entire ecosystem, where young founders are spinning out of those companies, are spinning out of banks and saying, “Well, I think I can do the same.”

The combination of new capital and incredible founding teams coming into the space with this vision of what the art of the possible looks like is just this self-reinforcing ecosystem that’s been accelerating.

There seems to be a payment startup funded every week. Is fintech investing becoming too crowded? 

Rotman: I am more bullish on the next decade of fintech than I was on the last decade of fintech. This next wave, you can call it v2.0 or v3.0 of fintech, is going to produce more durable and potentially even larger outcomes than the first wave of fintechs did.

The first wave was a bit more about UX, UI and APIs. It was more about application processes and reducing friction, and the look and feel of what a digital product or digital distribution of banking products look like. 

This next stage is actually tearing apart everything down to the atomic unit, about how financial services are manufactured and distributed, and rebuilding it in a digitally native way.

These new building blocks that are being built within the fintech ecosystem—we don’t know yet how they’re going to be assembled—is going to challenge the notion of how banking is actually manufactured and delivered across every single component of banking, and there are a lot of them. 

There’s a lot of innovation ahead, there are a lot of entrepreneurs and capital chasing it. But there’s a reason for it. There’s a lot still to be done.

Where do you see the opportunities?

Rotman: We are a fintech specialist firm. We have more than a dozen investment professionals, and each one has multiple themes they’re chasing. So it tells you how many things we’re interested in. There are dozens of interesting vectors, subsegments within fintech. 

If you look globally, some of the top market cap companies in each and every country are banks. And it’s not just because of the revenue they’re generating, it’s because of the profit they are generating.

Many of the banking organizations around the globe still are on their v1.0 of delivering a digital version of the product. So there’s a lot of work to do across every single aspect of banking. 

If you think about the core pillars, you have things like storage of money that’s about deposits, you have movement of money that’s about payments, you have the borrowing of money and the whole lending side of the business where people need money today to buy something they will pay for later. 

You have the investment side of the business. You can even start lumping in insurtech at this point so you have insurance. You have capital markets. So there are these different verticals within fintech and each and every one of them is interesting in its own way.

Do you see banks being displaced or adapting?

Rotman: It’s hard to talk about banks as if they’re a single thing, when you have almost 10,000 in the U.S. You have 5,000 traditional banking depository institutions. And another 5,000 credit unions. It’s hard to lump them all together and say this thing is going to behave in a particular way.

Within the banking ecosystem, you have banks that are addressing this issue in different ways. You have the top four or five banks in the country that are extremely well known, extremely well capitalized. They have the ability to innovate themselves. They can invest in people, in technology. They can choose to procure products from fintechs or build them themselves. They have every option available to them. 

I would put JPMorgan in that camp. If JPM wants to build something, it can build something. Whether it can build it, as well as a fintech can, comes down to the talent they can hire. 

You have much smaller organizations, smaller community banks and credit unions that are relying on third parties to assemble solutions for them. They don’t have the ability to attract the talent or put the investment in, to basically keep up with what’s happening in this transformation from the old way of delivering their service to the new way.

And you’re seeing some interesting companies emerge in the space. 

Look at Ncino as a good example of a more modern platform that a lot of smaller banking institutions, community banks and credit unions can use to basically catch up and become digitally native very quickly.

There’s a whole layer of fintechs that can exist to help the banking ecosystem update legacy tech without rip and replace. It could be additive, it could be new functionality. It’s less daunting than it was in the past about ripping out your core systems.

And then there are a lot of banks that are in the middle, where they’re going to give it the good old college try. And the question is whether they succeed. Some of them think they can build it, and the jury’s out on whether they will be able to build it.

Because banks are not a uniform thing, they’re not addressing the issue in a uniform way, and that actually creates a lot of opportunity for startups.

Is the banking system leveraging fintechs or are fintechs leveraging the banking system?

Rotman: Think about Marqeta, think about Stripe, think about Treasury Prime, think about all of these API companies and middleware layer companies that are emerging. They help everyone. Think about Plaid as another example of a company that’s helping both incumbents and fintechs. 

And then there’s another breed of fintech, one that’s going directly to the consumer, with whatever the product or service is, and meeting their needs. And some of those companies could be taking business away from banks. A lot of those need to rely on banks behind the scenes to actually be the regulatory layer and sometimes even the execution layer of the business or product that they are serving out to the market. 

So there isn’t a single configuration. You might have a challenger bank like a Chime or a Current that has amazing UX, UI and an amazing assemblage of product and service. But in reality they’re not a bank, which means they don’t have the legal ability to offer an FDIC insured account without another partner bank behind the scenes.

At the same time, you might have a company that is in the small business accounts payable or accounts receivable space, like a Bill.com or an AvidXchange, where the banks might become a distributor of the product because it helps their customers.

Banking is being broken down into atomic units at this point, and the question is how you reassemble those atomic units. The Lego blocks of banking are not different than they were before, and banks can buy the Lego blocks, they can partner with the Lego blocks, they can build the Lego blocks, but so can other people.

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Illustration: Dom Guzman

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