I’ve spent a lot of time thinking how to best advise and invest into fintech companies, and over time have come up with a few mental frameworks to assist myself. Here’s one of them:

Fintech startups can be categorized primarily into two realms,
- Soft fintech (services, don’t actually touch money as a business)
- Hard fintech (touches money as a means of doing business)

This feels analogous to software (bits) versus hardware (atoms) in many ways. Of course, there are examples that don’t fit well, and I always look forward to finding the exceptions.

Soft Fintech Categories: PFM, KYC, BaaS, Credit Monitoring, FP&A tools, Issuing Processing, Data Integrators, Fraud Data & Tools, Compliance everything

Hard fintech Categories: Merchant Acquiring, Lending, Insurance, Debit Cards, Credit Cards, Remittance, Brokerage, P2P

Examples of Soft Fintech:
@ncino @copilotmoney @usealloy @getVGS @finix @SentiLink @Shopify @Plaid @CreditKarma @NerdWallet, @fast @Verifi @NovaCredit @blendlabsinc @ModernTreasury @Galileo_Tweets @Marqeta, @synapsefi @unit_co_ @treasuryprime (don’t touch money as a business)

Examples of Hard fintech:
@Stripe, @Square, @LendingClub, @SoFi, @Opportun, @greenskypay, @Kabbage, @OnDeck, @Brex, @Chime, @Lemonade, @crossriverbank, @Adyen, @Robinhood, @Transferwise, @Affirm, @Betterment, @Wealthfront (touches money as a means of doing biz)

Soft fintech revenues rarely hit a billion: @Marqeta revenue is reportedly $300MM preIPO. @JackHenryAssoc w/ 1000s of customers is only at $1.6BN

Hard fintech can hit billions in revenue and scale beyond with one business:
@RocketMortage recently IPO'd with $5.1BN of revenue

It boils down to a few things:

Soft fintech has high gross margins.
Hard fintech has low gross margins.

Soft fintech are building towards product market fit.
Hard fintech rarely defines new products, so they’re building to an existing product market fit.

Soft fintech takes little cash to startup, but lots of cash to scale, usually due to sales. They do remain balance sheet non-constrained (BS Free).

Hard fintech takes gobs of cash to get running, but less to scale. Balance sheet reserves still grow, but opex is not tied to it.

Soft fintech looks at data as a way to build new products and ideas.

Hard fintech uses data to optimize existing products and find business efficiencies.

Soft fintech gets to build many products. You can build and mature multiple products in a company’s lifetime.

Hard fintech is lucky to ever really nail their core product and scale it. Typically you’re boiling the ocean whether you want to or not.

Soft fintech’s moat is product / design / distribution. Therefore you can define new product spaces to focus on and win.

Hard fintech’s moat is regulatory hurdles. Therefore it makes sense to build the same thing as big as possible before the world changes.

In Soft fintech, compliance is a cost of doing business.

In Hard fintech, compliance is a core driver of your ability to do anything.

Soft fintech partnerships can come and go relatively easily.

Hard fintech partnerships, once signed, will follow the company for a long time.

There are some exceptions to these categorizations that play on the hard fintech side, while getting the growth rates, multiples, and eventually margins of soft fintechs, and that’s where everyone should be looking to invest, looking at you @stripe

In writing this out, I’ve also realized a few things that feel valuable to share:

- Opportunity exists for a hard fintech focused VC, based on many conversations with early stage companies, someone with conviction and maybe a warehouse facility would be able to make a solid return with unique competitive advantage in the field

- As certain soft fintech categories achieve scale, usually acquiring but also others, it often makes ton of sense to use the existing scale to get into hard fintech (merchant cash advance - i.e. @shopify capital)

- Land grabs rarely exist in either soft or hard fintechs, the market rarely supports N of 1 wins, but when they do its an amazing opportunity

To wrap this up, many other areas where differentiation definitely exists could be explored in a longer medium:
- Market vs execution risk
- Customer acquisition
- Sales cycles vs contract values
- Data as a product
- Implementation
- Initial team sizes needed to get traction

Thanks to all my friends who gave this a read and provided some feedback, which have helped inspire some of this: @bapelj @lauraspiekerman @tberman @dadiomov
@julieverhage

and @anothercohen who got edited out by mistake lol