Fintech | Mike Palumbo

The book again is called Calculated Risk. You can get it on Amazon or on its website. The website's calculatedriskbook.com, one word, calculatedriskbook.com. It has been ranked as high as number 1 in our category for ebooks with over 500 books in the category. I believe it currently ranks somewhere in the 20s, like 25th. It's also being taught at Lewis University in Illinois. When we started the project, The idea was to write a white paper on startups and hopefully help some people understand what the basics are in starting your own business. That was 18 months ago. About 3 months later, we realized the project was going to turn into a book. The concepts in this book are mine, but there's no way I was able to write this book without the guidance of another published author named Mark Whistler. He did a great deal of the editing, helped me make the book flow. flow much better. And most importantly, what I learned is there are about 100 things you need to do in order to publish a book and write it. And I knew none of these things other than the writing part. Writing the book truly was a labor of love. You simply don't write books to make large amounts of money unless you're J.K. Rowling or Michael Lewis or Stephen King. You just write books to entertain and educate people. So I got to a point in my life when I felt it was a good time to share what I'd learned. With the experience of starting Third Millennium Trading and also firms in venture capital and real estate, I felt like I had made enough mistakes and had enough good experiences to share with others. I will tell you that anyone that says success is only based on talent is fooling you or lying to you, and they're probably fooling themselves as well. You need luck. And you need timing. And with any of the businesses I built that have been successful, we had a lot of luck. So the book chronicles every part of the journey in starting and running a business. We start by discussing what it takes to develop an actionable idea and how you know what you have when you have something special. The book describes the tests that you can use to determine how good your idea really is. We then discuss building your firm, including bringing in your first employees, and the characteristics you should look for beyond intelligence. The book takes you through every phase of building a successful firm, including how to raise money, what types of investors make the most sense for you, and shows you my go-to technique for valuing firms. We also look at various ways to measure the traction you are getting in the marketplace. Then we describe the different ways you can eventually exit the firm if you do desire to do so someday. The final part of the book was my favorite to write. It's a letter to the readers that talks about what I see coming in the near future in the world and how entrepreneurs will help to shape that future. I think it's the best part of the book, and many of the predictions are ones that you will not hear in the media or from the supposed experts. So let me talk about a few of the most important topics I cover in Calculated Risk that you guys might find useful. First of all, what kinds of employees should you hire? I rank the criteria I use for hiring people in the book, and here's the best thing to remember: the quickly changing work environment demands, and be prepared to retrain these people. Whenever you say this time is different, you better make sure you are looking at the picture correctly, because oftentimes it's not different, but in this case, I do believe it is. One other forecast I make is that technology will finally keep oil prices from rising. If you're interested in commodity prices, and you— then you know oil has basically been cut in half over the past couple years. And the reason why this has happened is because of technology. In America, we no longer completely depend on foreign oil, and this is a great thing. Advancements in shale oil production, along with alternative energy sources such as solar will finally put a cap on oil prices. I believe we will never see oil anywhere near $100 a barrel again, and obviously this is a good thing for consumers around the world. And you can thank technology for doing this. As I say in the book, technology is the main driver of deflation, just as population growth and governments are the drivers of inflation. It is this tug of war that always drives prices. I believe in the oil markets, the war is finally being won by technology. So now let's talk a little bit about what I see in the area of fintech. Maybe some of you are in the— in this area, or at least have some interest in it. I will speak in some broad strokes here. We have had a reasonably large pullback in valuations of public and large private startups over the past year, as things got a bit overvalued in 2015. This is true in fintech as well, as companies that went public in 2014 like Lending Club and OnDeck peaked immediately after their IPOs and then were cut in half and then some. There's definitely been a revaluation of technology startups, and I think this has been healthy. Things were getting a bit pricey, and now I think they are much more realistic. So what is happening in fintech right now, and how will it play out? First of all, there was a trend of firms being built to disrupt the banks, and at first these were very popular. You had Bitcoin-based startups and its copycats as well, and you had P2P firms like Lending Club and SoFi. From the early 2000s until the beginning of 2015, the main fintech focus was on disrupting the lending industry. These fintechs were starting to develop software to to disrupt the industry, but most couldn't get a lot of traction until the 2008 crisis for 3 reasons. First of all, technology wasn't nearly as advanced, so the ability to connect lenders to borrowers was either not there, or if it was there, there was no reason to trust it over the resources of a big bank. Second, until 2008, banks were still willing to lend to most people, as evidenced by so many bad mortgages being written. So the need for another source of loans wasn't there as of yet. And third, the general public opinion of big banks may not have been stellar before 2008, but whatever the sentiment had been, it undoubtedly got much, much worse after the banking crisis. The improving technology saw a ton of people with smartphones in the time around 2008 to 2010. That was combined with people feeling more secure doing their banking personally on on their laptop or phone because at this point the internet had been long— around long enough that people were comfortable using it. And then the most important catalyst happened, the actual financial crisis of 2008. The crisis left banks unwilling to loan to even above-prime clients, so there was plenty of opportunity for P2P and other new lenders to step in if they were willing to take on the risk. So from 2008 until the beginning of 2015, we saw the disruption in the lending industry. Non-bank lenders coming to the marketplace with access to capital, especially for below-prime consumers. These firms are now taking on the banks directly. They have had competitive advantages in that they were able to do bank-type activities like lending without the regulations that the banks had. But that landscape is changing. What we're seeing is the prospect that these firms will have the same regulatory scrutiny as banks, and that would explain some of the lower valuations these firms have been getting, because it will now be much harder for these firms to compete. The big banks have begun to push back, and the industry turned more towards commoditization and consumer reclamation by the big banks. For example, in early 2015, Goldman Sachs announced they were going to create an online consumer lending program which will be rolled out any day now. Soon all the big banks will offer the exact same lending services as the fintech startups. And naturally Goldman Sachs is going about it intelligently. They're initially targeting above-prime consumers. They're not currently looking at the normal people who may have been Occupy Wall Street people. They're looking to secure the 1%ers who still probably have some reverence for the Goldman Sachs name. The biggest benefit to the fintech lending industry early on is exactly what will become its biggest problem, which is going to be government regulation. Before 2008, P2P lenders didn't even have to register with the SEC. During the 2008-2010 period, when banks were the most heavily scrutinized over their lending after the crisis, standards and their— over their lending standards, Congress was creating new oversight rules for P2P lending, which essentially meant they were hoping they could apply existing rules for bank loans to new P2P. That was not going to work. The problem is like a trading floor trying to impose open outcry rules on companies that are electronically streaming quotes. It just doesn't work. There were a bunch of rules that didn't apply, some new issues that were specific to P2P lending, and a group of old regulators monitoring it all who didn't understand any of it. Regulators for P2P started to realize new rules were needed about 5 years ago, but seemingly nothing was done until October 2015 when the SEC finally adopted new rules specifically for crowdfunding. And then it was discovered that the San Bernardino shooters used Prosper to get $28,000 worth of loans, which helped them finance their massacre. This pushed members of Congress to fall over each other looking for a TV camera so they could be the first one to demand tighter regulations. Later that year, they created a new task force to investigate terrorism funding and also look into increasing regulation for online lenders. This plays, this plays right into the hands of the big banks, who would love stricter regulation of their competition. It's no secret that congressmen will often ask large institutions for guidance when creating regulations since the institutions themselves are the experts in the field. And more so, many Fed members, cabinet advisors, and regulators are ex-bank managers. So when Congress finally sets up a full set of rules for P2P, much of it will be designed by people partial to the large banks. Once regulation starts— takes away the startup edge, it will really come down to pure commoditization, a bunch of options with very little difference in cost. At that point, fintech startups may retain some of the below-prime customers that Goldman and Chase have lost forever, but the startups will have a difficult time competing for consumers with big banks. Will some succeed? Maybe so. A firm called SoFi is a very well-run company that thus far has not shown to be making the missteps that Lending Club has as far as the quality But one thing is clear, these companies who want to take on the big banks are going to be in for a tough road. If you know anything about the banking industry, it is an oligopoly that does not take too kindly to competition, and they are very politically connected.