Somewhere in an industrial estate in Australia, three angel investors sit in lounge chairs at one end of a warehouse. It’s a big, open space with large windows, deliberately not welcoming or comforting. Beside each chair is a small table with a note pad and a glass of water. Two figures appear in the distance, and walk towards the angels. It’s a surprisingly long walk, and the angels watch each step. Two men stop next to a whiteboard, positioned about five metres in front of the sitting angels.
Angel 1 speaks first. “Welcome, James and John. As you know, you are here to pitch your startup business to us. You have one hour to convince us to invest. We are seeing five presentations like yours today, and I’ve personally heard thousands of new ideas like this, and invested in a couple of dozen. Over to you.”
“Thanks,” says James, his mouth dry, his fingers fidgeting with his wedding ring. “Our business provides online financial advice and investment implementation, focussed on the best outcomes for our clients, and is called ‘MyOutcome’. We’re looking for one million dollars for 20% of the business.”
Angel 2 can’t help jumping in, raising his eyebrows towards the other angels. “So you value your startup business at $5 million. This better be good. Why’s it called MyOutcome?”
John responds eagerly. The name was obviously his idea. “This is ‘roboadvice’. We checked Google Trends, and ‘outcome’ is the most rapidly rising word in financial advice. Financial planners now talk about customer ‘outcomes’, such as saving for a car or holiday, or retirement, or financial freedom. Not all that boring stuff like asset allocation and portfolio construction … they are a switch off for most people.”
“Let me explain,” James says. “Roboadvice is online, automated financial advice without the need for human intervention, and it will disrupt not only financial advisors but the entire wealth management industry. In the United States, the two market leaders, Betterment and Wealthfront, have attracted hundreds of millions of startup capital, and billions of dollars is already held in their funds. Our robo model works like this: the investor goes online and answers a series of personal questions about risk appetite, income and assets, then we run this through our algorithm analysis, which picks the most appropriate portfolio from three alternatives: aggressive, balanced, and conservative. Each of these portfolios has a different allocation to exchange-traded funds investing in bonds, domestic equities, global equities, property, plus a link to a bank account. We provide regular reports and daily valuations.”
Now it’s John’s turn. “It’s a complete package of risk analysis, advice and investment implementation. We have the team in place. One cofounder cuts the code, I am a Certified Financial Planner and I have designed the portfolios, and James here, he’s the CEO, we have outsourced the web design to The Philippines. And we’ve just been accepted into Australia’s leading fintech accelerator programme,” he says. “Any questions at this stage?”
Angel 1 has been scribbling notes on his pad, and he looks up, tapping his pen on the paper. “Tell me some numbers. How much do you charge, how many customers do you expect, what are your costs?”
John steps in front of the whiteboard, a blue pen in his hand, and starts writing. “The numbers are simple, really. The entry level, for investments of less than $2,000, is free. That’s how we introduce people to MyOutcome. Above this, we will charge an administrative fee of only $5 a month. The cost of our roboadvice model, including the risk analysis and asset allocation, is only 5 basis points a month. That’s only 0.05% a month on the balance of the account. It’s a completely new price point that will disrupt the industry, blow wealth management apart. In superannuation alone in this country, there is over $2 trillion. Only 0.1% of that is $2 billion. This brings financial advice to the masses at a price they can afford.” James and John look to each other and smile.
“Do you have any customers yet?” asks Angel 2.
“No, but we have 50 friends doing beta testing on our website, and they love it. We expect to launch within two months, and most of them will join. And the really exciting bit,” says James, pausing for effect, “… is that the marginal cost is zero. Once we reach critical mass, it’s all profit. Every new investor just adds to our income.”
Angel 2 is not smiling. “Do you realise that in an industry where the marginal cost is zero, the price of the product trends to zero. That’s why newspapers are free online, why blogs are free, why there’s so much content for free. The internet killed the newspaper industry because it’s possible to distribute information for free.”
Angel 3 speaks for the first time. “OK, you’re a startup with no revenue. Fine, but I think I’m missing something important. I understand how you can design a website with some simple questions to establish a person’s risk appetite. I understand how you can buy ETFs in the market, that’s all easy. But you are taking people’s money. That involves identity checks, compliance, tax file numbers, reporting, tax returns, security, firewalls. It takes years to design and establish the systems and procedures for all that. Your coding mate must be a genius.”
“Yes, he is a genius, but not in that way. We’ve outsourced all that admin work to a company called General50. It’s a platform many of the financial advisers use. You’re right, we would never do all that ourselves.”
“And who pays for that?” said Angel 3.
“That’s part of our competitive advantage. We have negotiated a great price with General50 and we pay for it from our margin. It will cost about 20 to 25 basis points, depending on volume.”
Angel 2 again fiddles with his pad and pen. “So let’s look at the numbers for someone with say $10,000. To start with, you charge them $60 a year, that’s 0.6% per annum.”
John jumps in. “But it’s a flat cost, so only 0.06% on $100,000.”
Angel 2 carries on calmly. “Plus you charge 5 basis points a month … a month … which is equivalent to another 60 basis points or 0.60% a year. Or did I mishear that? I’ve never heard of anyone quoting their management costs in per month terms. That was not 5 basis point per annum charged monthly, was it?”
“No,” said John. “Per month, 5 basis points per month. Oh, and plus GST.”
Angel 2 is now shaking his head. “So on $10,000 …” He waited, the numbers running through his head, somewhat puzzling him. “The fee is 0.6% plus 0.6%, which is 1.2%. Is that it, is there anything else?
“But remember, that covers the advice and the admin,” said James. “Financial advisers charge at least $300 an hour, and they can take hours to give people this type of advice.”
Now it was Angel 1’s turn again. “But MyOutcome is simple investment advice, choosing between one of three portfolios. Financial advisers look at estate planning, insurance, super contributions … a wide range of planning issues. That’s what people pay for.”
“Not the 80% of people who never see a financial planner. That’s who we’re aiming for,” says James.
“OK, so let’s accept this is only investment advice. Come back to my question. 1.2%, is that the total cost for a $10,000 investor?”
John circled some numbers on the whiteboard for emphasis. “Yes, that’s what we charge. Oh, plus GST plus the cost of the ETF, which will average about 30 basis points, or 0.3%. But that is paid in the price of the ETF, it’s disguised in the ETF price.”
Angel 3 raises his eyebrows in surprise. “It’s still a cost to the investor. It is subtracted from the index return. So the return on the investment is index minus 30 basis points. Which combined with your 1.2%, takes the total cost over 1.5% for someone with $10,000. Do you realise there are retail and industry funds out there, offered by the big players, with multisector funds online for only 65 basis points all-in, for amounts above $1,000. These funds come with call centre support, comprehensive reporting and online tools, a big balance sheet should they make a mistake and need to compensate the investor, the comfort of dealing with someone who has been there for decades … versus … versus … you and your mates and a pretty website.”
There is silence in the room. John is fiddling with the seam on his trousers, James is feigning a smile. James speaks first. “But no financial advice, no risk analysis.”
“Your so-called risk analysis is a few basic questions to find out their risk tolerance. You don’t know what the rest of their assets look like. You might as well just ask one question. Like, “How much exposure to the stock market do you want?” and go from there. I can go onto a big bank website, check what their fund does using my own assessment of risk, and off I go for less than half the price you’re charging.”
“But we will provide the investor with planning tools using our algorithm which shows their likely outcomes, and they can choose one with say 20% certainty, 50% certainty or 80% certainty, and we will change their portfolio accordingly,” said James.
“Don’t tell me, let me guess,” said Angel 3. “Using a Monte Carlo simulation. You run 10,000 scenario tests to predict the range of outcomes.”
“Correct,” says James, proudly.
“We don’t have time for this now, but you will underestimate outlier results. There have been three falls in the stockmarket of over 50% in the last 40 years, but a Monte Carlo simulation predicts one every million years. Your models will be wrong on the downside. But like I said, that’s for another day.”
Angel 1 steps in. “Guys, I’ve done some work on the leading robo in the US, Betterment. Let’s compare your business to theirs.” He takes a sheet of paper from his jacket pocket. “For over $10,000, they charge 0.25%, no admin fee. Over $100,000, it’s 0.15%. Their average balance is $25,000, which at 0.25%, is $62.50. A lousy $62.50 per customer.”
James jumped in. “With no marginal cost.”
Angel 1 continues. “Do you know what CAC is, the Customer Acquisition Cost?” He does not wait for an answer. “It’s the most overlooked cost in all technology businesses. You think ‘we’ll build it and they will come’. It’s not like that. Betterment has been in the market for six years …”
James again. “And they already have $2.7 billion US dollars.”
“James, you’re talking about six years in the United States for the highest profile roboadvisor in the country. Vanguard manages $3 trillion, Charles Schwab well over $2 trillion. TRILLION. They have cash flows each week greater than the entire roboadvice industry. Let me tell you how Betterment gets its clients. They realised they were probably competing for the person who does it themself, or can’t be bothered. So now it pays other websites a finder’s fee of $40 per account. That’s most of the $62.50 charged in the first year. Do you know it costs $40,000 to sponsor a major financial advice conference for a couple of days? How many customers will you have, how much will it cost to find them and how much will be in their accounts within say three years?”
“We already have 2,000 Twitter followers, a Facebook page with over 5,000 likes, and each of us has at least 1,000 connections on LinkedIn. Part of the money we raise will go to advertising. Our budget says we will attract 2,000 people a year with an average balance of $20,000. That’s $40 million a year. 2,000 lots of the flat fee of $60 is $120,000, plus 0.6% of management fee on $40 million is another $240,000. So that’s about $360,000 by the end of the first year, or a million dollars after three years. Once we cover our fixed costs, our returns grow exponentially.”
“How much a year will it cost to run your business?”
“Depends how quickly we hire extra staff, but we hope to keep it under $1 million in the first year. That’s why we’re doing the capital raising.”
“Have you ever heard of the 10X rule? Common in Silicon Valley?” asked Angel 3.
John and James look at each other. “No,” they say in perfect unison.
“The rule says that a new entrant in an industry must be at least 10 times better than current products to overcome the incumbent market leader. Email is more than 10X faster than mail, Amazon has more than 10X as many books as any book store, Wikipedia has more than 10X the entries of other encyclopaedias. The winners redefine the industry. Amazon destroyed Borders, Apple killed Nokia, Netflix over Blockbuster. Is anything you are doing unique or can it be quickly copied by anyone?”
John this time. “We have a great team, our website is full of amazing graphics, our outcome tools show how much money an investor will have in 20 or 30 years based on different probabilities. They can plan whether to work longer or save more, focussing on ‘my outcome’. It’s better than anything out there at the moment.”
“But guys, there are hundreds of people like you in fintech hubs around Australia working on their own version of this. You’ll have a dozen competitors in your first year, and not just startups. Do you know that Blackrock, a major supplier of ETFs, just bought the Number 3 roboadvisor in the US for $150 million, a business called FutureAdvisor. This business only had a few million in revenue, no profits, but it had the systems. Blackrock has not bought it because they can make money from roboadvice. They want to direct people to their ETFs. The roboadvice will be free. How long before Blackrock roll it out here? And in the US with a market of investible assets of maybe $30 trillion, FutureAdvisor had gathered only $600 million in three years. The entire roboadvice funds in the US is less than one tenth of one percent of the market. You expect $120 million when most of that is locked up in the big banks, industry funds and self-managed super.”
“We know about all that,” scoffed James. “But there’s a massive backlash against banks flogging their own products. BlackRock can’t just sell its own funds. And you just proved how valuable our business is – when a big player pays $150 million for the technology instead of developing it themselves.”
“Nobody will worry about Blackrock selling its own ETFs when it’s free and just copying an index,” continued Angel 3. “It’s a commodity, they’re all the same. This is not pushing the product of an active manager who charges 200 basis points. If I invested in you, I’d worry there will soon be product in the market at a fraction of your price, yet you value MyOutcome at $5 million. Maybe, if one of the big guys panics and wants to buy some time, a neat website and some simple analytics, but that’s mainly their failing to be imaginative.”
Angel 2 had been quiet for a while. “Have you discussed this with any of the major players, the big banks for example?”
John laughs. “We don’t want them to know what we’re doing until we’re in the market. They know we’re the new kids on the block, the ones who will disrupt their industry.”
Angel 3 again. “One of the roles of an angel, even if we don’t invest, is to offer our guidance. I suggest you think far more B2B, that is Business to Business, and try to partner with one of the big guys. Your head is only in the B2C, or Business to Consumer, and the cost of finding consumers will chew all your capital. You will be on a continuous funding round trying to grow customers. In the most recent funding round, the Betterment CEO told his investors they would need to wait seven years for a return. Are you up for that?”
John and James looked at each other and nodded. James says, “We’re in this for the long haul. Whatever it takes.”
“So find a partner with existing clients. A major bank, a wealth manager, a super fund, maybe a national retailer, a newspaper, a financial newsletter with a big following … or your CAC will bury you.”
Angel 3 stood up and gave both James and John a business card. A glimmer of hope crossed their faces. “I love what you guys are doing. You could be like most of the other talented graduates who work for an investment bank or consultant and within a few years, you’d be earning half a million a year and set for life. Instead, you throw it all away and beg money from your family for your startup. The Next Big Thing. It’s wonderful and I hope it works for you. But sorry, guys, I’m out. Let me know when the all-in cost is less than 0.5%. That’s beating the retail and industry funds, or where they will go to soon, with their own analytics.”
Angel 1 jumps in. “Sorry, I’m also out. I hope you raise the capital before Blackrock and Schwab do the whole lot for free.”
John and James look at each other, then at Angel 2, their last remaining hope. He takes a long sip of a glass of water before speaking. “It’s an exciting journey you’re on, and I love that you’ve thrown away everything else to live your dream. If you work with me, I can get you the customers, but it won’t be direct to the market, waiting for people to visit your website. I’ll introduce you to the major players who want an offer for the clients they are currently turning away. You need me more than I need you, but I like what you’re doing. I’ll give you half a million dollars for 50% of MyOutcome. It will keep you going while I line up your clients.”
Five years later …
Graham Hand is Editor of Cuffelinks.
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