Why We Invested In Earnest: Inside A VC's Mindset

Earnest recently announced a $275M total raise (Series B + lending capital) on the back of well-earned momentum. As Series A investors in the company, I’ve been asked a lot of questions, including “Why/how did you pick that particular company in the more and more crowded fintech space?”  The short answer: our team at Wildcat Venture Partners has been excited about what the founders (Louis Beryl and Ben Hutchinson) are building since we first met them well over a year ago, and we continue to anticipate many more great things from them. The deeper answer represents a timely opportunity to share an inside look at the thought process that VCs often navigate when making investment decisions.

At a high-level, our decision to invest in any company is driven by three core factors: the market, the team, and the team’s unique insight. Using this three-pronged investment framework, the investment rationale unfolded as follows.

THE MARKET

Wildcat is a very thesis-focused investor, and we stick to our focuses with great discipline.  FinTech, especially alternative credit and payments, is one of our core thesis areas and has been for over five years. During the course of that time, we have made a number of investments in leading FinTech companies (including two proverbial unicorns, Kabbage and Coupa), and remain bullish on the category for the reasons detailed below. The primary drivers for our interest in FinTech, which we use consistently with our other thesis areas as well, include:

Rapid Scale In A Huge Market

Financial services, including the credit and payments sub-sectors, represent a huge segment of the economy – 20% of GDP in developed countries, or north of $13TN globally. Due to this size/scale and the omnipresent nature of financial services, technology-enabled companies can scale extraordinarily fast if they hit the right product/market fit.

Lack Of Competitive Barriers

Traditional financial services firms have meaningful challenges with customer acquisition, underwriting, and customer service due to bloated, inflexible, and incredibly expensive technology infrastructures in addition to siloed marketing channels built up over many decades. Agile technology-first competitors can leverage the latest and greatest in big data, analytics, cloud infrastructure, omni-channel digital marketing, and West Coast user experience design (Tech’s version of the West Coast Offense), at a pace and effectiveness that traditional financial institutions simply cannot match.

Large Opportunities To Transform Or Disrupt

Our core overarching investment strategy is to find companies that can unlock massive trapped value (hence the wildcatter nom de guerre). Financial services is a Permian Basin (look it up :)) of trapped value across many, many areas. Scale — and all the fossilized infrastructure, business processes, archaic regulation, and myopic strategy that come with it—now work against the incumbents. This has created vast areas of inefficiency, customer indifference (at best), and often misaligned product/market fit that survives only because there has been no alternative.

Earnest’s core business of alternative lending and their vision to build the bank of the future fit squarely with our FinTech focus and has a large addressable market.

THE TEAM

We are entrepreneur-first investors, and, as a result, we average six or more months getting to know an entrepreneur before making an investment. Long experience from our 30+ year venture investing portfolio, as well as across the VC landscape generally, shows a highly correlated link between entrepreneurs who “go all the way” (either as CEO or in a key role) and investment returns; domain knowledge and business building experience are key factors, among others, in assessing an entrepreneur’s ability to “go all the way”. Conversely, we have found a low correlation to successful outcomes when much of the capital we invest is spent on educating entrepreneurs, whether about the markets they are pursuing or about how to build a successful, legitimate business and not simply great products.

Louis, Ben and the rest of the team are impressive entrepreneurs with firm, experience-based views on their market and how to build a business. They are very open to feedback, learning, and coaching, but they also have a well-grounded vision, point of view, and set of principles against which to apply them. At the end of the day, it’s not just about being smart (which they undoubtedly are): it’s much more about minimizing mistakes and wasted motion and money, which, most often, only experience can provide.

One great example of this: while they were only a few months into generating revenue when we met them, Louis and Ben already had a very sophisticated view and plan for team development.  Financial services firms are more complex organizationally then most, in particular in areas around risk, credit, fraud/security, customer service, collections, etc.  These are all make-or-break functions in FinTech.  The founders had remarkably sophisticated and experienced financial people either onboard already or targeted for hire post-financing. These were people and hires that would only be possible with significant experience in and understanding of financial services, as well as quality networks in the FinTech sector.

THE INSIGHT

We have a strong point-of-view as a firm on opportunities in FinTech that derive from the misjudging of risk and the resulting mis-pricing of credit. In a world where massive data can be accessed about a person or business—and that data can be analyzed at remarkably low cost with remarkably high precision—traditional underwriting seems downright barbaric and cruel. Conventional methods also add a real and very unnecessary drag on the economy by mistakenly or incorrectly (or unfairly) denying credit to significant segments of the population.

We immediately connected with Earnest’s vision to serve prime borrowers who are classified as subprime or ineligible by currently arcane underwriting processes. Examples of this include recent college graduates with good jobs, but a poor credit history from their student days; non W-2 income earners such as small business owners, lawyers, doctors, veterinarians, venture capitalists :); and others who have what the financial services industry calls “thin files”–people with limited proof of income, assets, job history, etc.

I’m pretty sure both my plumber and electrician make more than my primary care physician, but what they all have in common is that they have very good income, are often in need of credit or to re-finance credit that is more expensive than it should be (e.g., student loans), yet for different reasons, the former often have a hard time getting credit, especially at reasonable and fair rates. And if my doctor is in a small two person practice (as he is), or recently out of med school, he is struggling to get credit, too.

Earnest is differentiated in bringing a very high “digital touch” user experience, exceptional understanding of each customer based on sophisticated analytics, proper underwriting of the user’s credit worthiness and cost of credit, and outstanding customer service and follow-up, again leveraging data and the web. Not surprisingly, all of these factors earn them a remarkable Net Promoter Score, especially for a financial services firm.

SUMMARY

Hopefully this is a useful peek into how we, as investors, think about opportunities and make investment decisions. Big markets undergoing major transformation and disruption, smart entrepreneurs with genuine market and company building know-how (or at least exposure), and unique, often contrarian insights about a specific market opportunity are qualities that are likely to earn you a lot of investor attention.

Read the original blog post in Forbes here.