Wirecard raises the bar for fintech due diligence: Understand the partnerships
Weekend Reading / Global

Wirecard raises the bar for fintech due diligence: Understand the partnerships

  • Wirecard depended on shady partners for revenue, while many fintechs depended on Wirecard for payments infrastructure

  • Revenue and infrastructure partnerships enable flexibility, innovation and speed, but can also be a source of risk

  • The saga shows that fintech investors should incorporate infrastructure and partnerships into their diligence process

Paul Domjan
Paul Domjan

Senior Contributing Analyst

Tellimer Research
18 July 2020
Published byTellimer Research

I personally began to worry about Wirecard in 2016, when Zatarra Research published its damning investigation into the company. In the intervening year, I watched with both amusement and dismay as Wirecard went from strength to strength, joining the DAX 30 and raising €900mn from Softbank. The amusement faded, and the dismay darkened, however, every time I read the fine print on an ad for the latest fintech and found that their payment services were being provided by Wirecard. Did customers realise that they were doing business with a company accused of serious fraud? Had investors considered the risk that Wirecard posed to these businesses? Did they even know that the companies they were investing in depended on Wirecard?

Let’s hit the rocket boosters

When I coach and mentor start-ups and early stage tech businesses, I always tell them that a founder only has one job: achieve product-market fit and growth will follow. Marc Andreessen defines product-market fit as “being in a good market with a product that can satisfy that market.” The tech space obsesses about product-market fit: conducting user interviews to understand where there is unmet need, constructing so-called North Star metrics to assess whether the product is meeting that need, using growth accounting and cohort analysis to track which parts of the user base are achieving that North Star, and aligning marketing messages and sales compensation to target segments and clients with good product-market fit. All of this focus on achieving product-market fit is indeed tremendously important because it is the foundation of a business that can grow, and I work with clients every day to do these things.

Once you have product-market fit, investors want to see growth. Indeed, when investors lack the data or tools to quantitatively assess product-market fit, growth often is seen as prima facie evidence that the firm has achieved product-market fit.

It’s time, as a founder who sold his business to AirBnB put it to me, “to hit the rocket boosters.”

But what are those rocket boosters? Typically, there is some sort of partner model for client acquisition to grow the user base faster and outsourced infrastructure that can scale with that growth. Nobody would launch a satellite without properly understanding the launch vehicle; fintech investors need to give the same focus to understanding their rocket boosters.

Inspect the foundations and understand the ecosystem

Both revenue and infrastructure partnerships are important parts of the ecosystem for growth, but the story of Wirecard highlights the importance of fintech investors understanding the infrastructure upon which the businesses in which they invest are built.

Partnerships can accelerate growth, but they are complex to build and hard for investors to perform due diligence checks on. One of the major realisations in the course of the FT’s investigation of Wirecard, which had been touted as Europe’s greatest fintech, was that half of Wirecard’s revenue and nearly all of its profits came through partners in Dubai, the Philippines and Singapore. Investors in Wirecard needed to know that they were taking risk on these previously unheard-of partners.

Market infrastructure is complicated and costly, so many fintech businesses are sexy applications with good product-market fit running on outsourced market infrastructure. Outsourced market infrastructure has enabled smaller fintechs to succeed, making the fintech space more flexible and dynamic despite the complexity of regulated finance. For many European fintechs, this has meant using Wirecard for payments. These businesses may never have questioned the wisdom of using Wirecard any more than they questioned the wisdom of using Amazon Web Services for hosting. After all, Wirecard was a regulated entity with authorisation to provide these services.

Beyond Wirecard

That all changed on 26 June, when the FCA froze Wirecard’s UK accounts. Not only did that impact Wirecard customers, but it meant that customers of fintechs that used Wirecard infrastructure, like Curve, Anna Money and Pockit, suddenly had the double disappointment of finding their accounts frozen and learning that they were not eligible for deposit insurance, because neither the fintechs they were “banking” with nor Wirecard UK were banks. Curve, to use one example, was lucky to be able to become a direct member of the Mastercard network over the weekend of 27-28 June. I doubt that many Curve investors or customers knew that they had exposure to Wirecard or thought carefully about the risks that might entail. Fortunately, the fraud did not impact the value of customer funds held by Wirecard UK and Ireland Limited, and Wirecard UK was able to resume operations four days later.

Wirecard isn’t the only recent case in which the failure of one fintech has put another firm’s products at risk. In an even more recent example, just this Sunday (12 July), the Israel Discount Bank experienced a mini bank run on funds in its mobile payments app. The app was based on technology licensed in 2014 from a fintech start-up, PayBox Payment Solutions. Although the Discount Bank claims that it no longer has any connection with the start-up, customers still began to withdraw funds from the app when PayBox went into liquidation earlier this month.

And to the future…

Tech investors need to go beyond the story of the application or the use case and understand the real detail of the business, the partnerships upon which it relies and the ecosystem that supports it. My colleagues at Tellimer, Tracy Kivunyu and Rohit Kumar, have looked at cloud computing partnerships in Africa and EM digital payments platforms, respectively, as well as some aspects of the ecosystems they inhabit.