Investing in a more diverse fintech future

Investing in a more diverse fintech future

In the ultracompetitive fintech space, it’s hard for any startup to attract funding, and it’s even harder for Black, Hispanic, women and LGBTQ entrepreneurs.

Elizabeth McCluskey from the Discovery Fund at CUNA Mutual joins us to discuss investing in fintechs being started up by members of underrepresented groups.

A few takeaways from the conversation:

  • She sees her fund’s role as identifying promising businesses and getting capital into their hands to add more diversity to the industry.
  • Most credit union membership growth is from multicultural consumers, and fintechs from these communities may know how to best meet their needs.
  • The Discovery Fund is focusing on solutions to help with cash flow and budgeting, credit access and wealth building for low-income consumers.

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In the competitive fintech space, it’s hard for any startup to attract investor funding. But it’s especially hard for entrepreneurs who are Black, Hispanic, women or from the LGBTQ community. Joining us is Elizabeth McCluskey, who heads the Discovery Fund at CUNA Mutual Group. She’s here to talk about the venture capital fund and about investing in fintechs led by founders from underrepresented demographics. Elizabeth, thank you for being here on the BAI Banking Strategies podcast…

Thank you. I’m excited to be here.

Elizabeth, we’ll be mostly talking about the Discovery Fund today, but let’s back up a bit and get some general background on CUNA Mutual. You provide products and services to credit unions, but tell us more about what you do and how your organization is growing and changing to keep pace with the significant changes in the industry that we’re seeing.

CUNA Mutual traces our origins back to the great depression when the company launched as an insurance provider for credit unions. Our mission then is really the same today, which is to help hardworking people build financial security. We execute that through relationships with over 95% of credit unions in the U.S., as well as other financial institutions, corporations and we also work with consumers directly. We launched CMFG Ventures in 2016 as a strategic fund to drive new growth and identify opportunities to help credit unions remain relevant in a rapidly evolving financial environment. Our Ventures arm builds connections between financial institutions and fintechs, while keeping that mission in mind of helping consumers achieve financial security. As part of the CUNA Mutual ecosystem, we are always trying to surface and support new innovators in the financial services space through both our investments and then partnerships with our parent organization. And so that strategy has been bearing fruit with a growing number of portfolio companies that are actually being offered to the financial institutions that CUNA Mutual serves through our newly launched fintech solutions group, which we can talk about more later in the podcast.

And we will be talking about it more later in the podcast. But a little more scene setting here, I want to ask you about how you’re thinking about the relationship between credit unions and fintechs in a broad sense. For banks, we’ve certainly seen an evolution in the fintech-bank relationship from one of intense rivalry to one with more opportunities and openness to partnerships. Is that the same thing that’s going on inside the credit union world as well?

Yes, that’s definitely aligned with what we’ve seen. I think it makes sense when you think about credit unions partnering with fintechs because credit unions can bring their existing membership bases, those trusted relationships, as well as banking licenses and compliance expertise and low-cost deposits. Credit unions are bringing a lot to the table that fintechs are interested in accessing and partnering with. Then on the fintech side, they’re contributing world-class technology and ability to hyperfocus on one particular solution, as well as the flexibility and agility to adapt as technology evolves. And so I think because those two parts of the equation really go together nicely, we’ve seen a major uptick in credit unions who consider fintech partnerships important to their organization. From some survey results, we saw credit unions who considered fintech partnerships important going from 49% in 2019 % to 89% in 2021. I think COVID has really accelerated the pursuit of these partnerships, and I think there’s a lot more opportunities to come between credit unions and fintechs when it comes to partnerships.

Now it’s time to shift our conversation over to the Discovery Fund. Elizabeth, give us, if you could a brief overview of the fund, that includes its objectives, where the idea for the fund came from, how much money is in it, how long it’s been around, that sort of general stuff.

We launched the fund in July of 2021. We are investing about $5 million a year into early-stage fintech companies that are led by underrepresented founders, which for us we characterize as women, people of color and LGBTQ entrepreneurs. The fund was launched in the wake of a lot of the social justice conversations that were happening in 2020 and CUNA Mutual has long been committed to diversity, equity and inclusion, both in terms of our own employees, the customers we serve, and supporting the financial institutions that we work with, so it was the natural next step for us to extend that strategy into our Ventures portfolio.

The tech industry as a whole is heavily skewed toward white and male. There’s been a lot of discussion and a lot has been written about that in recent years, how this skewing impacts products being developed and how algorithms are created. Does the diversity profile of the fintechs segment differ in any meaningful way from the technology industry overall?

I would say unfortunately not. I think it’s pretty representative of the tech industry overall, and I do think it bears repeating just how underrepresented most of the U.S. population is when it comes to who is getting funding in the sector. Women founders receive less than 3% of venture capital funding annually. That number really hasn’t moved materially in the last 10 years. The same pattern goes for black and Hispanic founders, who’ve received 1-2% of venture capital dollars for the last five years, with just slight upticks recently. There’s plenty of diverse founders out there who are building compelling businesses. We see it as our job as the check writers to go out and find them and fund them and foster that representation within fintech.

This is a venture capital play focused on underrepresented segments of the fintechs entrepreneur community. What’s in it for CUNA Mutual to target what, based on the statistics that you’re offering, seems to be a pretty niche opportunity set?

We actually think this is the opposite of a niche opportunity. The reason these founders are defined as underrepresented is because the level of funding they received is so far below their demographic representation. Over 60% of credit union membership growth is coming from multicultural consumers, and as high as 20% of Gen Z identifies as LGBTQ. Financial institutions really have to come to terms with the fact that they have an increasingly diverse set of consumers whose needs they need to serve. And we think the people who are best positioned to build solutions for these diverse consumers are those who come from these communities, who have lived the same financial experiences that their peers have and know where those pain points are and how to address them. We think this is not only the right thing to do from a representation perspective, but we think it’s an overlooked opportunity for financial returns.

What are you looking for when you’re assessing potential investment? How early are you looking to get in on a company and what level of funding do you provide for the companies in which you invest?

We are investing primarily in pre-seed and seed-stage companies that are focused on solutions for financial inclusion. We’re looking for companies that are post-idea stage, but still fairly early. Ideally, they have their product built out, even though they might be pre-revenue or have just a handful of customers at that point. We invest in a mix of direct-to-consumer and B2B business models, as long as the underlying objective of the company is to improve access or affordability of financial services for underserved consumers. And because we want to play that catalytic role in these early-stage companies and support founders who may not have received attention from other venture capitalists, we’re typically part of that first or second round of institutional funding, and our check size – commensurate with the size of the round – is $250,000 to $500,000.

On the part of that question about what you’re looking for when you’re assessing the potential investment. You mentioned the stage, but what are you looking for in the entrepreneurs that you’re looking to invest in?

Because these are such early-stage companies, there’s often not a lot of financial metrics to grasp onto, so it is a lot of evaluation of the entrepreneur and of the founder. And so we spend a lot of time with them, understanding what are their motivations for solving this problem? What is their experience with it? Has it been in a personal or professional capacity? Have they been able to attract other people to their mission, whether that’s early employees that they’ve hired, other investors that are at the table or advisors who have been working with them, and getting some perspective from those people, have the founders been open to feedback and coaching and are they looking to build a relationship with us where they can trust us we can trust them to actually have an iterative dialogue where we can provide them some counsel and some guidance over time and just let them know that we’re there to support them? Because I think being an entrepreneur can be an often lonely journey, and so we want someone who’s open to us, not just as a cheque writer, but really as a partner in growing their business.

The goal here is to promote diversity in fintechs, but it’s also to make a worthwhile financial gain, right? In terms of balancing risk and reward, does the fund approach potential investments using the standard metrics that your typical hardnosed VC type of investor might use? Or are you willing to consider a broader range of potential risk metrics when deciding whether to invest? And if that’s the case, what metrics do you look to?

We don’t think you have to sacrifice returns or take on more risk to invest in diverse founders. We think that the demographic trends and market patterns are compelling to support a thesis of investing in diverse founders. We actually think we’re ahead of the curve here in finding some of the next big opportunities and investing in them early. We have the same financial return expectations as other venture capitalists. It just so happens that our investment thesis centers on diverse founders and financial inclusion. That’s not to say that these investments are not risky at all, because at the early stage, everything is. It’s not that we are making investments that are not risky. We just don’t think they’re riskier than those who don’t have this explicit investment lens.

Do you offer other nurturing beyond the monetary part? I’m thinking, for instance, about mentoring, about coaching, maybe strategy development, that sort of thing – things that might give the companies you seed a better chance to succeed in the long run?

That is a big part of our value add and I think the venture capital world has been fairly competitive for the last couple of years where entrepreneurs have had their choice of who they’re taking a check from. And so I think you do have to distinguish yourself as being able to add value besides just a check. Whether portfolio companies are part of our Discovery Fund or part of CMFG Ventures, our team is always communicating with our companies regularly to see how we can support them. Sometimes that’s giving them feedback on a pitch or talking them through a fundraising strategy and making introductions to other investors. Often our unique value ad is making introductions to credit unions and other financial institutions, where CUNA Mutual Group has those deeply established relationships. Our fintech solutions group is actually going out and selling on behalf of a handful of portfolio companies today. So we hope to grow the number of companies we’re able to do that on behalf of going forward.

No doubt, you and CMFG ventures, you’ve spent a lot of time thinking through the fund’s objectives and the strategy, gaming out different scenarios, asking a lot of “what ifs” before that first investment dollar went out the door. But even with all this upfront work, you couldn’t possibly have anticipated everything that you’ve run into along the way. What are some of the surprises, maybe some of the key lessons that you and the Discovery Fund team have learned during your first year or so of operation?

The lesson I’ve learned before, and I have to keep learning it. I think entrepreneurs are eternally optimistic and as venture capitalists, we tend to drink a little bit of that Kool-Aid as well, but we have to be realistic too. And so I think everything in the startup world takes longer than you expect. Sales cycles are longer, building products takes longer, fundraising takes longer, hiring takes longer. And so it’s my job as an investor to coach entrepreneurs based on some of those patterns I’ve seen play out over time and make sure they’re setting themselves up for success, which means encouraging them to have a scrappy attitude, focusing on cash management and setting expectations, both internally and externally, to appropriately allow for some cushion when things don’t go according to plans.

Kind of a follow to that. What areas in the fintech space are you seeing as particularly attractive these days in terms of where you want to invest and what makes those areas attractive to you? Add on to that, how do these areas line up with your mission to invest with entrepreneurs from underrepresented groups?

It’s a very interesting time in the fintech investment space because we have some economic conditions we haven’t seen in quite some time. In some people’s cases, they’ve never seen them in their lifetime. For example, sustained rising interest rates, potentially on the verge of a recession. We’re doubling down on some of the themes that we’ve been focused on, because we think they’re going to be even more important in an environment where people’s economic status is more uncertain, or potentially not as strong as it has been. Liquidity management is one area of focus where we’re looking for tools that can help people manage their cash flow, their budgeting, and just basic checking and saving needs. Another area is credit access. We’re looking for solutions around credit building, alternative credit and then affordable loans, whether they’re personal, student, mortgage, auto, etc. Especially important in a rising interest rate environment where people are going to be facing much higher financing and credit costs than they have been used to. Then the last area is wealth building, so looking for investment and retirement solutions, particularly for low and moderate-income consumers who have had low participation in the stock market. But that really is where the bulk of wealth generation has happened for the last decade.

This has been a really great conversation laying out what the Discovery Fund is and how it works. Thank you so much, Elizabeth, for that. I’d like to wrap things up by having you share with us a couple of what you see as your most successful investments to date and what makes them successful. I know it’s early and that it takes time to really know for sure how these kinds of investments are going to pan out, but with your experience in the VC space, you also know the promising signs to look for at this stage of the process, so share some of those with us.

First one I’d love to call out is called Line, which was actually one of the first investments we made out of the Discovery Fund. It’s about a year old at this point. We invested in them  pre-launch. They were a very early-stage company. It was a lot of faith and a bet on the entrepreneur. They have just exploded and exceeded all expectations right out of the gate. Their business is helping consumers get really small dollar amounts, so $20 to $500 for emergencies, and they do not require credit checks. They don’t charge interest or late fees. It’s just a simple subscription model with plans that are starting at under $2 a month. They’re also arming consumers with tools around financial education services to save, spend, and plan better. They’re exciting because they’ve seen this tremendous user growth. They have really low default rate, so their model is working and they’re helping people actually get these financial lifelines they wouldn’t have otherwise had access to. So both from a financial returns potential and an impact realized, we’re already starting to see some really promising indicators for Line. Then the second one is called Zirtue, which is a relationship-based lending and alternative bill pay application. They simplify loans between friends and family with automatic monthly loan payments. I love this founder. I love their mission. I think they have a pretty simple model that just intuitively makes sense. They’ve gotten some really strong traction so far with enterprise customers, like utility companies and health care systems. And so we’re hoping to make some introductions on their behalf to credit unions because I think that could be a really synergistic partnership between a fintech and credit unions. But we will ask you to stay tuned on that one.

OK, and we will stay tuned indeed. Elizabeth McCluskey, director of the Discovery Fund at CUNA Mutual, many thanks again for joining us on the BAI Banking Strategies podcast.

Thank you. It was my pleasure.

Elizabeth McCluskey, is Head of Discovery Fund at CUNA Mutual Group.

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