QED Investors newsletter January 2024

As the holiday season concludes and we begin 2024, I'm filled with pride, gratitude and optimism.

I'm heartened by the team QED has assembled to tackle the unbelievable opportunity ahead of us in fintech and I'm deeply proud of how we have helped our portfolio companies weather the storm of the violent vicissitudes of the past 12 months specifically and more generally since the onset of COVID-19 some three-and-a-half years ago.

I'm grateful for the unwavering support of our existing investors and for the trust shown in us by the new fund managers who invested in us for the time time as we raised almost $1 billion this summer for our eighth early and second early growth fund.

And I'm optimistic that we have crested the hump of a rocky macro economic climate that has been continually pounded by pandemics, wars, rampant inflation and supply chain disruptions.

This, too, shall pass. It must pass. Interest rates will come down.

Valuations will continue to regress to an historical mean from the peak madness. Deal flow will increase. M&A activity will pick up. The IPO window will gradually open, even though not fully perhaps until the middle of 2025. Liquidity and equilibrium will return.

Through it all, the traits of successful leaders will persist. Continue to be restless. Show curiosity. Be intellectually honest and follow your North Star. Focus on adding value to amazing teams with breakthrough ambition.

Here's to a healthy and prosperous New Year.

- Nigel Morris, Managing Partner ??

QED's 2024 Predictions

Frank Rotman, Co-founder & Chief Investment Officer There’s a battle of giants right now and it’s a question of who will win. I anticipate that we’ll see competition continue to heat up, as OpenAI and Google compete to be market leaders. Google can’t lose this battle. I don’t know if people appreciate that Google’s business might be the best business ever created in the history of humanity, and that’s not an overstatement.?

Google is under attack, and I think we’ll see its core business dissolve as it shifts resources to the AI fight. You have one of the deepest-pocketed players who can’t NOT win this game. And they’re competing against other well-funded players like OpenAI and, they can’t NOT win either, given how much money has been put into the platform.?

There is room for smaller players to come in, and I expect to see more emerge in 2024 but, for the generic AGI-oriented LLMs, they’re going to be a bunch of very well-trained models that you can pick up off of the shelf.?

You can’t imagine deeper-pocketed players playing this game. The question is, who will win? ??

Laura Bock, Partner

After five quarters of declining deal activity since Q1 2022, I expect a bounce back in fintech deal activity in the U.S. Many companies have done a bridge round, if not multiple rounds, but will need to come to open market for a full raise.

According to proprietary SVB data, 53 percent of fintechs will be cash out by Q3 2024 if they do not raise or exit. After several years of fintech startup shutdowns being few and far between, we will unfortunately continue to see more failures, including high-profile fintech bankruptcies.

While that threat is real, there are also several opportunities for fintechs in 2024, particularly among regtech startups as fintechs continue to ensure they are buttoned up on the regulatory and compliance front. Regulators rolled up their sleeves when it came to rule-making for fintech in 2023.

For example, this past summer, the OCC, FDIC and Federal Reserve collaborated to issue guidance on third-party relationships, declaring that banks are responsible for the risk of their fintech partners. In the past few quarters, regulators have put increasing pressure on partner banks to better manage the neobanks they power.

Thematically, there are a number of interesting trends to look forward to in 2024:

1. Industries impacted more by interest rates, like lending and real estate, will continue to need to tamper expectations. Infrastructure and financial software should fare better.? ?
2. Digital payments surged during the pandemic and?this hasn’t slowed. People now prefer contactless payments and are looking for easier, more contextual ways of paying. This trend will continue into B2B where opportunity still abounds. B2B payments volume is massive (5x B2C) but digitization is in the earliest innings. ? ?
3. On the back of Section 1033 of Dodd-Frank, open banking, in which banks and fintechs share data, will continue to grow. Open banking systems will give consumers more control over their data and enable them to do more from a personal financial management perspective. This will present opportunities for the infrastructure players that help facilitate this securing sharing of data and for fintechs to create new user experiences powered by this data.? ?
4. The march towards embedded finance will continue. The next generation of payfac-as-a-service is helping enable embedded payments in the solutions in which consumers and businesses transact. ?
5. As LLM and other AI models continue to improve, more fintechs will employ these models to deliver new products and services. Financial services will become more personalized as tailored advice on once only available to the high net worth will be more accessible to a broader audience.? ?
6. The adoption of real-time payments will increase. Real-time more sophisticated fraud solutions will be needed.

Chuckie Reddy, Partner, Head of Early Stage Growth

• 2024 will be a pivotal year for VC.?The Band-Aids applied to keep companies alive will mostly not hold until the end of 2024. It’ll be a time to make the tough choices after a couple years of fearing the shoes will drop.?But, as we’ve seen, innovation can’t be stopped. ?
• As some post-COVID trends retreat, and people choose to spend more leisure time at work again, both gaming (video games) and gaming (sports betting) will have nice tailwinds.?We'll likely see more dollars attracted to both industries in infrastructure – largely in payments, but also in identity. ?
• Elsewhere, data analytics and insights are just beginning their own full refresh of innovation using next generation technology.?There are such wide ranging use cases which will manifest themselves over a multi-year cycle. It may sound like a boring category, but you’ll be left wondering, “how did they know that?"

Bill Cilluffo, Head of Early Stage Investments

• The trend toward markets valuing unit economics and profitability will continue. After two years of companies focused on reducing burn and getting to break-even will also continue. However, as many companies will have made great progress there, a focus on growing will start to become more of the dialogue. ?
• Cross-border topics will continue to be important -- in cross-border payments, trade finance, the use of crypto rails to facilitate, and FX. The world is still settling into new patterns post COVID?in trade, shipping and e-commerce and will need new and better solutions. ?
• The hunt for transformational fintech businesses built on AI will continue. There haven’t really been many yet. Lots of tactical wins, but few transformational plays.?It's hard to see if some will really start in 2024, but everyone is searching. ?
• We will start to see more M&A, both large companies buying interesting fintechs, once burn is lower and they can be absorbed. But also mergers within fintechs, where companies can fill in each others gaps?and further scale can enable them to better compete.

Amias Gerety, Partner

• Open Banking finally arrives: CFPB finalizes the?1033 rule, banks fail to change the?rule to enable them to have preferred providers, but nonetheless, the reality of industry data standards heralds a new era of competition on financial data where the pressure?moves from access to data quality and enrichment and analytics. ?
• Banking as a Service stabilizes as weaker players exit and stronger banks step up to meet the new standards.?In particular, regulators begin to communicate more clearly their "supply chain" expectations as they continue to make clear that?banking as a service providers need to be facilitating partnerships between banks and fintechs, rather than acting in the shoes of the bank on compliance and fintech partnership.? ?
• Real-time payments sees traction with its first commercial use case.?Following the lead of Robinhood, trading apps, gaming and digital wallets offer instant withdrawals for a fee.? ?

Maryalice Viljoen, Vice President of Administration & Talent

• Expect a more recovery-friendly workplace. The Biden Administration recently released a?recovery ready workplace toolkit?that provides resources to assist employers in preventing and responding more effectively to employer substance misuse. ?
• Additionally, look for more?recovery-supportive work cultures?with a transition from team activities that are alcohol focused to ones that are healthier in nature (read: less happy hours and more walking challenges). ?
• Anticipate a growing expectation that?mental wellness and behavioral health support be included in basic health benefits?offered by employers. ?
• Leadership will be challenged to offer?practical, hands-on training?to managers and supervisors about how to communicate about mental illness and create a safe environment for discussing the topic and how to assist employees who seek help for issues. ?
• Similar to the ESG score that measures a workplace culture's sustainability and ethical performance, look for a?similar tool to universally measure the mental health of an organization?in a consistent and meaningful way.

Alexandra Piedrahita, Principal ?

Wealthtech will be back in and AI will finally enable advisory work to be enabled at scale for the elusive "mass affluent." ?

With a background in the asset management space, I have always had an eye for the sector as a VC. However, when I entered the industry back in 2020, the sector was highly unfavoured. An onslaught of so called "PFMs" had entered the market, raised?more than $1.9 billion in funding from VCs, which lead to CAC wars that made unit economics untenable for the a product that was hard to monetize to begin with. ?

This negative outlook frustrated me as we all know that as consumers, we are simply not satisfied with?today's wealthtech solutions. We still lack that "holy grail" solution that gives us 1) visibility into our wealth spread across assets, 2) access to a variety of products to invest in 3) enough advice as to what suitable products would be for our own goals and risk appetite. ?

However, one seismic shift dramatically altered the outlook for wealthtech businesses in 2023, and we see another coming in 2024 that will steal the show. We think the combination of these two shifts will finally enable wealthtech to fulfill both its customer promise as well as business potential. ? What happened in 2023? Rising rates catalyzed wealthtech businesses in three ways:?

1. 4-5% Interest products attract more customers - being able to offer 4.5% interest on accounts with no lock-up (as Chase UK and several other platforms are) attracts customers in hoards. It has dramatically lowered CACs for these businesses. ?
2. An overall inflationary environment alerts more consumers that they need to put money to work in order to just maintain (let alone grow) their net worth. ?
3. Interest income from idle cash balances, and the spread businesses are able to generate on interest products, have provided a new revenue channel that have partly answered the monetization struggle of this sector.

What do we see coming in 2024? AI will finally enable the third frontier of wealthtech at scale: Advisory. ? Despite the demand from consumers, advisory has remained a tricky product for wealthtechs to offer effectively at scale.

The tradeoffs between automating more with bots versus enabling more personalized solutions with human-in-the-loop has challenged many. But one thing will promise to change that; AI. This will take place in two key forms;?

1. Technology that enables wealth managers?today:?Will AI fully displace the wealth manager? No. There will always be customer segment that will want a human advisor. Many AI-based solutions will be built to serve advisors across 1) data and analytics, helping consolidate public and private information, 2) automate workflows, from compliance to execution, and 3) generate communication, reporting for clients. And there is significant pull from the wealth management market for these products - four in five financial advisors expect to use AI in their own processes in the next few years. ?
2. DTC wealthtech?- The core of the "mass affluent" segment that wealthtechs have often gone after are the "HENRY's" - High Earner Not Rich Yet. These are consumers with $50,000-$1 million?in wealth that want to invest but don't want to go to wealth managers because a) they think they can do it better themselves, b) they don't want to pay the fees, and c) they are digitally native and don't want to be held back by human-in-the-loop interactions. This segment want very personalized advice, delivered through tech, at the lowest possible fee. The advent of LLMs and personal GPTs will finally enable advisory to be accurate, personalized?and be offered through tech at scale.

Yusuf ?zdalga, Partner, Head of UK and Europe

1. M&A in VC land, including GPs: More M&A was a prediction for 2023, and it is set to continue in 2024. We also now expect more GPs?to enter the M&A conversations, meaning we will see more GPs?merging with one another or acquiring one another. ?
2. Secondaries to pick up: We have seen a some secondary activity, but we expect that to pick up in 2024, meaning many funds will be looking to sell their holdings or positions to other funds. ?
3. The dominance of "macro": Whether it is central banks making rate decisions, or voters going to the polls, macro and political events will dominate the headlines. Key things to watch will be U.S. elections, UK elections, central bank rates and?the wars in Russia and the Middle East, just to name a few.? ?
4. RIP ZIRP strikes home: While rates may come down, the zero interest rate environment will not return, and this will start to sink in with the investor community to an increasing extent. With zero rates, a 2x return over 10 years is also a 2x "real" return, but with 5% risk free rates, a 2x return over 10 years is actually only a 1x "real" return.? ?
5. Regulation will?continue: As we had predicted for 2023, regulators will start taking stronger positions on financial services innovation. In 2023 we had seen this impact crypto, in 2024 this?will continue, but we will see more regulation of AI, and lots of debate and regulatory action on how to approach data protection, intellectual property?etc. In Europe, there will?be a continued strong regulatory push to find and sponsor?local champions in the world of AI.

Mike Packer, Partner; Ana Cristina Gadala-Maria, Principal, Latin America? M&A:?

Generally, we anticipate 2024 will be a year of further consolidation in the market. With fundraising markets still rough, companies are finding resilience through M&A or in several cases ceasing operations.

A year from now, we expect there will be fewer startups in crowded spaces, and a continued trend of mergers and acquisitions.?

Nearshoring:?We’re excited about nearshoring and the wave of innovation it will bring to Mexico. With over $33B of investment made in the last 12 months, and 150+ companies setting up operations in Mexico, we expect many opportunities for new businesses. This includes cross-border payments, processing payroll, AR/AP management, and supply marketplaces.??

Cross-border Payments & Global Trade:?We continue to be excited about cross-border payments and global trade. Nobody has solved global payments at scale, and based on the early businesses we are seeing, 2024 should be a year of building and learning - discovering how to build the rails to make cross-border payments work. Businesses that revolve around global trade will continue to flourish as the tailwinds remain strong.

AI:?We believe AI will be a common undercurrent to businesses in LatAm in 2024. We expect this to manifest more as a tool for efficiency than necessarily new business models and are holding higher standards for companies when it comes to fully leveraging the power of AI. Businesses should be fully taking advantage of AI for customer service, analytics, and marketing, among others.?

Macro:?Interest rates should start to come down in 2024, both in the U.S. and LatAm economies. This should provide a much-needed jolt to capital markets (particularly debt) and relief to the average consumer’s wallet. Mortgages, credit card spending, and financing in general should be stimulated in a positive way if this comes into effect, and delinquencies should begin to lower.