Illuminate Financial Management, founded in 2014 in London, is a venture capital firm funding financial technology startups that have the potential to effect real change within capital markets. Since late 2015, folks at Illuminate have been investing from the IFM Fintech Opportunities Fund, which counts Deutsche Boerse Group and Markit among its LPs.
The operating model at Illuminate starts with the close partnerships they have formed with firms within the capital markets ecosystem, including buy- and sell-side firms, infrastructure providers, and capital-markets-focused information service providers. These partners, a number of which are also strategic investors in the fund, help focus Illuminate’s investment team on solutions that resolve specific problems in capital markets. In this way, they expect to avoid investing in solutions that are still in search of a problem.
Illuminate looks primarily at late seed and series A stage deals. Current portfolio companies are CloudMargin, a web-based collateral management system, ChartIQ, which offers charting and data visualization solutions, and Privitar, which provides data risk and privacy management solutions.
In this specialized corner of FinTech, startups are likely to be selling to capital markets incumbents rather than trying to displace them. But, FinTech firms hoping to serve capital markets players face multiple, well-known challenges. Financial institutions are often slow to adopt new technologies, and vendor management and procurement processes are focused on contracting multi-million-dollar enterprise solutions from billion-dollar corporations. Illuminate expects to add value for portfolio companies by making connections between the established financial services firms that need solutions and the entrepreneurs who are creating them and by closing the gap between capital markets FinTech and the financial institutions it should serve.
Mark Beeston is Founder and Managing Partner at Illuminate Financial. He began his career in derivatives trading at Deutsche Bank, where he eventually served as COO for both the Global Rates and Global Credit businesses; he later launched and ran T-Zero (now ICELink), a subsidiary of Creditex Group, before joining ICAP as CEO for the Post Trade Risk and Information business.
Q. Mark, why specialize in startups serving the capital markets?
A. I set the firm up, Jim, because I believe we at a moment of generational change in terms of capital markets infrastructure, driven by three major industry factors: huge deleveraging, massive multi-jurisdictional regulations, and the fact that at some point we transitioned into a zero-tolerance compliance environment.
When you take all those factors together, we end up in an environment where a huge chunk of the infrastructure stack is either already no longer fit for purpose or in the process of being rendered no longer fit for purpose. Therefore, there’s a sort of mandatory change agenda which, instead of being driven by the front office quest for competitive advantage, is actually driven by cost, control, capital, and compliance. Our view is this is a generational change, and we want to position ourselves to facilitate the winners in that and grow our own returns alongside that.
Q. How much capital did you raise for this first fund?
A. The target was £35 million and we have raised £35 million.
Q. Describe the type of startups you are looking for.
A. We are looking for capital markets FinTech firms – late seed or series A. They need to already have a product (we don’t invest in PowerPoints) and they need to have some commercial engagement. The best real measure of commercial engagement is revenue, but we would take multiple trials or PoCs potentially. The key thing is to be a capital markets financial technology company at that early stage where we think Illuminate can contribute to their success.
Q. What do you expect your average sized check will be initially?
A. We have already written checks as small as £250,000 and as large as $3 million. I think $3 million is probably as large as we would go for a first check from this fund which puts the average initial check likely to be in the $1.5 million – $2 million range.
Q. And over the life of the investment?
A. We have a 15% concentration limit, so that the theoretical maximum for this fund is around £5 million. However, with potential co-investment from our various partners we could certainly take on larger opportunities in the future.
Q. Are you always the lead investor? And do you always take a board seat?
A. We don’t have to be the lead. We are happy to lead but we are equally happy to work with others. We are working on one deal right now that will be led by someone else. However, we do take the view that we have to have a board seat. We think that is critical to the second part of our investment thesis, which is that we want to be able to influence the companies in how they come to market and connect them to our own networks to contribute to their success.
Q. You’ve made three investments in the last year or so. Is that the investment pace you are aiming for?
A. No. I would expect a faster pace. I would have expected to finish 2016 with a couple more deals in the portfolio than we did. The combination of our own fund close in October, Brexit earlier in the summer, and the U.S. election slowed down the pace of deployment. With a strong pipeline as well as the deals that rolled over from H2 2016 now well underway, I would expect to see a significant pick up in activity over H1 2017.
Q. It seems fair to say that capital markets focused technology startups receive less attention from traditional VCs. Why don’t they do more in this area, when there is clearly a lot of opportunity? Is this because capital markets firms are notorious for long sales cycles, because of regulatory concerns, or is it something else?
A. It’s our observation that capital markets FinTech has very different characteristics than other, more broadly focused FinTech, particularly B2C or retail.
If you look at the space and you track the exits of the companies in this space – and we tracked about 200 in our information memorandum before we raised the fund – it’s a very consolidation-driven landscape. If you look at capital markets technology IPOs, they are few and far between. It’s a sector that’s super interesting if you’re investing out of your first £35 million fund, but it’s not very interesting if you’re investing out of your 11th $500 million fund, because then you need to be looking at things that have a risk profile such that everything could return $1 billion. Anything under that just doesn’t move the dial in terms of your fund performance for those mega funds.
So, there’s a funding gap, and it’s a fantastic niche for us to exploit, not least because a lot of these companies are trying to sell to the same relationships. To the extent that we have these relationships, we can help to take them there as well.
Q. Do founders of capital markets FinTech recognize that their most likely exit is M&A? Is this something they know going in?
A. Yes. I think the vast majority that we speak to do.
And, one of the reasons we have multi-billion-dollar LPs in our investor base is that those companies themselves are interested in forming long-term relationships with the next wave of market infrastructure. We talk to companies all the time that tell us they view our LPs as amongst the potential competitors for their exits.
Q. Do strategic investors play a bigger role in funding these types of startups? Do VCs who aren’t as focused on capital markets as Illuminate tend to follow the strategic investors?
A. I think the dynamic in this area is a little different. It is a space where, historically, there’s been a lot of strategic investment, particularly from the banks. Constraints on capital, deleveraging, Volker, and the Bank Holding Act have now changed the shape of some of those deals. But you still see quite a lot of strategic investment in the space.
Strategic investors in general are an important source of funding in the marketplace. One of the reason we went after strategic investors of our own was to increase our own operating leverage in the landscape to the benefit of our portfolio companies where interests are aligned. Some of our portfolio companies have already taken advantage of that.
Q. What do you expect the fundraising environment will be like for FinTech startups seeking their first outside capital in 2017? For companies that are raising a B or C round?
A. The market clearly calmed down a little in the second half of last year, but it’s still a relatively rational market where intelligent ideas are getting funded. The big swing factor here is what Trump does around the regulatory environment.
There’s the whole emerging – or emerged – subgenre of FinTech known as RegTech. For example, you have the imminent implementation of the margin rules which will benefit companies in the collateral space, you’ve got a year to get ready for the many challenges of MiFID II (it doesn’t look like there will be much change there), but you have a lot of question being raised around Dodd-Frank and the whole US regulatory environment. Regulatory uncertainty does not help RegTech firms get funded because uncertain timelines or rules don’t help them get adopted.
The flip side is that this uncertainty may be broader FinTech’s gain. So much of the change mandate and budget is being consumed by necessary regulatory compliance. There’s been relatively little left over for FinTech that actually contributes to business advancement or business efficacy or other improvements in the underlying business model. To the extent that the Trump factor might influence RegTech in a negative way, I think broader FinTech will benefit from some change dollars getting freed up.
Q. Are capital markets firms still investing in risk management software and applications, or has that wave peaked?
A. Capital markets firms are in a risk management business and there is never an end to the cycle in terms of companies wanting to manage risk better. In terms of firms adopting next generation solutions, we are actually at the start of a wave rather than at the end of a wave. What’s peaked is the multi-million-dollar enterprise software sale, which the vast majority of major market participants are still beholden to. But they are increasingly thinking about models that give them scalability of cost, both upwards – which we always cared about – and also downward compared to volume, which means a transfer to a much more “as a service” type architecture. And probably to a much more micro-services-driven architecture, as well. Financial markets firms are just starting to get to grips with the cloud, and that disaggregation of enterprise software into a series of best-in-class micro-services is a wave that is literally just getting out of the gate.
Q. Every capital-markets-focused startup I talk to is building applications that run in the cloud. But are most capital markets firms comfortable putting critical applications in the cloud today?
A. If I look back at the conversations I was having nearly three years ago when I set the firm up, it was very clear that no major institutions were ready for that. But now, that wall has crumbled dramatically, and in terms of where we are on the adoption cycle I think we’ve gone through the early adopters and reached the second segment, the mass adopters. We are crossing that chasm, as it were.
There’s always going to be stuff that people aren’t comfortable to put outside their walls but there are models to deal with that, as well.
Q. Do startups need to be able to service both types of clients – those that are ready for the cloud and those that are not?
A. They absolutely do. They also have to be able to service both tier 1, slow adoption cycle, long sales cycle institutions as well as tier 2 and tier 3 organizations that may have faster adoption cycles. There’s a series of at least four different strategies that you need to be considering across size and infrastructure.
Q. Do startups tackling capital markets pain points require more capital initially to ensure they can offer high standards of service and reliability established firms will require, and to help them survive long sales cycles?
A. I don’t think they necessarily need more capital because the new operating environment means you can deliver exponentially more for less. You don’t have to spend 50% of your first raise on hardware for instance, because AWS allows you to scale with your clients and focus on core product. That said, one of the reasons we set ourselves up the way we did is that they need more leverage. You can have all the capital in the world, but if you can’t get meetings with the right people – or if, when you do, they say they can’t be the first person to cross the Rubicon, come back when you’ve got ten – you’re not going to get very far.
What we’ve done is put in place a model where people know that if we’ve invested, then these companies potentially have access to more capital so they’re going to be around, and behind us are multi-billion-dollar companies that have an interest in these emerging solutions, which makes it even more likely that they’ll be around. So, you start to build credibility that goes a long way toward getting through some of those procurement cycles.
Having credible investors and connectivity to a market network is definitely part of starting to answer those questions. It’s not just about balance sheets.
Q. How formal is your process for helping companies do this? Is it more ad hoc, because each one has different needs and different target markets, or have you mapped out exactly what each startup gets when you invest?
A. We don’t have a cookie-cutter program. When we’re sat down with the company going through our assessment of them as a potential investment and their assessment of us as a potential investor, there’s a lot of conversation about where we can add value, the sort of relationships we have, etc., so by the time we’re cutting the check, there’s a plan that details the people we’ll help get them in front of.
I will sit down with the head of sales at any of our companies and go through my rolodex to work out who we go see together. We will introduce them to the relevant contacts at our investors, and at other companies we know. If the right person to talk to is at an exchange that isn’t one of our investors, we’re pretty sure we can get you connected to that person as well.
Q. Are there rules for successful collaboration in the capital markets arena? Who do you see doing it well?
A. I don’t think it’s as much about collaboration. The way I think about it, there are two types of new technology out there. There’s disruptive tech and there’s enabling tech. Enabling and collaborating are not necessarily the same things.
Take your example for a second. Let’s talk about the risk infrastructure. Within the risk management world, everyone has a risk management system. It could be one of the well-known enterprise solutions – Murex, Calypso, etc. Or it could be a spreadsheet someone’s been working on for ten years.
Even if it’s just a spreadsheet, they are hugely vested in that. If you turn up and try to sell them a risk system, that is a disruptive sale. Disruptive sales are hard because you are not just selling something better, you are telling them they need to get rid of something else. Even if you came in and offered to sell the best risk platform in the world for $1 for a perpetual license, someone might not buy that because they realize it’s going to cost them millions to decommission the old one. There’s a lot that’s outside of your control.
Now, what if you go in to a firm and explain that the EMIR implementation in collateral management means they’re going to have to deal with a heck of a lot more margin calculations and margin optimization. That’s an incremental challenge and if you have a solution that you can actually layer over the top of their existing provider, that’s an enabling solution that is dramatically less disruptive. It solves an immediate problem that has a tight timeline, and it becomes a really interesting insertion point.
Luckily for the FinTech community, there are hundreds of these opportunities around right now – regulatory reporting deadlines, new reconciliations that have to be done, new types of risk factors that need to be calculated and reported on, best execution needs, probably 83 different gifts to the FinTech community from MiFID II. Every single one of them requires an immediate solution today that you didn’t need yesterday. Going in and solving against that incremental challenge is the way you land your stake in the ground that you can then expand on. We always tell our companies to look for the incremental opportunities to sell against rather than trying to displace the old guys because that sale is certain death in capital markets.
Q. Who is smarter about innovation, the buy side or the sell side?
A. That’s a leading question! I don’t think you could say that one side’s smarter than the other but I do think the adoption cycles can be a lot faster on the buy side. The organizations are generally a lot flatter and it’s easier in many cases to find the right person. A lot of sell-side decision-making processes have gotten very syndicated. It’s a lot harder to get things done in many sell-side environments than it used to be.
But one of the key industry challenges around innovation is that organizations are spending an awful lot of time trying to work out how they create more innovation within. There’s a huge amount of investment going into FinTech labs, hubs of innovation, corporate tourism to the West Coast, etc., etc.
The reality is that there’s an enormous mass of innovation happening right outside the front gate. As an industry, we’ve let hundreds of thousands of domain experts go as we’ve been deleveraging our world. And we’ve let them go into this really fertile environment where it’s cheaper than ever to deliver technology. You don’t have to go and buy a million-dollar box from IBM, you can put your credit card details into Amazon and access untold quantities of compute power. Not only is it easier and cheaper than ever to access compute power, it’s also easier than ever to find technologists to turn your domain expertise into solutions to problems you used to suffer from. We’re constantly astounded by the volume of companies we see.
In our largest quarter, we saw over 170 capital-markets-only FinTech companies. That is just a huge quantity of innovation. The industry challenge is not innovation, in my view, it’s validation. You need to validate innovation against your needs before you can adopt it. Trying to find ways to bring innovative culture inside a 200-year-old financial institution that is being run by its 28th CEO by visiting Silicon Valley, is I would argue, just not realistic. Finding ways to make your innovation agenda be one of being open to identifying it when it comes near your door, and welcoming it, and understanding it, and looking for ways to use it and bring it inside is a much more addressable challenge.
Q. Taking 30 executives on a tour of Silicon Valley will no impact on the business. They can tell the board they have an innovation agenda but all it amounts to is innovation theater. You get to see the innovation efforts of established capital markets firms up close. What observations or advice do you have for them? When it comes to innovation, what are they doing right, and what are they doing wrong?
A. How do you connect entrepreneurs and startups to multi-billion-dollar companies, whether banks or the buy side, that could benefit from their solutions if only they could get these multi-billion-dollar organizations to hear their messages? We‘ve developed a very simple model for doing that.
We have a number of strategic partnerships with banks where we give them access to our pipeline – not just our portfolio but our undiluted pipeline. Since we are assessing this landscape anyway, and since some of these organizations are largely impenetrable from the outside, we can help to cross the chasm between the large and the small.
Illuminate assesses these companies for business fit as part of our own investment assessment, so understanding fit against industry problems for our partners is a highly valuable by-product of our own investment process. That by-product is valuable because whilst we might only invest in one out of 140 things that we see, ten in 140 might solve problems that our industry partners have.
So, we actively introduce those relevant early stage companies to tier one banks we work with, buy side firms we have relationships with and others irrespective of our own investment plans. That’s our “crossing the chasm” type approach.
In a sense, Jim, you kind of answered your own question in its formulation. Innovation has to be connected to the business. Setting up an innovation infrastructure that sits 3,000 miles away from your business – or even 30 yards away from your business – only serves to make it as disconnected from your business as the average frustrated entrepreneur is. Then it’s only a PR, box-ticking exercise that will ultimately not solve any problems. Whether you are partnering with us or partnering with somebody else, it’s got to connect back to the business in some way, shape, or form.
Q. This may be a dumb question, but where are we in terms of FinTech’s impact on capital markets?
A. It’s not a dumb question given the hype, but FinTech is just a word that got the world excited…
Sure, it’s all very in vogue to talk about FinTech. But while Illuminate are known as a purely capital-markets focused FinTech fund, we are nothing more or less than an old-fashioned business solutions investor looking to understand business problems better, filter the best solutions, back them, and bring those solutions to market.
Before FinTech was around, there were just software companies serving capital markets. The oldest of those are 50 or sixty years old. So, it’s not a dumb question, it’s just driven by the crazy penchant for calling everything FinTech. When I launched T-Zero, T-Zero was a FinTech firm but we never called it that. I’d never heard of FinTech. This was 2005 – 2009. So, the reality is that the whole of capital markets are incredibly well-served by FinTechs with names like Calypso, Murex, Markit, and Ion Trading, and lots of other companies that were never called FinTech before FinTech became this new thing everyone’s excited about.
Q. Investment activity seems heavily focused on front-office initiatives within execution and pre-trade. Funding for post-trade activities has been much more modest. Where do you see the biggest opportunities? Front, middle, or back office?
A. I think the biggest opportunities are where the biggest problems are, so there’s huge opportunity in the middle to back. We have 20-year legacy of investing in straight-through processing that was about getting transactions out the door as fast as possible, with very little investment in how to get them back as fast as possible. There have been and will continue to be interesting opportunities in solving those kinds of problems.
I don’t tend to find new execution venues to be a particularly interesting part of our pipeline. An ex-trader will always be able to convince you that this is a better way to transact, but the reality is that liquidity only tends to move if you already have ten times more liquidity, or you’re ten times cheaper, or the incumbent screws up.
So, middle and back, and the fact of that matter is that the regulatory environment, and the capital environment as a consequence of things like Basel III, are the gifts that keep on giving to the FinTech entrepreneurial community.
Q. Which new technologies are you most excited about right now? Which are overhyped?
A. We are not a technology investor. Technology is a means to an end. We are a solutions investor. We don’t get excited about technology for its own sake. The Street is brilliant at ignoring cool technology. But what it doesn’t do is ignore its cost, control, capital, and compliance issues.
I think what’s going on in blockchain is interesting. I have no doubt that blockchain will solve a lot of problems for a lot of people in a lot of subjects at some point in the future. But right now, no one knows which problems, when or who. Nor do they know how much it will save. Yet every company in the space is being treated like a multi-billion-dollar savior.
I don’t want to sound like a blockchain luddite. I do believe there will be huge value to come out of the blockchain world and from distributed ledgers in general, but it’s not going to start tomorrow. It’s a journey away. Right now, it gets more than its fair share of the headlines for the problem that its solving.
Q. What do you expect from AI? Are you seeing startups that using AI to solve problems in the capital markets today?
A. I do think there are places where application of machine learning, natural language processing, or AI are starting to be pretty interesting in terms of things like fraud detection AML, and other compliance challenges. There’s also definite value to be had from machine learning in terms of how humans are processing transactions to work out what else can be automated away. There are real platforms out there that are starting to deliver benefits. But the efficacy of a lot of AI solutions will only be as good as the data that you’re prepared to give them. As a highly-regulated industry, it’s making data available in a secure and compliant way that will enable those kinds of technologies that will be the real gating factor to the value that AI is ultimately able to deliver.
Q. So how do we help give startups access to the data they need? Do you have any thoughts on how to help capital markets startups clear this innovation hurdle?
A. There are two separate things. Initiatives like FinTech Sandbox are great in terms of access to a market dataset. There is increasingly good support from partners like Markit to make that available to this development community and that’s fantastic.
But I think the real challenge is around access to the underlying data they want to operate on. It’s one thing to know where markets were, it’s another thing for a major bank to give your FinTech startup access to Mark Beeston’s financial transaction records. Or to where he tends to be and at what time he tends to use their app.
We’ve made an investment in a company called Privitar, which you should look at. What they do is make it easy for highly-regulated industries, such as finance, to provide data scientists access to highly-confidential datasets in a risk managed and complaint way.
I would argue that is a great example of an enabling technology to help our industry get to the next level.
Q. I think I saw that you are involved in the 3D FinTech Challenge, which has focused on risk management and RegTech in the last few years. What is your strategy when it comes to incubators and accelerators?
A. Yes, we’ve supported that for the last few years. They were close partners with one of our other partners, Deutsche Boerse, and we want to contribute to the ecosystem.
We’re open to partnering. We are a relatively small team, so there’s always a limit what we can do, but we definitely view karma as one of our core values. You give to the FinTech ecosystem and the FinTech ecosystem gives back to you.
Q. We talked a bit about the exodus of smart, talented people from the capital markets firms creating a pool of people available to startups. Some will start companies themselves. Are the capital markets firms then at a disadvantage when it comes to recruiting tech talent, because they’re not as sexy as FinTech startups and don’t offer as much upside?
A. There’s a recruiting and retention issue for the sector in general. It’s not just about competing with startups. It’s also about competing with Google, Amazon, Facebook, SpaceX, the app economy, etc. I think it’s challenging but I don’t think the FinTech community represents the biggest risk of drain on the technology side. But it does represent a risk on the domain expertise side. If I had a pound for every disaffected banker who had come to me asking how to get into FinTech I would never have had to raise a fund!
But the one thing the capital market firms have on their side is that they can pay well. So, it’s horses for courses. It’s not necessarily a fair fight. One side finds it hard to offer table tennis and a bring-your-dog-to-the-office policy, the other side finds it hard to pay hundreds of thousands of dollars. You choose your own preference.
Q. Illuminate is headquartered in London, but I know you spend close to half your time in New York. Where do you see the most interesting startups coming from, geographically? How important is location to the startups you are looking at? Is geography destiny? (Meaning proximity to buy- and sell-side firms, or to exchanges?)
A. You don’t have to originate in New York or London, but New York and London are going to be where the vast majority of your potential client base is. You mentioned that we have three companies in our portfolio. One of those was founded in London but is now in London, New York, and Singapore. Another was founded in London and is still only in London but NY will come next. The third is headquartered in Charlottesville, VA, that well-known, massive financial marketplace. One of the reasons that they were raising money is that they wanted to be on the ground in London and New York which they are now.
Technology can originate anywhere, but a lot of the client base and the domain expertise tends to be located in the major financial centers. In that sense, New York and London dominate.
We are global in our investment mandate but 85% of what we see comes out of London and the East Coast.
Q. Are you hiring?
A. Yes we are.
Q. How do you want entrepreneurs to contact you?
A. They can use info@illuminatefinancial.com or the London phone number which is +44 (0)203 198 1600.
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