Should You Invest in a Venture Fund?

Community banks needing to innovate are hoping they can gain an edge – and valuable exposure – by investing in venture capital funds focused on early-stage financial technology companies.

Investing directly or indirectly in fintechs is a new undertaking for many community banks that may lack the expertise or bandwidth to take this next step toward innovation. VC funds give small banks a way to learn about emerging technologies, connect with new potential partners and even capture some of the financial upside of the investment. But is this opportunity right for all banks?

The investments can jump start “a virtuous circle” of improvements and returns, Anton Schutz, president at Mendon Capital Advisors Corp., argues in the second quarter issue of Bank Director magazine. Schutz is one of the partners behind Mendon Ventures’ BankTech Fund, which has about 40 banks invested as limited partners, according to S&P Global Market Intelligence.

If there is a return, it might not appear solely as a line item on the bank’s balance sheet, in other words. A bank that implements the technology from a fintech following a fund introduction might become more effective or productive or secure over time. The impact of these funds on bank innovation could be less of a transformation and more of an evolution – if the investments play out as predicted.

But these bets still carry drawbacks and risks. Venture capital dollars have flocked to the fintech space, pushing up valuations. In 2021, $1 out of every $5 in venture capital investments went to the fintech space, making up 21% of all investments, according to CB Insight’s Global State of Venture report for 2021. Participating in a VC fund might distract management teams from their existing digital transformation plan, and the investments could fail to produce attractive returns – or even record a loss.

Bank Director has created the following discussion guide for boards at institutions that are exploring whether to invest in venture capital funds. This list of questions is by no means exhaustive; directors and executives should engage with external resources for specific concerns and strategies that are appropriate for their bank.

1. How does venture capital investing fit into our innovation strategy?
How do we approach innovation and fintech partnerships in general? How would a fund help us innovate? Do we expect the fund to direct our innovation, or do we have a clear strategy and idea of what we need?

2. What are we trying to change?
What pain points does our institution need to solve through technology? What solutions or fintech partners have we explored on our own? Do we need help meeting potential partners from a VC fund, or can we do it through other avenues, such as partnering with an accelerator or attending conferences?

3. What fund or funds should we invest in?
What venture capital funds are raising capital from community bank investors? Who leads and advises those funds? What is their approach to due diligence? Do they have nonbank or big bank investors? What companies have they invested in, and are those companies aligned with our values? What is the capital commitment to join a fund? Should we join multiple funds?

4. What is our risk tolerance?
What other ways could we use this capital, and what would the return on investment be? How important are financial returns? What is our risk tolerance for financial losses? Is our due diligence approach sufficient, or do we need some assistance?

5. What is our bandwidth and level of commitment?
What do we want to get out of our participation in a fund? Who from our bank will participate in fund calls, meetings or conferences? Would the bank use a product from an invested fintech, and if so, who would oversee that implantation or collaboration with the fintech? Do bank employees have the bandwidth and skills to take advantage of projects or collaborations that come from the fund?