Why private equity just invested $84 million in Guideline

Whenever I try to explain the 401(k) industry to private equity or venture capital professionals, the usual response is, “That doesn’t make sense.” I get the same response from plan sponsors.

Regardless, the defined-contribution industry keeps growing. And none of the venture-backed fintech start-ups have made a real impact other than Financial Engines, which chose to be integrated within the system rather than disrupt it.

Are the PE firms that have thrown almost $200 million at Guideline and Vestwell foolish and bound to fail, much as the backers of Emplanet, GoldK and ExpertPlan did in the early 2000s?

Maybe not.

To understand why Guideline, Vestwell and other tech-based record keepers like For Us All, Human Interest, Betterment, Ubiquity, Honest Dollar and Smart Pension might be successful, it's helpful to consider some background about the state of the DC record keeper industry.

The record keeping business is like a wheel inside a wheel -- nothing is straightforward. These businesses operate on systems built in the ’90s, and not surprisingly they are struggling to provide the rich and intuitive digital experience that consumers today expect. It’s like trying to put a Tesla engine inside a Pinto without pulling over.

The conventional wisdom is that record keeping is a low-margin business in the late innings of consolidation, with more to come. So why are PE firms doubling down?

The first 401(k) record keepers in the 1980s were pension administrators and third-party administrators that charged plan sponsors a per-participant fee. These were start-up plans, sponsored by big companies.

Fidelity disrupted that model in the ’90s by providing asset-based record keeping and administration paid for by the mutual funds on plan menus. That was the beginning of the slippery slope of opaque revenue-sharing arrangements and conflicts of interest.

Today, there is less conflict and more transparency than ever. But most record keepers rely on revenue from the investments on their platform, whether proprietary, third party or stable value, to stay alive.

A new development is that record keepers are going after participants directly, focusing on assets at the expense of the advisers who brought them the plan and the money managers that subsidized the record-keeping services.

But plan sponsors and participants are slowly waking up. When they begin to understand revenue sharing and asset-based fees charged by advisers and record keeper alike, they see the inherent conflicts that do not benefit them.

That is where the new breed of fintech record keepers come in.

They are not trying to disrupt an industry buffeted by lobbyists and distribution networks. They simply see a complicated process that starts with onboarding employees to payroll systems. The magic of tax-deferred payroll-deduction savings, with access to low-cost investments overseen by a plan sponsor fiduciary, is compelling. It’s why DC and IRA assets now total close to $20 trillion and why those assets are growing faster than any other sector of retirement, even with the clunky systems, lack of transparency and conflicts of interest.

Vestwell has raised $49 million, with the last round of $30 million led by Goldman Sachs. For that company, it’s about automation and low costs. It’s about identifying and analyzing outliers and errors, like census data, and then cleaning that up on the front end.

“We have 92% straight-through, clean processing, limiting human intervention,” Vestwell CEO Aaron Schumm said. “We’re looking hard at the errors for the other 8%, like incorrect birthdays, and then fix them on the front end.”

“It’s also about analyzing participant data to enable better decisions,” he said. “Traditional record keepers hoard the data. We are creating one ecosystem to efficiently serve the clients.”

Guideline just raised $84 million, adding to $60 million in prior funding. For Guideline, it’s about tapping into an unserved and unattractive market.

“Our investors see a retirement gap, with just 10% of small businesses currently being served,” Guildeline CEO Kevin Busque said. “We provide the right pricing and technology [that is] not offered by [n]or attractive to legacy providers.”

But neither Guideline nor Vestwell is looking to disintermediate retirement plan advisers or record keepers. They are simply building a Tesla that both can buy or hop into as their legacy businesses wane.

Ultimately the DC industry must look beyond its own needs and understand the end clients and the problems they face. For plan sponsors, it’s about compliance, payroll integration, costs and liability. After that, they can focus on helping employees to save and spend wisely.

For employees, it’s about an easy and transparent digital experience that provides advice on how to integrate other company benefits, save and spend.

Rather than posing a threat, these well-funded fintech record keepers are potentially good partners for both providers and advisers. They can enable the industry to benefit from the convergence of retirement, wealth and benefits through efficient, low-cost but profitable record-keeping platforms that do not need to be fueled by revenue sharing or conflicts of interest. 

[More: Secure Act’s pooled employer plans a dramatic change for 401(k)s]

Fred Barstein is founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews’ Retirement Plan Adviser newsletter.