Are funding and valuations really in the doldrums, and how can fintech firms fight back?
“It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.” Charles Darwin
Fintech firms looking to raise money are not quite in panic mode, but rear ends are becoming a touch squeaky. The near-term economic outlook is miserable. The Nasdaq is down 30% since the start of the year. High profile layoffs have hit former fintech darlings, Klarna and Robinhood. VC money is slowing. Down-rounds are the order of the day. Exits have dropped and M&A has dropped. The ‘crypto winter’ in recent months has seen the likes of Bitcoin and Ether plummet.
What is really going on here? Can the drivers of fintech – technology disruption, financial regulation, and the growth of self-service – suddenly have reversed? Can all that ‘dry powder’ of investment money, built up over more than a decade of a low-interest rates, have vanished? And what can companies do to convince investors they are still great to invest in, and buck the seemingly bearish trend?
There are a few reasons for this, but perhaps the macro-economic environment is only one. Funding has come down to more normal levels seen before 2021. Pressure on mega deals at the top end – and late stage of the market – is where the problem is most apparent.
A good bad news day
Digging deeper we see that the longer-term trends in funding are still robust. A BofA survey this week showed that a strong majority of investors do not expect long-term rates to rise, signalling that investors still need to make their money work and raising debt will not be quite as expensive as feared. All the main indicators for fundraising were at historic highs last year, but considering previous years, the 2021 highs could be seen as an outlier.
Meanwhile, many excellent companies are still raising, typically at earlier stage and in non-US and non-European regions. Africa is a bright spot. Already at 71% of 2021’s figures, $1.7bn was raised by African start-ups in 2022 so far. At the current rate, funding could exceed last year’s figure by $1bn. If this occurs, this will be the second year of continuous and significant funding growth for the continent.
And last week, Sequoia Capital’s China affiliate raised an impressive $9bn in fresh capital to back tech companies, at all stages. The fund was oversubscribed by 50%. Although activity in China is slowing to $13.6bn, a 40% drop year-on-year, Sequoia is banking on deploying an ocean of funds at depressed prices, anticipating that the market will recover.
Behind all of this is a narrative which potentially allows the VCs to invest at better prices for them. In May, Sequoia said “Capital was free. Now it’s expensive”. The bar for investment has gone up. But the nature of the VC model – unicorn hunting, and expecting most companies to fail, and one or two to be winners — has not changed. The decades of dry powder built up in a low interest rate environment have not disappeared. It is, however, a much more cost-effective time to invest and arguably the smart money is using this as an excellent buying opportunity.
Fintech continues to account for a significant share of global funding. In 2021, an estimated 21% of all venture deals were fintech. In the second quarter of 2022, according to CB Insights, investment into fintech start-ups wasn’t too far behind that: fewer dollars are being invested generally, but fintech is still attracting major investor interest.
In institutional finance, B2B fintech’s major customers, big banks are growing their capital-light services linked to connected data and tech. A report by Oliver Wyman says that nearly a third of the top 50 financial institutions are now data and technology firms rather than regulated balance sheet firms. In the past decade, a combination of the large financial institutions and data and fintech firms have delivered 400% value growth and nearly $2.3tn of value.
The main driver of this shift has been slower growth of more capital-intensive risk intermediation services — which have grown globally at about 3% per year over the past decade – relative to the faster growth of more capital-light services linked to connected data services and value technology services, which have been growing at about 10% per year.
In B2C, fintech has fundamentally changed the supply and demand for financial services.
Fintechs haven’t replaced traditional financial services firms, but they’ve introduced new products and services to the market. With 30% of Gen Z and Millennial Americans now calling a fintech their primary bank account, they’ve captured market and mind share. And the demand for fintech has increased demand for financial services altogether. According to Cornerstone Advisors’ research, 40% of consumers between the ages of 21 and 55 subscribe to fintech services, with half spending $10 or more each month, for a total of $13 billion annually.
The fight back
While growth at all costs is no longer being rewarded, fintechs need to demonstrate more near-term certainty. That means a shift to promoting companies’ profitability and ability generate cash today. Favouring a narrative that shows consistent, durable growth and disciplined financial management that translates into improving margins. Adaptability is the name of the game. To be able to survive, conserving cash, therefore, is a necessary exercise which will be helped shortly by recruitment – which has been such a headache for fintech firms – set to become significantly easier in the near term.
Fintechs should showcase the leadership that reminds customers, employees, investors why they joined their vision of the future in the first place, with positive direction and decisive action. It is best to do this with conviction, but also balancing both realism and optimism. This is not the time to shy away from headwinds, but to be authentic in recognising the challenges, and demonstrating, as TechCrunch puts it when inviting pitches to their team, “what makes your company stand out. Why is it unique? Why would our readers care? Is it bucking a trend?” The best capital will seek out the best companies, and those with a strong, adaptable mindset will emerge as winners in this time of uncertainty.