Ensuring fintech success through economic headwinds

The UK fin­tech mar­ket has been on a roll. In 2021, invest­ment hit £27.59bn, a sev­en­fold increase on the £3.85bn achieved a year ear­li­er, accord­ing to KPMG’s Pulse of Fin­tech report. That was dri­ven by record deal-mak­ing activ­i­ty as fin­techs bounced back from the pan­dem­ic. The total num­ber of M&A, pri­vate equi­ty and ven­ture cap­i­tal trans­ac­tions reached 601 last year, up from 470 in 2020, accord­ing to the report.

“We’ve been through a peri­od of very strong growth, par­tic­u­lar­ly com­ing out of Covid,” says John Hallsworth, part­ner and fin­tech co-lead at KPMG UK. “There’s been a lot of invest­ment activ­i­ty as a vast amount of pri­vate cap­i­tal has been look­ing to invest in emerg­ing tech, and the move to dig­i­tal has real­ly helped accel­er­ate that even more.”

That peri­od of expan­sion, how­ev­er, has start­ed to stall. The eco­nom­ic out­look is less buoy­ant, with the UK econ­o­my poised for slow­er growth in the months ahead. Inter­est rates are also on the rise, which may cre­ate chal­lenges for some fin­techs, says Hallsworth.

“First of all, the cost of fund­ing has gone up,” he says. “And sec­ond­ly, the eco­nom­ic con­di­tions mean that investors are more ner­vous about what they invest in and so it’s hard­er to attract invest­ment.”

Added to that, the reg­u­la­to­ry back­drop con­tin­ues to inten­si­fy. Areas such as cryp­tocur­ren­cy and buy now pay lat­er are like­ly to face increased scruti­ny, which will poten­tial­ly tem­per growth in those mar­kets. Yet those head­winds are not going to have a uni­form­ly neg­a­tive impact, with some fin­tech sub-sec­tors expect­ed to fare bet­ter as mar­ket con­di­tions become more chal­leng­ing to nav­i­gate.

In the more mature fin­tech sec­tors, there’s going to be a flight to qual­i­ty and estab­lished busi­ness­es, which could trig­ger con­sol­i­da­tion

“The eco­nom­ic back­drop is going to sig­nif­i­cant­ly influ­ence which fin­tech use cas­es are going to be sup­port­ed,” says Joe Cas­sidy, part­ner and head of FS strat­e­gy at KPMG UK. “Fin­tech busi­ness­es that are non-dis­cre­tionary are the ones that have the most chance of doing well in this envi­ron­ment, while those which are dis­cre­tionary and are focused on B2C (busi­ness-to-con­sumer) activ­i­ties may lag slight­ly behind.”

Sec­tors set for suc­cess

Those sub-sec­tors that are like­ly to thrive in the cur­rent envi­ron­ment are regtech busi­ness­es, cyber-relat­ed ser­vices, wealthtech firms and alter­na­tive financ­ing providers that are help­ing fun­nel mon­ey towards small and medi­um-sized enter­pris­es (SMEs).

Regtech busi­ness­es are like­ly to ben­e­fit giv­en the broad­er reg­u­la­to­ry back­drop and the hefty com­pli­ance bur­den finan­cial insti­tu­tions con­tin­ue to face. Giv­en the tighter labour mar­ket and ris­ing com­pli­ance costs, finan­cial insti­tu­tions are increas­ing­ly look­ing to tech­nol­o­gy to man­age reg­u­la­to­ry change more effi­cient­ly.

“KYC (know your cus­tomer) and AML (anti-mon­ey laun­der­ing) respon­si­bil­i­ties are increas­ing, not dimin­ish­ing, so this is an area where we are see­ing a lot of inter­est and a lot of com­pet­ing com­pa­nies, some of which are extreme­ly viable and investable as we go for­ward,” says Cas­sidy.

Cyber­se­cu­ri­ty busi­ness­es are also going to be in demand, as many finan­cial insti­tu­tions have expand­ed the perime­ter of their organ­i­sa­tions by enabling wide­spread remote work­ing. In addi­tion, increased cyber threats and fraud means dig­i­tal sur­veil­lance needs to step up accord­ing­ly.

The UK’s Data Reform Bill and the emer­gence of an open finance frame­work are like­ly to favour wealthtech firms who will be able to access shared data on a customer’s entire finan­cial sit­u­a­tion. Mean­while, fin­techs focused on pro­vid­ing work­ing cap­i­tal, trade finance and sup­ply chain finance are also like­ly to ben­e­fit giv­en the grow­ing finan­cial pres­sures on SMEs as eco­nom­ic con­di­tions dete­ri­o­rate.

“There still remains a lot of cap­i­tal to invest,” says Jere­my Welch, head of KPMG UK’s finan­cial ser­vices deal advi­so­ry. “To start with, we’re still tran­si­tion­ing to a dig­i­tal future and there­fore the sec­tor remains attrac­tive to investors invest­ing for the long term. There’s also been an ame­lio­ra­tion in valuations–a lot of peo­ple felt the mar­ket was get­ting frothy last year, so that may make invest­ment slight­ly more attrac­tive even if that cap­i­tal may be redi­rect­ed to dif­fer­ent sub-sec­tors.”

A tighter grip on finances

While some sec­tors have the poten­tial to thrive in the cur­rent cli­mate, fin­techs with strong attrib­ut­es – those that have untapped growth poten­tial in new mar­kets, or busi­ness­es that are already prof­itable – will con­tin­ue to com­mand pre­mi­um val­u­a­tions regard­less of sec­tor, says Welch. “In the more mature fin­tech sec­tors, there’s going to be a flight to qual­i­ty and estab­lished busi­ness­es, which could trig­ger con­sol­i­da­tion.”

Investors are also going to be more focused on cash burn rates than absolute growth. For those busi­ness­es that might be more vul­ner­a­ble to any eco­nom­ic down­turn and that have been oper­at­ing in an envi­ron­ment where pre­vi­ous­ly there was a lot of cheap cap­i­tal avail­able, they are going to have to tight­en their belts, says Welch.

“They need to focus on what they’re spend­ing mon­ey on, assess the effec­tive­ness and cost of cus­tomer acqui­si­tion chan­nels, and maybe cut back on some of the geo­gra­phies that they’re try­ing to tar­get or the sheer num­ber of prod­ucts they’re try­ing to launch,” he says. “Dis­cre­tionary spend will be con­trolled and we have already seen a few con­tem­plat­ed lay­offs and hir­ing freezes. So cash will become more impor­tant.”

There is one pos­i­tive. Many fin­techs have already raised ample cap­i­tal and are com­ing into this peri­od of uncer­tain­ty with rel­a­tive­ly robust bal­ance sheets. “Com­pa­nies may have a high cash-burn rate, but it’s not like they have no cash avail­able,” says Welch.

Those fin­techs that have yet to reach prof­itabil­i­ty and whose busi­ness mod­els will poten­tial­ly be more chal­lenged by less bull­ish mar­ket con­di­tions may be forced to reset their expec­ta­tions.
“It’s inevitable dur­ing this stage of the cycle that there’s a lot of ear­ly-stage dis­rup­tors who don’t have the cash flow com­ing in but have got inter­est­ing intel­lec­tu­al prop­er­ty that they could try to com­mer­cialise in oth­er ways,” says Cas­sidy.

Poten­tial deal activ­i­ty

To start with, fin­techs could seek a broad range of M&A oppor­tu­ni­ties. One poten­tial route is for large fin­techs or those with the cash avail­able for acqui­si­tions to bring in tech­nol­o­gy that is com­ple­men­tary to their exist­ing busi­ness. A sec­ond route is for ven­ture cap­i­tal or pri­vate equi­ty firms to look at com­bin­ing some of their port­fo­lio com­pa­nies to cre­ate a more round­ed fin­tech propo­si­tion. Or anoth­er route is via tra­di­tion­al finan­cial insti­tu­tions or advi­so­ry firms that could be inter­est­ed in acquir­ing busi­ness­es that enhance their exist­ing ser­vice offer­ings.

Oth­er options are also on the table, says Cas­sidy. “They could refi­nance, they could give up some equi­ty or they could part­ner,” he says. “It’s all about how they feel in those cir­cum­stances.”

Some fin­techs may also piv­ot from offer­ing B2C ser­vices to sell­ing direct­ly to oth­er busi­ness­es, with busi­ness mod­el piv­ots a fea­ture of pre­vi­ous peri­ods of eco­nom­ic tur­bu­lence. “We often see fin­techs white labelling their tech­nol­o­gy and being used by big finan­cial insti­tu­tions that don’t have the abil­i­ty to build their own,” says Han­nah Dob­son, fin­tech co-lead and indi­rect tax part­ner at KPMG UK.

In oth­er cas­es, fin­techs may apply their tech­nol­o­gy to anoth­er con­sumer mar­ket that is more in demand. Part­ner­ships and joint ven­tures (JVs) between fin­techs and tra­di­tion­al finan­cial insti­tu­tions are also an effec­tive way of com­mer­cial­is­ing valu­able intel­lec­tu­al prop­er­ty devel­oped by fin­techs.

“Fin­techs who have already tak­en steps to iden­ti­fy, pro­tect and opti­mise their intel­lec­tu­al prop­er­ty assets will fare bet­ter in part­ner­ships and JV arrange­ments,” says Usman Wahid, a tech­nol­o­gy law part­ner at KPMG UK. “Opti­mi­sa­tion of intel­lec­tu­al prop­er­ty, in par­tic­u­lar, should enable fin­techs to effec­tive­ly seg­ment their IP for use in part­ner­ships and JVs with­out weak­en­ing their stand­alone core busi­ness.”

Solv­ing for big­ger prob­lems

Gov­ern­ment efforts to super­charge the fin­tech indus­try may also cre­ate new oppor­tu­ni­ties for exist­ing busi­ness­es to piv­ot or enter new mar­kets. For exam­ple, the Kali­fa Review of the UK fin­tech indus­try – which KPMG made sig­nif­i­cant con­tri­bu­tions towards, with KPMG UK’s vice chair of finan­cial ser­vices Kay Swin­burne co-chair­ing the pol­i­cy and reg­u­la­tion chap­ter – is designed to encour­age more inno­va­tion and make the indus­try more investable.

In this more test­ing envi­ron­ment, there is also an oppor­tu­ni­ty for firms to think more ambi­tious­ly about how they can devel­op as the mar­ket matures. “A lot of the fin­tech world today is focused on nich­es rather than nec­es­sar­i­ly solv­ing end-to-end prob­lems,” says Hallsworth. “There’s an oppor­tu­ni­ty in this envi­ron­ment for fin­techs to think big­ger and try to solve some of the big prob­lems on an end-to-end basis and by doing it in a col­lab­o­ra­tive way.”

Ulti­mate­ly, the key to remain­ing suc­cess­ful in the peri­od ahead will not only hinge on the val­ue and util­i­ty of a firm’s tech­nol­o­gy, it will also rely on the qual­i­ty of the peo­ple run­ning the busi­ness.

“The fin­techs that will stand out from the crowd if we enter into dif­fi­cult times will be the ones that have a unique prod­uct that’s solv­ing a prob­lem,” says Dob­son. “But it’s also impor­tant to have a real­ly good man­age­ment team who can antic­i­pate prob­lems and then pre­pare for these accord­ing­ly. Invest in real­ly good peo­ple to run your busi­ness and your busi­ness will sur­vive.”

For more infor­ma­tion, vis­it home.kpmg/uk/en/Fintech

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Pro­mot­ed by KPMG