Venture capitalists reap the fintech whirlwind

Tech­nol­o­gy invest­ing came back down to earth in the spring. A com­bi­na­tion of a stock mar­ket rout – which has seen the tech-heavy Nas­daq Com­pos­ite fall by 32% so far this year – Russia’s inva­sion of Ukraine, infla­tion that is touch­ing 10% in some devel­oped mar­kets, inter­est-rate hikes and inti­ma­tions of reces­sion caused some ven­ture cap­i­tal­ists to pause for thought and oth­ers to redis­cov­er a sense of cau­tion.    

Last year, ven­ture-cap­i­tal fund­ing of fin­tech bal­looned to $131.5 bil­lion (£109 bil­lion) world­wide, near­ly three times the $49 bil­lion that was invest­ed in 2020, accord­ing to CB Insights. The con­sen­sus among investors is that this annu­al total is unlike­ly to be repeat­ed any time soon. 

Bet­ter Tomor­row Ven­tures’ found­ing part­ner Sheel Mohnot said: “My gut feel­ing is that we’ll have less invest­ment than in 2021.” At the recent Founders’ Forum event in Oxford­shire, he said it was clear that some investors, espe­cial­ly the “tourists” who had only dis­cov­ered an appetite for fin­tech invest­ing since 2020, have already “checked out of the mar­ket”. 

Sil­i­con Val­ley-based investors Andreessen Horowitz (also known as a16z), say val­u­a­tions of pub­licly list­ed fin­tech com­pa­nies have col­lapsed from 25 times for­ward rev­enues in Octo­ber 2021 to four times for­ward earn­ings in May, a big­ger reduc­tion than in any oth­er tech sec­tor. 

This has had knock-on effects for val­u­a­tions in the unquot­ed space. Hox­ton Ven­tures’ ana­lyst Hus­sein Kan­ji said: “I don’t think any­where near as much mon­ey is going to be flow­ing in this year as we saw last year. You have to be very vig­i­lant about the macro­eco­nom­ic pic­ture, espe­cial­ly where the mid­dle class­es are get­ting hurt.”

He point­ed out that Britain was behind the curve in recog­nis­ing changed mar­ket real­i­ties. “In the US, fin­tech investors were get­ting pan­icky in Feb­ru­ary-March but the Euro­peans didn’t seem to get the memo until late May.” 

He said that as they seek alter­na­tives to the so-called “cash burn” approach amid a tougher fund­ing envi­ron­ment, some fin­tech com­pa­nies will strug­gle to read­just their busi­ness mod­els. There will be “some wreck­age” in the fin­tech sec­tor, said Kan­ji.

One con­se­quence of the down­turn is that investors are tak­ing longer to make invest­ment deci­sions. Due dili­gence and tyre-kick­ing, which until recent­ly was only tak­ing a cou­ple of days, is tak­ing sev­er­al weeks, accord­ing to Mohnot. Anoth­er is that investors are shift­ing their focus away from cus­tomer-fac­ing fin­techs, such as neobanks – whose cus­tomer acqui­si­tion costs are often very high – and are more enthu­si­as­tic about infra­struc­ture fin­techs, which pro­vide so-called “picks and shov­els” for incum­bents and oth­er finan­cial firms. 

Hen­ry O’Brien, a British fin­tech investor and co-founder of Mur­al Cap­i­tal said: “Ven­ture cap­i­tal­ists are look­ing for infra­struc­ture and cap­i­tal/as­set-light busi­ness mod­els that can be scaled up fast.” 

How­ev­er even infra­struc­ture busi­ness­es will not be ful­ly immune to the down­drafts.  

Kan­ji says: “Everyone’s look­ing at two vari­ables: unit eco­nom­ics – whether the busi­ness is capa­ble of mak­ing mon­ey – and speed of growth. If a com­pa­ny is grow­ing at 400%, real­ly lean and gen­er­at­ing healthy mar­gins, there will still be a queue of peo­ple want­i­ng to invest.”

Share prices of list­ed fin­tech firms have gen­er­al­ly fall­en by 65% to 75% since their ini­tial pub­lic offer­ings and, for some ven­ture cap­i­tal­ists, this is a reli­able proxy for the unquot­ed sec­tor. 

O’Brien believes investors’ appetites for deals, and unlist­ed com­pa­nies’ val­u­a­tions are going to be col­lat­er­al dam­age, though he also pre­dicts falling val­u­a­tions will pre­cip­i­tate a string of trade sales in the sec­tor: “It will be worth watch­ing for major acqui­si­tions by glob­al banks, insur­ance com­pa­nies, pay­ments com­pa­nies.”

Mohnot pre­dicts a slow­down in merg­ers and acqui­si­tions activ­i­ty dur­ing the sec­ond half of 2022. Regard­ing trade sales, he said: “The acquir­ers’ stock prices are depressed com­pared to what they were, so they don’t want to make stock-fund­ed acqui­si­tions and they don’t want to pay cash, since they don’t know how tough it’s going to be to raise the next incre­men­tal dol­lar.” 

He pre­dicts that some over­val­ued com­pa­nies should be able to use their over­val­ued stock to make acqui­si­tions, though sus­pects this win­dow is rapid­ly clos­ing.

What we are see­ing, says Mohnot, is a return to 2019 lev­els of mar­ket activ­i­ty, after a 2020 to 2021 peri­od which was, in effect, an aber­ra­tion: “Due to Covid, near-zero inter­est rates and a bunch of oth­er things, we had a two-year crazy time. Val­u­a­tions were get­ting ahead of them­selves and the sec­ond half of 2021 was just nuts.” 

Now he believes the mar­ket is becom­ing more dis­ci­plined and, indeed, nor­mal again. “We’ve snapped back to an ear­li­er time. Europe is a lit­tle bit behind the US in mak­ing the shift back.”   

While they are gen­er­al­ly a neg­a­tive for the sec­tor, Mohnot also points out that high­er inter­est rates will be ben­e­fi­cial for some fin­tech play­ers: Mer­cury, a neobank in which many star­tups deposit the pro­ceeds of their fund­ing rounds, for exam­ple. 

“As a com­pa­ny that makes mon­ey from deposits, they’re sud­den­ly mak­ing a lot more mon­ey than before.” 

Kan­ji says “the top 5% or 10% of fin­tech com­pa­nies are still get­ting trans­ac­tioned”, with proac­tive investors knock­ing on their doors try­ing to per­suade them to embark in fur­ther fund­ing rounds. 

“You would have thought that, in a reces­sion­ary mar­ket, peo­ple would be pulling back and every­thing would stall but, with real­ly inter­est­ing com­pa­nies, deals are still being done,” he adds.

In the long term, the cus­tomer-fac­ing and infra­struc­ture sec­tors of fin­tech will con­tin­ue to offer attrac­tive invest­ment oppor­tu­ni­ties, says Mohnot. “If you step back for a moment, there’s a lot that is bro­ken in finance. And if there’s a lot that is bro­ken, there’s a lot of oppor­tu­ni­ty. From a macro per­spec­tive, mas­sive changes that will be ben­e­fi­cial for con­sumers are going to come from fin­tech.” 

O’Brien says that, with­out ques­tion, fin­tech will remain an attrac­tive sec­tor. “Fin­tech and the need for finan­cial ser­vices under­pins so many busi­ness mod­els,” he says, adding that 50% to 60% of invest­ments made by Men­lo Park Cal­i­for­nia-based Sequoia Cap­i­tal in emerg­ing mar­kets is being chan­nelled into fin­tech. 

“When you tie in blockchain-relat­ed projects and also decen­tralised finance, I think fin­tech and all adja­cen­cies will remain a core focus for most.”