Has fintech lost its shine? What VC investors need to see from founders

Fintech companies must cut costs and keep their heads above water for the next 18 months, writes Royal Park Partners’ Aman Behzad.

Image source: Pexels/ThisIsEngineering

After a record year for fintech investment in 2021, last year the sector experienced a global slowdown.

Balloon inflation, which led to large interest rate increases and weakened consumer and investor confidence, was characteristic of 2022.

Global deal volumes fell 38 percent (although they remained high by historical standards) as market turmoil took hold and funding costs rose.

Against this backdrop, it is important to note that the UK demonstrated its resilience as a top destination for fintech, providing more VC investment than the next 13 European countries combined.

On a positive note, fiscal measures and improved geopolitical sentiment appear to be raising hopes that we have avoided the worst-case scenario, with founders and investors in a position to pursue growth more confidently this year.

Turn the tide

The biggest shift at the start of 2023 was a renewed sense of stability and confidence in public markets, which naturally had a ripple effect on private markets.

Despite some recent wobbles related to the banking sector (SVB, Signature Bank, Credit Suisse, etc.), we continue to see strong performance in public technology stocks, with the Nasdaq having its strongest start to a year since 2000.

Just last November it felt like the industry was staring down the barrel of a gun. The perceived threats were multiple, but the biggest was a looming recession, compounded by uncertainty about when, and if, China would ever fully reopen.

These two contributing factors painted a frightening picture as investors considered how macroeconomic factors would play into the success of fintech companies, particularly revenues and costs.

At this point, there were not only major question marks around funding, valuations and the wider interest rate environment, but fundamentally the financial and underlying performance of these businesses.

Fast forward to 2023 and it appears that US inflation is largely under control and any further tightening is now well priced into equity markets. People can finally start sketching what the public markets will look like later this year and early next year.

This is all to say that there has been positive sentiment in the first few months of the year, with China opening faster than expected and inflation no longer expected to breach the back of the economy.

Naturally, it will take time for this feeling to play out in the private finance markets, but the signs are promising.

Has fintech lost its shine?

The adjustment of fintech values ​​in 2022 made investors suddenly sit up at board level and start paying attention.

And when you start asking pressing questions and following the money trail—where it is, where it’s gone, and what accountability there is for it—that’s when you begin to uncover errors, problems, and in many cases, unfortunately, fraud. That’s where we saw companies like FTX exposed, casting a shadow over the entire industry.

When public market valuations begin to fall rapidly, we see smaller rounds and valuations; the first to be affected are always late-stage companies – the private companies that are closest to going public.

Most noticeable is the rapid disappearance of the large $100 million checks, or so-called “Mega Rounds,” with capital generally deployed less frequently and in smaller amounts.

Funding rounds revert to milestone-based calculations, where further funding is only provided with the achievement of hard targets and sustained development of a company.

With all that said, fintech is as lucrative as it’s ever been. The key difference now is that investors are taking a more thoughtful approach, dedicating more time and attention to assessing the promise of fintech companies, and ensuring they can play a role in their continued success. This is a good thing, encouraging companies and investors to do due diligence in both directions and pushing for capital efficiency versus a “growth at any cost” mantra.

What investors need to see from Fintechs in 2023

The desire to “get in early” is growing, and deals in earlier stages are favored. In fact, this bracket has been largely protected from the recent periods of stagnation, and has not been affected either on the valuation front or on the actual amount being distributed.

Data shows that while activity slowed in most rounds, with the largest decline in later-stage funding, seed rounds boasted good growth levels in 2022 with a healthy $7.5 billion invested – compared to just $5.8 billion the previous year.

We will continue to see strong activity in these early stages, driven in part by a growing base of investable assets. This includes proven revenue models, attractive financials and product differentiation as the founders double down on their core business fundamentals.

Investors are keeping plenty of dry powder to invest in high-quality assets as growth technology companies continue to adapt to new market conditions and expectations.

In total, 142 companies raised $4.3 billion in the first two months of 2023 alone, according to PitchBook data, with activity picking up quickly in the later phase as well. In February 2023, 76 per cent of the total funding went to later agreements.

This means that the opportunities are not limited to companies of a certain size, shape or stage. More flat rounds and down rounds are to be expected as the runway tightens for companies that took off a few years ago, but investors will continue to fund companies that excite them regardless of the market.

Be warned, though: Founders can expect to see bumpy terrain, and late-stage companies in particular may have to rethink their next steps as the focus shifts toward unit economics.

Companies that stand out will include those that have realistic growth targets in light of the rising cost of capital.

This means having a laser focus on profitability and clear methods of saving money for a longer runway (ideally well into 2025), which will largely allow companies to control their own destiny independent of macroeconomic factors.

Buyers and investors will tread carefully, but if companies can cut spending and keep their heads above water over the next 18 months, the funding environment could look much different in the medium term.

Now is the moment of truth, as fintechs face their biggest challenge yet, operating through an economic cycle for the first time and working to demonstrate their value.

The views and opinions expressed are not necessarily AltFi’s.