Have VCs found a purpose, or gone cold on the fintech market opportunity?
Recent data shows that VC investment in fintech – historically Europe’s best funded sector – has been eclipsed by climate and deep technology funding.
As tempting as it is to interpret this shift as a sign that VCs have discovered a new moral compass and turned their backs on fintech in favor of the more noble endeavors of education, health and the planet, I find it hard to believe. This depends heavily on the loss of attractiveness of Europe’s largest fintech market: the UK. Behavior matches incentives, and incentives to invest in the UK fintech scene have waned since the glory days of 2017-21.
Investors are simply looking for their next cash cow. Here are some reasons.
Fragmented markets and little room to scale
Every country has its own unique mix of regulation, market structures and consumer behavior to navigate – but not all have the early-adopter consumers, pro-competitive regulation and digital economy that the UK has. This makes it incredibly difficult to export fintech products designed for the UK to other markets, including those across Europe.
Fintechs on the continent also continue to grapple with the challenges of market fragmentation as EU policymakers have yet to achieve single market integration – take the N26’s struggle to export a European product to the UK or the catalog of failed attempts to pass coalition-based arrangements, most recently the P27 planned to integrate payments between different currencies in the Nordics which withdrew its license application last month.
The startups that show signs of potential global success are those that solve payment problems across national borders – such as Wise, Airwallex and GoCardless.
Most fintechs in the UK and Europe – with the notable exceptions of Adyen and Klarna, which have their own headwinds to contend with – have failed to break into the world’s biggest market for finance: the US. When you remove the global audience from fintech ventures and are left with largely domestic European markets, it all starts to look much smaller and more saturated.
Exit options
As the increased cost of capital weighs on VC activity and stock markets, the established playbook of “scale then IPO” is breaking down.
This is a problem because for fintech scalers like Monzo and Starling, their only option is IPO. Their costs are too high for profit-conscious buyers, and integration efforts will be grim. Trade exit opportunities in fintech have always been much more limited than other technology industries.
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Incumbent banks in the UK and mainland Europe, while in a position to buy, will not
From my experience working with established banks in the UK and mainland Europe, while they are able to buy, they won’t. IP-based valuations or “perceived valuations” seen in venture rounds are less attractive, and while revenue multiples have declined, they remain high compared to publicly traded incumbents.
Trade exit options are therefore limited to “big fintech buys small fintech”, but even these warchests are being eroded by falling valuations.
Lack of business model innovation
Perhaps the most difficult reason to blame the “environment” is the lack of genuine business model innovation in fintech and the lack of good ideas. Many of the best-supported and better-known fintechs have driven adoption by solving convenience needs, rather than doing anything truly original in terms of business models. The retail banking model, for example, continues to sell debt and collect exchange on card spending.
This means winning depends on displacement, rather than serving an entirely new need. There are a handful of exceptions, such as Nutmeg, Bank of London and ClearBank, but the vast majority of venture-backed fintechs are pushing behind closed doors in the UK and Europe and will struggle to reach the heights as a result.
Global markets by nature
Reverse, climate tech, health tech and edtech benefit from characteristics that are likely to make them much more valuable investment targets in the coming years.
Markets such as health, education and reducing emissions are global in nature. For example, diabetes, mental health or heart health are worldwide pandemics, with clinically predictable impending growth and a compelling scientific basis. The need is universal, physiological and constantly changing compared to financial needs, which are contextual and have not changed much since the invention of the card.
While healthcare may be different around the world, it is not difficult to see a global market for a health technology such as an early detection platform for mental health or a consumerized heart health product that sees a common global problem with a well-designed solution, and there is no reason why to the fact that a British-backed enterprise cannot provide that answer.
Relatively understood and misunderstood
Likewise, these markets are new. They do not replace an analogous, suboptimal status quo. In many cases, they solve new problems, such as recycling EV batteries, or solve old problems with new technology.
This means by definition that a solution or way to solve the problem has not spread, so there is a real opportunity for the market to pick a winner of a global award.
Ability to find ‘positive sum’ opportunities
There are massive socio-economic, health, education and environmental problems for the world to solve, and entrepreneurship can be the best weapon to solve them. This provides a unique opportunity for ventures that create both successful entrepreneurs and happy investors, as well as positive human and societal impact.
Despite the (very) positive PR push for “impact investing”, we cannot pretend that the filter will not always be the commercial return.
Conclusion
Now is a good time for VCs to pick a new hero. The rapid economic shift will help prune the large number of unviable and unimaginative fintech ventures that limp through the venture cycle.
It makes a lot of sense for investors to support entrepreneurs with ideas that have the potential to solve the world’s big problems, rather than putting a new digital front-end on another old industry.
As much as I’d love to think this shift was the pull of a higher mission, I suspect it’s more likely pushed to a sketchy return horizon for their fintech work.
