State of the Fintech M&A Landscape: Market Trends and Regulatory and Enforcement Considerations | Morgan Lewis

Three months into 2023 and the fintech landscape looks completely different than it did this time a year ago. Global economic uncertainty clouds the fintech industry, and it faces challenges from rising interest rates, significant layoffs in the tech space, and high visibility of cryptocurrency bankruptcies.

INFLUENCE OF (INCREASINGLY) INCREASING INTEREST RATES

As a result of a period of high economic activity fueled by low interest rates and “easy money”, prices were pushed up. To control inflation, the Federal Reserve has gradually increased interest rates, with levels of 0.08% in January 2022 to 4.57% in January 2023. Interest rates are expected to rise in the near term. The fintech industry is affected in a number of ways:

• Reduced demand for servicesas higher prices force companies and consumers to scale back.
• Reduced employment and mass redundancies are seen across the board, affecting Big Tech companies right down to startups. But when you look at the financial crisis of 2008-2009, one of the most important factors was that a number of people who lost their technology jobs saw an opportunity in the disruption market, and a similar situation could be seen in today’s layoffs throughout the industry.
• Less demand for assets that are considered riskier results crypto bankruptcies. In a strong statistic from CoinGeckothat reported the number of deactivated cryptocurrencies on their platform, more than 4,000 cryptocurrencies did not make it to their two-year marker.
• VC capitalists invested $57.6 billion globally in enterprise and consumer fintechs in 2022, a reduction in fintech deal activity from a high of $100 billion according to Pitchbook. Nevertheless, both the value of VC deals and the number of deals in 2022 remained above pre-pandemic levels, suggesting that investors continue to see long-term opportunities in the sector.

CONSORTIUM AGREEMENTS: AN ALTERNATIVE METHOD OF FINANCING

A financing trend that is gaining popularity among fintech transactions is to form a consortium-structured fintech company, either financed by a group of banks or other financial services firms, or such a company can be put together by one or more firms, based on the identification of a particular need. Structured either as a corporation or as an LLC and often preferred due to its great financial and management flexibility, there are a number of advantages and challenges associated with this method:

BENEFITS

• The financing is based on strategic as well as economic and commercial reasons.
• Investors are likely to be less sensitive to valuation or market sensitivity.
• The fintech consortia provide the investor groups with early access to customers, revenue and referrals to other industry participants for further acquisitions or revenue sources.

CHALLENGES

• Misalignment of prioritization, pricing, product fit and roadmap, and commercial and growth interests of core customers and non-customer shareholders in investor syndicates
• Differences in exit/sale/liquidity strategy
• The complexities of designing non-cash equity incentives to recruit and retain management
• Varying strategies around subsequent investment rounds, such as identifying syndicate partners, balancing valuation and commercial considerations, and governance structures and policies
• Antitrust and regulatory compliance considerations

ENFORCEMENT AND THE IMPORTANCE OF REGULATORY CONDITIONS

When dealing with a transaction, the parties should consider not only the transfer of value, but also the transfer of regulatory and enforcement risk. Over the past two years, there has been a marked increase, particularly from the CFPB and FTC, and state-level attorneys general and banking regulators, in looking at aiding and abetting liability, secondary actors, and successor liability. This has been magnified by the recent development at the US Department of Justice that is being replicated by most federal and state agencies, the Self-Reporting Policy which places a premium on early and full disclosure. Due diligence must not only be thorough and complete, it must be done correctly.

Regulatory considerations

In this current environment where valuations have fallen dramatically, opportunities may arise for traditional incumbents to invest strategically in companies at more favorable valuations. An advantage of this type of investment is that it allows investment in a new line of business without having to build it from scratch. Due diligence is an essential component of these agreements as it can determine the associated risks and whether there is a way to reduce or eliminate those risks.

Some questions to consider when inquiring about the target entity, including determining whether it is registered with a US regulatory agency, are (1) has it been the subject of regulatory investigations, and if so, what were the results and have they been resolved, (2 ) what business activities it is considering for the future, and (3) who is responsible for regulatory compliance after the completed transaction. Depending on the results of regulatory due diligence, an investor may be able to seek specific representations in its agreement to reduce potential risks and associated costs.

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