The curious case of extreme fintech deals

Big deals and small deals – with not much in between – seem to be the new trend when it comes to fintech funding, writes John Clark, CEO of Royal Park Partners.

Image source: Pexels/Savvas Stavrinos

As fintech entered a period of re-calibration in 2022, the pace at which investment has been deployed across the globe has slowed compared to the golden age of 2020/21.

However, a closer look at fintech funding data points to some interesting trends. One of these is the growing correlation between deal size and funding, with data showing that the majority of funding raised last quarter went to either larger deals over $100 million, or smaller deals under $25 million. This is not a sign of a lack of capital per se, but of a more thoughtful investor struggling with current market conditions.

With that in mind, we know that investor interest in certain sectors of the market is still growing, with new winners emerging and existing leaders maturing and diversifying. With current conditions in mind, what’s on the horizon for fintech funding in the coming year?

An investor-driven market for financing – what does that mean?

Half of the market is currently focusing on their existing portfolio companies, which to some extent can explain the calm experienced in some areas. With the break to continue into Q1 and Q2 2023, investors would do well to focus on using their available cash reserves to support their companies in the coming quarters as conditions remain uncertain.

That said, we are seeing a shift in where the other half of the market is focusing its attention, with less appetite for “growth at any cost” seen in recent years. The bar for financing is rising, and calculations are becoming all the more important for making investment decisions.

There is still plenty of dry powder available, but there has been a notable flight towards early-stage bucket and later-stage quality funds, with a much stronger focus on capital efficiency over high growth.

Dealmaking has remained robust among angel, seed and early stage rounds through Q3 2022, with approximately one-third of completed deals being seed funding. Yet entrepreneurs today are increasingly judged on their ability to streamline their business and focus on their core proposition, with the current status reminiscent of the 2014 cycle, where investors drive the processes rather than the companies themselves.

Some VCs are able to add much more value by investing at an early stage, allowing them to maximize value over the long term.

While there is undoubtedly greater risk involved, investors are hedging their bets on repeat founders at the helm of earlier-stage companies with a promising proposition that can deliver strong returns in the long run. Many funds at this end of the investment spectrum look for a 1:1 ratio of revenue to capital raised, to prove the underlying fundamentals of a business.

Companies with a longer path to revenue have a harder time meeting new expectations, with Series B and above typically not yet proven product-market fit.

Customer adoption of truly innovative business models takes time, and companies in this segment will generally require heavy infrastructure investment over a long period of time before revenues start rolling in.

With that in mind, investors globally are also turning to proven, later-stage companies that have shown promise to achieve meaningful scale and profits.

Late-stage deals continue to account for the majority of capital raised in Europe this year, with companies at this stage of growth generally boasting a strong market presence and well-known offerings, and approaching profitability (or already profitable).

Those who favor late-stage deals now carefully consider whether firms are managing their money wisely and keeping costs low before pursuing investments.

Following the funds – trend summary

While funding in early and later stages is indicative of a stage-to-funding correlation, mapping data over the last quarter also paints a picture of emerging and mature market segments.

Payments attracted the lion’s share of investment this year, attracting $3.4 billion in the third quarter of 2022 alone, closely followed by crypto and DeFi ($2.8 billion) and insurtech ($2.1 billion).

Payment solutions remain attractive VC targets, driven by the continued acceleration of digital trends and increasing demand for alternative payment models, while blockchain is set to take center stage in 2023 as we approach the tipping point where these technologies will be adopted at scale across economies worldwide.

Elsewhere, wealth technology companies are on a strong trajectory, having seen an increase in funding in Q3 2022 versus Q2 2022. There is huge appetite from investors and the M&A community for technology solutions for the wealth management industry, with the numbers reinforcing this growing trend.

The takeaway

The current marketplace is an environment that will drive resilience and innovation, with investors now more concerned with the bottom line and cash flow. This provides a new opportunity for fintech companies to pause, reassess and pursue change, and it will strengthen their business foundations.

High-growth darlings will continue to attract funding and reach ever-higher valuations, and there are still big rewards for early-stage companies with solid fundamentals, especially in market segments that have yet to realize the fruits of digital transformation.

What we are seeing now is a return to pre-pandemic levels, not an existential crisis. The return of a more cautious risk appetite will separate fintechs that can demonstrate high capital efficiency and scalability from those that cannot.

This will only serve to strengthen the sector, and pave the way for a more sustainable and strengthened financing environment in the future.