The VC playbook for investing in fintech during a market downturn

Over the past decade, the UK fintech ecosystem has flourished. From a global perspective, the UK punches well above its weight, accounting for 10% of the worldwide fintech market, according to the recent Kalifa Review.

A symbiotic relationship between investors and entrepreneurs has been crucial to this success. Venture capital and growth equity firms are looking to the UK as a place to find and invest in cutting-edge fintech companies with high growth potential, supported by its proximity to the City of London and UK consumers’ willingness to adopt new financial technology.

Fintech entrepreneurs see the UK as the perfect place to launch a new business, with easy access to funding and guidance from sophisticated investors who have backed several other success stories.

This ‘power circle’ dynamic – promising businesses attract funding, which in turn attracts promising businesses, and so on – has driven investment in UK fintech companies to record levels. The UK accounted for almost half of the European total in fintech investment last year. In the first six months of this year, it ranked second only to the United States as the largest hub for fintech investment, according to Innovate Finance.

But the mood music within private finance markets has changed during 2022. Fintech investors are asking a completely different set of questions than before. We experienced this shift in focus firsthand when we raised our $110 million Series C last November, and as global financial markets pulled valuations down by over 80% in many cases, we successfully completed an oversubscribed $50 million top-up to this the round. summer. This amounted to $160 million in equity without the need to lower our previous valuation of $2 billion.

Market volatility

Historically, venture capital funding has been drawn towards – and then used to subsidize – fintech companies that can demonstrate rapid growth. Aggressively expanding your customer base was the main concern, for entrepreneurs and investors alike.

In the digital banking space, Revolut last year secured the highest valuation of a UK tech company – rising fivefold to $33 billion – after passing 16 million users globally, despite annual losses increasing year-on-year.

We experienced a similar dynamic. Our customer acquisition rates, which had taken us past one million customers a couple of months earlier, were central to our discussions with investors around our Series C round.

Then came market volatility in early 2022 and everything changed. Rising interest rates, rampant inflation and declining valuations in the public markets had an immediate knock-on effect on how investors viewed and valued private fintech companies seeking to raise new equity funding. There were two main areas where fintech companies – especially those offering a consumer-facing product – suddenly came under much closer scrutiny.

Fintech investors focus on new metrics

First, what kind of relationship do you have with your customer base? It’s all well and good to have reached millions of customers, but these numbers can be deceiving. Do you own the relationship with these customers, or are you relying on other companies to refer them back to your product? Are you offering them a unique proposition to which they are loyal, or are they constantly on the verge of jumping to a competitor offering the same commodified service?

The more long-standing and traditional operators in buy-now-pay-later space find themselves on the horns of this particular dilemma. Because they effectively fund the purchases made by the customers of the merchants for whom they process payments, they do not own the relationship with those customers.

If their major retail partners choose to put another BNPL vendor’s button on the payment page, a chunk of their customer base will disappear overnight. The largest operators have experienced dramatic declines in value in recent months, in no small part for that reason.

The other area of ​​increased investor scrutiny is whether a company’s product is profitable and its margins sustainable. When we talked to our investors over the summer, they put a lot more emphasis on the net transaction margin on our customers’ purchases and our path to profitability.

Any fintech company looking to raise more capital needs to have answers to exactly these questions. Of course, it will not harm them at all to have a strong growth at the same time. But that will no longer be enough. Customer loyalty and commercial viability are increasingly at the forefront of private fintech investors’ minds.

Philip Belamant is CEO and co-founder of Zilch.