Where investors see fintech opportunities during a downturn | Source of payment

The technology market seems to be following economic trends downwards, but companies that focus on embedded finance – payments and other digital financial products that can be deployed in third-party platforms – attract great interest from investors.

“Embedded financial providers are the building blocks for the next generation of fintechs,” said Adrian Mendoza, founder and general partner of venture capital firm Mendoza Ventures.

Embedded payments or embedded finance companies hold up relatively well compared to other VC-funded businesses, prompting investors to seek out companies that streamline the payment experience, or help build financial super apps. Two-thirds of adults have used embedded-finance services under the online cash register in the past year, according to Temenos. VC investments in embedded finance doubled between 2020 and 2021 in North America and Europe, according to a report from Stripe and Finch Capital, which found that the total for 2021 was around 6.7 billion dollars. The total through the first third of 2022 was just over 2 billion dollars, which signals a slight decline, but still well ahead of the 2020s.

Built-in economy versus do-it-yourself technology

“It is often a real business case to work with a market-leading provider of embedded financial infrastructure that has strong [application programming interfaces]instead of building capacity internally and having to navigate any regulatory requirements that may exist, “said Spencer Hurst, vice president of private equity firm Lowell Minnick.

Lovell Minnick invests in embedded finance in two ways. One strategy is to discover software platforms that embed financial and payment tools for their customers, such as Billhighway, which sells software and payment products to non-profit organizations. Another approach is to invest in infrastructure providers that allow the software to offer built-in finance, such as Fortus and LSQ.

A built-in payment strategy enables a software company to monetize additional customer costs, collect more customer data, drive increased loyalty and provide a strong user experience, according to Hurst.

“When done right, these built-in financial cross-selling sales have an insignificant customer acquisition cost and increase the lifespan of the customer,” Hurst said.

Companies that distribute their products through embedded payment providers tend to see better storage than companies that rely on distribution rails that are not directly connected to customers’ core technology, according to Hurst.

“One of the keys to success in embedded finance is enabling a friction – free customer experience,” said Hurst.

LSQ recently announced a partnership with Esker, a software platform for purchasing and accounts payable that integrates LSQ’s supply chain financing offer into Esker’s core software platform, Hurst noted.

Mendoza Ventures’ recent investments include Finaeo, which builds rails for digital life insurance companies that integrate purchases and offers of life insurance and other complex insurance products directly into fintechs through API connections. Another investment, in Senso.ai, incorporates mortgage purchases and pre-approval directly into the software of banks and other fintechs.

“We have seen banks and credit unions use embedded financial solutions from startups, instead of trying to build these services themselves,” Mendoza said.

It is an opportunity in built-in finance for startups that can streamline payment and financial processes, and create new competition for existing companies in such as Synapse, Stripe and Dwolla, according to Mendoza. This is especially true in the current market, where fintech startups are being asked not just to expand their own runwaybut also reduce the cost of financial services, “he said.

And any decline in IT spending in the financial industry could create opportunities for new companies that can demonstrate an ability to cut processing friction while reducing costs, as outlined by Mendoza and Hurst.

“In the current economic climate, I think you’re going to see a lot of big fintech players pushing down spending on innovation, and this will allow others to break through,” said Ralph Dangelmaier, CEO of BlueSnap, a digital payment company.

An overall fall in fintech start-up financing

While 2022’s total investments in embedded finance companies are about to be at or just below 2021’s total, the trend is coming against a backdrop of a much larger decline in investments in relatively new technology companies.

Fintech financing fell 18% during the first quarter compared to 2021’s first quarter, according to CB insight. And public fintech values ​​peaked at 25 times the average full-year revenue forecast for listed fintech companies in October 2021, dropping to 4 times those estimates by June 2022, according to Future.comthe site of a technology investor.

“For the past 18 months, we have been scratching our heads after the money grab for companies that received insane valuations and funds from VCs to make enough market noise without actually providing real value to customers,” said Isaac Gurary, CEO of NoFraud. a digital security company. “It was a big link between inflated valuations and real life. VCs apparently threw money at anyone who asked for it.”

The recent decline has been characterized by dramatic declines in the financing or valuation of buy now / pay later and crypto companies. Global crypto VC funding fell from $ 6.8 billion in April to $ 4.2 billion in May as the digital assets sector spiraled downward, according to Dove Metrics.

In the BNPL sector, Affirms action fell more than 90% earlier this year from 2021, and Klarnas valuation has fallen from a peak of more than $ 45 billion to around $ 6 billion in the last year.

“There have been several compressions in valuations. For companies that had ‘high growth’, the current market environment has made it difficult for these companies,” said Philip Belamant, CEO of Zilch, a BNPL lender.

Zilch recently announced a $ 50 million expansion of its $ 2 billion Series C funding. In addition to BNPL, the company offers a virtual Mastercard for digital payments, with the option to pay in full in exchange for repayment or four-payment loans. Zilch plans to offer debt consolidation and FICO scoring in an effort to increase site utilization and increase fee generation, which is part of fintech’s strategy for maintaining valuation, Belamant said.

The decline in fintech investments comes as total VC funding fell from around $ 200 billion globally in the fourth quarter of 2021 to around $ 100 billion in the second quarter of 2022, according to Crunchbase.

The reason for the dropout depends on the sector – BNPL investors are worried increasing regulations and delays in a slow economy for example, while investors in cryptocurrency startups are worried about an asset bubble in the underlying crypto. The overall trend is to continue to invest in innovation, but to seek companies that contribute to specific uses in financial services more than to estimate rapid growth in new users.

The need for innovation in payments and financial services remains, given the rapid shift to digital that emerged from the pandemic and has continued. This means that there is still a demand for fintech startups and for investment, but focused more on providing necessary services than those designing marketing or hype, according to Gurary.

“Any company in the fintech industry that has added value to sellers and / or consumers, even if the company was overvalued or margins inflated, is likely to withstand the test of time,” Gurary said.