Big deals and small deals - with not much in between - seems to be the new trend when it comes to fintech financing, writes John Clark, managing director at Royal Park Partners.
As fintech entered a period of re-calibration in 2022, the pace at which investment has been deployed across the globe has slowed compared with 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 either to larger deals over $100m, or smaller deals under $25m. This is indicative not of a dearth of capital per se, but of a more thoughtful investor grappling with current market conditions.
With that in mind, we know that investor interest in certain sectors of the market is still burgeoning, with new winners emerging and existing leaders maturing and diversifying. Keeping current conditions in mind, what’s on the horizon for fintech funding in the coming year?
An investor-driven market for funding – what does it mean?
Half of the market is currently focusing on their existing portfolio companies, which goes some way to explain the lull experienced in some areas. With the hiatus 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 next few quarters as conditions remain uncertain.
That said, we are seeing a shift in terms of where the other half of the market is focusing its attention, with less appetite for ‘growth at all costs’ seen in the past few years. The bar for funding is rising, and metrics are becoming all the more important in making investment decisions.
There’s still plenty of dry powder available, but there has been a notable flight towards the early-stage bucket and later stage quality assets, 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 roughly a third of completed deals being first-time financings. Yet founders today are increasingly being assessed on their ability to streamline their business and focus on their core proposition, with the current state of play reminiscent of the 2014 cycle, whereby investors are driving the processes instead of companies themselves.
Some VCs are able to add a lot more value by investing at an early stage, enabling 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 cmpanies with a promising proposition that can deliver strong returns in the long run. Many funds on this end of the investing spectrum are looking for a 1:1 ratio between revenue and capital raised, to prove the underlying fundamentals of a business.
Companies with a longer path to revenues are having a harder time meeting new expectations, with Series B and above typically yet to prove product-market fit.
Customer adoption of truly innovative business models takes time, and companies in this segment will generally require heavy infrastructure investments over a long period before revenues start coming in.
With that in mind, investors globally are also turning to proven, later-stage companies that have shown promise in attaining meaningful scale and profits.
Late-stage deals still 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 favouring late-stage deals are now carefully assessing whether firms are prudently managing their money and keeping costs low before pursuing investments.
Following the funds – trends roundup
While early and later-stage funding is indicative of a stage-to-funding correlation, charting data across the last quarter also paints a picture of emerging and maturing market segments.
Payments attracted the lion’s share of investment this year, attracting $3.4bn in Q3 2022 alone, followed closely by crypto and DeFi ($2.8bn) and insurtech ($2.1bn).
Payment solutions remain attractive VC targets, driven by the continued acceleration of digital trends and increasing demand for alternative payments models, while blockchain is set to take the stage in 2023 as we approach the tipping point where these technologies will be adopted at scale across economies worldwide.
Elsewhere, wealthtech firms are on a strong trajectory, having seen an increase in funding in Q3 2022 versus Q2 2022. There is a huge appetite from investors, and the M&A community towards tech solutions for the wealth management industry, with the numbers reinforcing this growing trend.
The current marketplace is an environment that will drive resilience and innovation, with investors now more concerned with the bottom line and cashflow. This offers a fresh opportunity for fintech companies to take pause, reassess and pursue changes and that will strengthen their business fundamentals.
High growth darlings will continue to attract funding and reach ever greater valuations, and there are still great rewards for early-stage companies with solid fundamentals, particularly in market segments that have yet to realise the fruits of digital transformation.
What we’re seeing now is a reversion 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 can’t.
This will only serve to strengthen the sector, paving the way for a more sustainable and invigorated funding environment in the future.
The views and opinions expressed are not necessarily those of AltFi.