Has fintech lost its lustre? What VC investors need to see from founders

Fintech companies need to cut back on spending and keep heads above water for the next 18 months, writes Royal Park Partners’ Aman Behzad.

Following a record-breaking year for fintech investment in 2021, last year the sector experienced a global slowdown.  

Ballooning inflation, which brought on large interest hikes and sapped consumer and investor confidence, was characteristic of 2022. 

Global deal volumes dropped by 38 per cent (though remained high by historical standards), as market jitters took hold and the cost of financing increased. 

Against this backdrop, it’s important to note that the UK showed its resilience as a top destination for fintech, netting more VC investment than the next 13 European countries combined.

Positively, fiscal measures and improving geopolitical sentiment seem to be raising hopes that we have avoided the worst-case scenario, with founders and investors in a position to pursue growth more confidently this year.  

Turning tides 

The biggest shift at the start of 2023 was a renewed sense of stability and confidence in public markets, which naturally had a spill-over effect into private markets. 

Despite some recent wobbles associated with the banking sector (SVB, Signature Bank, Credit Suisse, etc), we continue to see strong performance in tech public stocks, with the Nasdaq recording its strongest start to a year since 2000.

Just last November, it felt like the industry was staring down the barrel of a gun. The perceived threats were multi-fold, but the biggest was a looming recession, compounded by uncertainty around when, and if, China was ever going to fully re-open.  

These two contributing factors painted a frightening picture, as investors considered how macro economic factors were going to play into the success of fintech businesses, in particular revenues and costs.

At this time, not only were there big question marks around funding, valuations and the wider interest rate environment, but fundamentally the economic and underlying performance of these businesses.  

Fast forward to 2023, and it looks like inflation in the US is largely under control and any further tightening is now well priced into the equity markets. People can finally start to underwrite what the public markets will look like later this year and early next year. 

This is all to say that there has been a positive turn of sentiment in the first few months of the year, with China opening quicker than expected and inflation no longer expected to break the back of the economy. 

Naturally, it will take time for this sentiment to play itself through into the private funding markets, but the signs are promising.  

Has fintech lost its lustre? 

The adjustment of fintech valuations in 2022 made investors suddenly sit up at board level and start to pay attention. 

And when you start to ask pressing questions and follow the money trail – where it is, where it’s gone, and what accountability there is over it – that’s when you start to expose flaws, issues, and in many cases, unfortunately, frauds. That’s where we saw companies like FTX exposed, casting a shadow over the whole industry.  

When public market valuations start to dip quickly, we see smaller rounds and valuations; the first to be impacted are always late-stage companies - those private companies closest to going public. 

Most noticeable is the rapid disappearance of the big $100m dollar cheques, or so called “Mega Rounds”, with capital in general deployed less frequently and in smaller quantities. 

Funding rounds are returning to milestone-based metrics, where further funding is only given with the achievement of hard targets and the sustained progression of a company.

With all this said, fintech is just as lucrative as it always was. The key difference now is that investors are taking a more thoughtful approach, dedicating more time and attention to assessing the promise of fintech businesses, and ensuring they can play a role in their continued success. This is a good thing, encouraging companies and investors to perform due diligence in both directions and pushing for capital efficiency vs a ‘growth at all costs’ mantra.

What investors need to see from Fintechs in 2023  

The desire to ‘get in earlier’ is growing, with earlier-stage deals being favoured. Indeed, this bracket has largely been protected from recent periods of stagnation, having not been affected either on the valuation front nor on the actual quantum being deployed. 

Data show while activity slowed in most rounds, with the largest decline in later stage funding, seed rounds boasted good levels of growth in 2022 with a healthy $7.5bn invested – compared to just $5.8bn the year before.  

We will continue to see strong activity in these early stages, driven in part by a growing base of investable assets. This includes proven revenue models, attractive economics, and product differentiation as founders double down on their business fundamentals.   

Investors retain lots of dry powder to invest in high-quality assets, as growth tech companies continue to adapt to new market conditions and expectations. 

In total 142 companies raised $4.3bn in the first two months of 2023 alone according to PitchBook data, with activity also picking up quickly in the later-stage bracket. In February 2023, 76 per cent of the total funding went to later-stage deals.  

This is to say that opportunities are not restricted to companies of a certain size, shape or stage. More flat rounds and down rounds are to be expected as the runway tightens for companies that raised a few years ago, but investors will continue to fund companies that excite them regardless of the market. 

However, be warned: founders can expect to see gnarly term sheets, and late-stage businesses in particular might have to rethink their next steps as the focus turns to unit economics. 

Companies that stand out will include those that have realistic growth targets in light of the rising cost of capital. 

This means having a laser focus on profitability and clear methods to conserve cash for a longer runway (ideally deep into 2025), which will largely allow companies to control their own destiny regardless of macroeconomic factors.  

Buyers and investors will tread with caution, but if companies can cut back on spending and keep heads above water for the next 18 months, the funding environment could look a lot different in the medium term. 

Now is the moment of truth, as fintechs face their biggest challenge yet, operating through an economic cycle for the first time and working to demonstrate their worth.  

The views and opinions expressed are not necessarily those of AltFi.