Dry powder: A fintech M&A boom is kicking off

With the temperatures starting to head south and an uncertain winter ahead, so too is the outlook for many fintech companies' ability to raise fresh funding rounds.

It is no surprise therefore that the past few weeks have brought the sad news of a number of fintech companies winding down. 

Bank North, the middle market regional SME lending neobank, announced that it was set to close after failing to raise a new funding round meant it didn’t meet regulatory capital requirements.

Today we learned that Flux, an early UK  fintech company founded by three ex-Revolut employees, will shutter its receipts and cashback network.

Even Marcus, the ambitious project to turn investment bank Goldman Sachs into a fintech consumer powerhouse, looks uncertain following a report in Bloomberg that the bank would scale back its plans for the five-year-old flanker brand.

It all points to an accelerating mergers and acquisitions (M&A) trend in the fintech space. 

Dealmaking

Global fintech M&A saw a sharp rise in the first half of 2022, according to a recent report from Hampleton Partners, which has recorded 591 deals so far this year, defying the broader M&A slowdown.

This represented a 46 per cent increase on the same period in 2021 when there were 406 fintech deals as well as a 70 per cent increase (348 Fintech deals) on the same period in 2019 before the pandemic set in.

Miro Parizek, founder and principal partner at Hampleton Partners, says that for dealmakers fintech is proving to be very attractive and is therefore defying a broader global slowdown in M&A deals.

Data from Dealroom reported by Sifted also points to another healthy year for fintech M&A in Europe, with 190 fintech acquisitions in Europe, versus 241 in 2021. 

The trend also comes at a time of falling venture funding for fintech startups and a seemingly ever-worsening macroeconomic backdrop as major countries including the UK and the US brace for an expected recession.

Dry powder 

There is a “major difference” between today’s market and the previous recession of 2008, says Parizek. Dry powder. 

“This year, deployable private capital, including buyout, VC, growth and real estate, hit its highest level in history at $3.6trn - three times the figure in 2008,” he said.

“The availability of capital is driving buyers and investors to increase their acquisitions at a time when their pockets are full and high-growth fintech companies are being sold at all-time affordable prices. Any potential recession won’t dampen Fintech M&A as it did in 2008,” he added.

Howard Watt, a partner in Fladgates' venture capital practice, says there are a lot of investors who either recently raised funds, or who are sitting on huge amounts of capital that they raised before the market mood turned sour owing to Russia’s invasion of Ukraine and its associated problems.

”They have to deploy it because every fund has an investment period, usually around five years and you can extend that usually by one or possibly two years. But the clock is still ticking for them to deploy that money. They do actually have to deploy it,” he said.

Watt agrees we are starting to see M&A pick up in the fintech space.

"It's a good time if you're sitting on a bit of cash to consolidate and start picking off some good targets," he said.

In addition, he thinks there are many fintech companies out there - and their investors - that are "sitting on that precipice" where they might have tried a high growth "moonshot" strategy but now want to consolidate gains rather than risk oblivion should things get tougher in the funding environment.

"Given the way the economy is, they're now thinking, okay, maybe let's take this exit ramp because the valuations decent everybody gets an ok return. It's not the homerun that some VCs want, but VCs might be quite happy just to cut their losses and walk away with a 3x, or so if there's a decent opportunity that just at least reduces their downside and stops this being a loser," Watt said.

Finch Capital, a venture capital firm, in a report published today also says it is forecasting a period of "cooling and consolidation" across the fintech sector owing to the macroeconomic becoming more "challenging".

The good news, according to the firm is that the abundance of dry powder will result in a "soft landing" for founders and investors.

“After many years of impressive growth, perhaps overheated, there is no doubt that a worsening macroeconomic situation and tightening money supply are weighing on the fintech sector. This doesn’t mean that funding has dried up, simply that investors are becoming more discerning and price sensitive. In fact, our research indicates that dry powder is at an all-time high, with $28bn of undeployed capital among fintech investors," said Radboud Vlaar, managing partner at Finch Capital.

Vlaar believes investors are now becoming more cautious in their approach and how they deploy money. This alongside a number of "overinvested" start-ups struggling to exit will mean a period of consolidation.

“There was always an element of uncertainty around the long term sustainability of valuations for certain companies, particularly at growth stages. This shake-up, while painful, is also necessary. Consolidation and more competitive investment flows, combined with still significant levels of undeployed capital, will bring maturity to the fintech sector. And, despite difficult near term prospects in the economy at large, a new normal level of activity will resume in FinTech over the next 12 to 18 months, with a focus on long term sustainability,"  he said.

All of this paints an interesting picture. While initial public offerings (IPOs) have long been the dream of founders, funding pressures and mountains of dry powder' is already prompting a wave of entrepreneurs to head down the M&A route.