This article was originally published in FinTech Global on 8 August 2022; here: Should FinTech companies worry about the current market?
The financial market is going through a rough patch. The rising cost of living, soaring inflation rates, war in Ukraine and the post-pandemic environment is having a major impact on businesses and individuals. Companies are starting to feel the pinch and the FinTech sector is among them. However, how bad is it for FinTechs?
Well according to Lars Seier Christensen, chairman of the Concordium Foundation and founder of Saxo Bank, “I would say FinTech is already in turmoil. Valuations are way below 12 months ago, and cash burning early-stage FinTech companies are finding life very difficult.”
There is clearly a slump in the FinTech market at the moment. A report from the Financial Times claimed that almost a trillion dollars has been wiped from the valuation of FinTech companies. It stated that over 30 companies have listed in the US since the start of 2020. The report highlights that shares in recently listed FinTechs have fallen by an average of over 50% since the start of the year. This is compared to a 29% drop in the Nasdaq Composite.
One of the most high-profile companies to publicly show their experiences in the troubled market is buy now, pay later giant Klarna. The company recently raised $800m in a funding round that put its valuation at $6.7bn – an 85% drop from its valuation in 2021. The FinTech company has also cut its global workforce by 10%. Last year, Klarna was valued at $46bn, but a downround had been rumoured for several months.
The company blamed the drop on the worst stock downturn in 50 years. In a statement it said, “The fresh investment in Klarna occurred during possibly the worst set of circumstances to afflict stock markets since World War II: high inflation, rising interest rates, mounting fears of a recession, the aftereffects of the first global pandemic since 1918, strains on commerce caused by supply chain disruptions, rising gas prices, and, especially in Europe, the dislocations caused by the war in Ukraine.”
But other FinTech companies are also showing their troubles. For example, US digital bank Varo Bank recently cut 75 people from its team, which represents around 10% of its total team size.
Not quite FinTech turmoil
Matt Clifford – chief executive and co-founder of investment firm Entrepreneur First – said the current dip isn’t the end of FinTech, but the correction of the market. “The whole venture capital market had an extraordinary bull run through 2020 and 2021.
“What we’re seeing now is a return to reality, not an existential disaster. Will it be harder to raise capital this year? Absolutely, particularly for later stage companies. But it might be a great time to start a company in FinTech. The opportunity to build the future of finance is undiminished and if you’re small and capital efficient, the broader market turmoil will have relatively little impact on your long-term prospects.”
In a similar vein, Henrik Grim, GM Europe at investor Capchase, stated that it is hard to know how deep and long the current slump will be in the FinTech sector, but there is a negative shift in risk appetite and funding in the sector, which is also being felt in the wider technology ecosystem. However, Grim noted this is not going to be a momentous drop like the 2000 tech bubble burst.
Grim said, “But unlike the 2000 tech bubble crash, I would argue that the current dynamic is instead a return to the more cautious valuations and risk appetite of former years. Looking at SaaS multiples, for instance, we did see crazy public and private valuation metrics in the last 18 months. The current numbers are actually very close to what we saw during most of the 2010s, e.g. 2013-2018.”
One of the reasons Grim offered as to why this won’t be like the 2000 crash, is because Europe and the US have a much deeper tech industry now, which is composed of varying categories and risk models. This makes the market more robust and less likely for the whole sector to crash.
There are always winners
Even more optimistic about the current situation was Martin Cook, head of FinTech and partner at law firm Burges Salmon. Cook stated that many businesses are going to feel the impact of the trepid market, including FinTechs. However, things are a little more hopeful for the FinTechs.
Cook said, “On the whole, I’m still bullish about the opportunities for the FinTech market. At a time of inflation, and with cost of living and cost of business increases, surely the need for financial tools and access to funding – particularly where they can be delivered with speed and convenience via digital means – is needed as much as ever?”
While there might be opportunities for FinTech companies, they will still need to entice investment firms to see the potential, which might prove difficult. But FinTech companies could be their own saviours. Cook said, “While some firms will no doubt delay investment decisions as a result of market pressure it is likely that B2B-focussed FinTechs have a role to play in helping larger institutions adopt technology that improves operating efficiency.”
Similarly, payment platform Payoneer’s SVP James Allum said there is still hope at the end of the tunnel for many FinTechs. Allum said, “There’s still plenty of innovation and growth in the industry. I am confident that the sector will emerge from this challenging period with a number of companies ready to seize the opportunities of the future – this may well include some consolidation.”
While the market is going through a rough patch, there are still a lot of companies raising capital. In the first half of 2022, $76.8bn has been raised across 3,447 deals, according to data from FinTech Global. The sector leading the charge is blockchain and cryptocurrency, accounting for 20% of the deals, followed by WealthTech with 15%.
Consolidation of the FinTech sector?
Whenever there is a dip in funding it is followed by talk of consolidation. With the market blooming and thousands of startups hitting the market, it makes sense there will be consolidation, but the funding seems to never stop.
IBM managing director financial services digital transformation Prakash Pattni said, “The FinTech sector benefited from industry hype, as well as factors including low interest rates and post-pandemic recovery, which resulted in growth. But as market conditions begin to settle, we will see a period of consolidation and increased rationality in investment decision-making, which will ultimately be healthy for the sector.”
Capchase’s Grim said funding will likely continue to drop across all technology funding stages. He stated that funding amounts and valuations will likely revert to the historical levels of 2017 – 2019 over the coming months.
Grim said, “Looking back to when I started in venture capital in 2015, the fundamentals of investing were very much in vogue. We spoke about gross margins, capital efficiency and burn rates, and because of that, loved software businesses.
“Many of the recently failed investments are low-margin businesses with terrible capital efficiency. They simply would not have got off the ground 5-7 years ago, because they would not have had the funding. Since then, investors got increasingly competitive in looking for the next big opportunity. They lowered the bar, and reduced due diligence scrutiny.”
However, not everyone was certain this was consolidation, but just a natural cycle between risk and spending. Christensen said, “You have periods of exuberance and periods of risk adversity. This is a good opportunity to tighten the ropes of the ship, and come out stronger from the dust, with less competition.”
Should FinTech companies be worried?
If the market continues to get worse, firms are going to need to be prepared. When asked if FinTechs should be worried, Christensen said, “Absolutely. If you have a long way to profitability or a high burn rate, this is a toxic environment. It will definitely be terminal for some.”
This was a similar sentiment for many; these will be challenging times and firms should be cautious, but this isn’t the end of the world. Pattni said, “The FinTech industry is experiencing a challenging period, but companies shouldn’t panic – they should use this time to re-evaluate their focus and priorities. Like any industry, periods of strife separate the companies which are able to cut through the hype to deliver growth and those that can’t.”
Just because the market is getting tougher, doesn’t mean there will no longer be a place for FinTech. “There will continue to be a need for solutions providers, so there will be opportunities for FinTech growth across all sectors, especially those in financial security, artificial intelligence and fraud detection that banks need to tackle,” Pattni added.
Grim was also confident that FinTech companies might not be as affected as other sectors. Grims stated that for a well-run and viable startup, cutting headcount might be unnecessary. There will also be funding available if support is needed to survive.
“I also predict that this tech downturn is going to be very uneven. Pure tech businesses like SaaS, cybersecurity and many FinTech startups are going to be much less exposed than tech-enabled businesses. The latter, with their lower margins and capital efficiency, are going to find it a very tough time – think logistics, PropTech and physical goods retailers.”
There will be opportunities to acquire the customer base of struggling competitors or prepare the business for the market rebound, Grim stated. Cutting staff could be a ‘self-fulfilling prophecy’ and stop the company focusing on the potential.
Grim said, “My advice to entrepreneurs is to not be spooked by news of layoffs and feel pressured to follow suit. Of course, keep managing your runway diligently. But double down on efficiency and performance rather than cutting the meat of your business. Seeking out alternative financing can provide a war chest and reduce the pressure to seek external funding over the next year. The main message is that you do not want to be fundraising at the moment.”
Surviving the troubled market
There is no simple answer. However, there are some things firms can do to survive. For example, Cook offered some advice on weathering the storm. This included effectively managing cost base and risk profiles, seizing opportunities to stand out and being agile and adaptive to changing markets. Cook also stated that companies should offer services that customers need and want, and understand the current environment, both in terms of pressures on customers and positive demand-led change like net zero targets.
Pattni stated that there will be funding for successful companies, ones that have focused on profits and their customers. Additionally, Pattni argued that successful FinTechs will partner and collaborate with larger firms, such as IBM, that have a stronger customer base and understand the financial services market to build a joint go-to-market proposition.
Clifford added that to survive, companies will need to reassess their operations. “I still like the distinction between companies whose products are “vitamins” (or nice-to-haves) versus those whose products are “painkillers” (or must-haves). Life is going to be a lot easier for companies selling painkillers; vitamins are the first items to be cut when budgets get tight. If you’re already spending too much money and capital is scarce, make the tough decisions early to get to a sustainable place.”
As for small companies, Clifford urged them to focus on the customer. “Listen to them and iterate on your product until you’re really meeting their needs in a way they can’t live without. Stay lean and keep costs low until you feel certain you have real pull from the market.”
One method to survive might be to quickly raise capital. While this might be a great way to increase a cash reserve, firms shouldn’t see it as the holy grail. Instead, it is better to control costs or seek other opportunities for survival. Besides, many agreed that funding will still be available for great companies, so there is no need to frantically panic.
Speaking on whether companies will seek quick funding rounds, Clifford said, “We’ll see lots of companies try – but not all will succeed and most that do will have to accept valuations that they would have turned their nose up at last year. This effect will be least strong at the earliest stages, where I expect investor optimism to hold up a lot better, largely because by the time these startups mature the macro environment will (I hope!) be much better.”
What areas are staying strong?
It is not all doom and gloom for the sector. Cook listed some of the areas that he sees customer demand staying strong. These include digital financing tools, lending and funding, ESG solutions, savings, wealth management, pensions and new technologies that improve efficiency and customer service.
Grim was positive that most of the FinTech sector will stay strong. Pure technology businesses will be less exposed to the effects of the recession and will still grow, Grim stated. The ones that are more at risk are the tech-enabled businesses, such as grocery delivery, due to those having lower gross margins and capital efficiency. said, “Most FinTech companies that are pure tech typically enjoy high gross margins, higher capital efficiency and greater scalability, which makes them more attractive investment cases. If there are strong fundamental drivers of demand, that will help further.”
Allum stated that e-commerce could be a saving grace for many in the sector. “E-commerce will provide much of the growth needed for FinTech firms to mitigate against inflation,” Allum said. “The global digital commerce ecosystem is still rapidly growing and relies upon the technology provided by the FinTech industry.” Additionally, SMBs are a major drive for economic growth and recovery, meaning FinTech companies can support recovery by supplying companies with tools to leverage global digital commerce.
However, while most people are confident the appetite for FinTech will maintain, if not increase, there is no guarantee. Christensen said, “Market participants such as hedge funds and VCs tend to go on-off on risk appetite very broadly. So even good companies will be dragged down, when people are trying to reduce risk in a given sector.”
What’s to come?
This is likely just the beginning of the tough times and things will get worse. Many said there would be losers and winners, with the latter becoming much stronger through their survival.
Adaptive Financial Consulting chief strategy officer Fergus Keenan said, “There will be a lot of lessons learned for first-time founders going through a difficult period for the first time. Some good businesses will suffer through no fault of their own, of course. But, overall, we believe there will be plenty of investment available for well-run FinTech firms to continue to innovate and create differentiation solutions in the industry during the next 12 months.”
Allum believes that collaboration, specifically with banks, will be key over the coming year. “There’s a reason that they have stood the test of time and are steady institutions which can be leaned on in times of turbulence.” By working together, Allum is confident they can improve the financial market to be even more welcoming for all players.
On an optimistic note, Clifford concluded, “I think we’ll see a tonne of innovation at the early stage. There’s been a lot of talent tied up in companies that were overvalued and will now be considering their options. I expect a lot of those individuals to decide to start companies. Many great startups were started in very tough macro conditions (think Airbnb or, going back further, Microsoft) and I believe we’ll see lots of long-term FinTech winners founded this year.”
This article was originally published in FinTech Global on 8 August 2022; here: Should FinTech companies worry about the current market?
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