The pendulum is swinging away from ‘growth at any cost’, say fintech VCs.

By Liza Tetley on Tuesday 17 May 2022

FeaturesAlternative LendingDigital BankingSavings and Investment

As rising interest rates and tech stock repricing spook investors, AltFi speaks to venture capital companies to get their take on where this leaves fintech funding.

The pendulum is swinging away from ‘growth at any cost’, say fintech VCs.
Image source: Francesco Filia/Fasanara

 

Tech investors have taken a beating in the past few months. With interest rates creeping up, the market has lost confidence in high growth ‘spec tech’, and star performing investors like Tiger Global, SoftBank and Coatue that are banking on these startups are suffering large losses.

Yet it’s not all bad news, according to venture capital companies. In fact, some even say that this environment is ideal for those looking for a good deal and can serve to ‘sort the wheat from the chaff’ when looking for companies to invest in.

“The current difficult market for tech allows for an expansion in some ways – it is the ideal time to make the most of lower prices,” says Francesco Filia, CEO at Fasanara Capital. “We can do better deals at cheaper prices, with bigger stakes than we could six months ago.”

Fasanara Capital put its money where its mouth is with the launch of a new fund last week specifically for fintech, Web3 and crypto startups – all areas in which the VC firm has particular expertise.

Filia remains unconcerned about gloomy reports of the 27 per cent fall in the US tech-heavy Nasdaq index. He believes the current market conditions are both more moderate than many have been led to believe and are also long overdue.

“The Nasdaq has actually only gone down a little overall; it is still much higher than where it was both before and during the pandemic,” he says. “It’s taken some steam off the top. This isn’t a crisis, it’s a minor dip.”

“Moving interest rates should also be put into context,” he continues. “Interest rates of zero are unsustainable – this should be viewed as a welcome adjustment.”

Pain for fintechs?

This is not to say fintech funding deals are continuing at the pace that they were back in 2021.

According to data from CB Insights in its State of Fintech Q1’22 Report, global fintech funding in Q1 this year was down 18 per cent compared to the same quarter the previous year, representing the largest percentage drop in quarterly funding since 2018.

“There is an asset repricing taking place in response to a number of macroeconomic factors, including rising rates, tightening of monetary policy and inflation,” says Ruth Foxe Blader, Partner at Anthemis Capital. “Deal velocity has slowed and [….] some of these mega deals aren't going to happen.”

For some fintechs, a change in the investment environment could introduce some new strategic, and perhaps even operational, considerations.

“We have lived through an unprecedented era of low interest rates and a favourable environment to raise money,” adds Richard Hoskins, co-founder and partner at Kin Capital.

“I think in some ways, VC-backed companies have sometimes been led astray with pressure to raise more and more money at a higher and higher valuation.”

Funding availability has already been impacted, according to Hoskins, with later stage fintech deals more affected than companies at seed, series A or B funding rounds.   

“Companies that have taken advantage of the frothy period to raise a lot of capital at inappropriately high valuations will likely be impacted,” adds Blader. “Companies that have grown sustainably and are growing interesting businesses will likely continue their growth.”

In terms of interest rate exposure itself, Hoskins predicts that rising rates will benefit fintechs that hold client cash but aren’t expected to pay interest. For some investment platforms or pre-paid card providers that hold uninvested cash balances, increasing interest on these holdings could actually become a significant additional source of revenue that could help offset losses elsewhere.

But for highly capital intensive fintechs – i.e. those developing software – or investment platforms where the bottom line is driven by the volume of transactions, the pain has just begun. Costs will need to be reined in and the first to be cut is often staff.

“We have already seen some high flying fintechs chop staff,” says Hoskins. “Robin Hood letting go of 9 per cent of its staff is a sign of more to come. Rising interest rates have killed just about every bull market in history.”

Trending towards sustainable

Aggressive, high-growth strategies may go out of fashion in the current climate, with a shift instead towards sustainable growth. VCs also expect there will be increased focus on cash generating businesses.

“The old rule that cash is king, is going to come back,” says Hoskins. “Companies get cash in two ways: either by generating as much revenue as possible, or through funding. I think the pendulum will swing away from funding, and towards organic growth.”

While the low interest rate environment made it easy for fintechs to acquire capital without near term prospects of profits, there will likely be more pressure for startup businesses to turn a profit.

Many fintech companies are still years away from profitability. For example, as AltFi reported back in March, despite launching in 2016 and successfully raising over $100m since, investment app Moneybox had still not become profitable. The company is by no means alone in relying on investor capital to fulfill its growth plans but it did also last week successfully raise £6.25m from retail investors via a crowdfunding campaign at a £300m valuation, double that of two years ago.

It predicts three more years of losses totalling £30.8m, according to a report in the Times. In 2025 though it suggests it will hit an ebitda profit of £3.7m. 

“There’s always a balance between growth and path to profitability,” says Blader. “Most investors are erring towards path to profitability at the moment and looking for growth that’s sustainable.”

“When cash is abundant it’s easy to say, ‘growth at any costs’, but I think more investors are going to be asking companies: ‘if this was the last round of capital that you ever raise, how would you build the business?’”

The sentiment is also echoed by Fasanara Capital, where the VC says it has a preference for profitable, or soon to be profitable, businesses.

“We don’t like cash burning businesses,” says Filia. “We like the ones that [are] close to profitability and are not throwing money at the business to make money.”

A helping hand

VCs’ advisory role is likely to take on more weight in the coming months too. For many young fintech founding teams, with no working experience of “normal" interest rates or an economic downturn, this period could be challenging.

The need for advice and support on how to cope with the new environment will be key, so it’s possible that we’ll see more VC involvement in the strategy of their portfolio companies.  

“Fintechs in particular spend a lot on the cost of acquisition of customers,” Hoskins adds. “They might have to push forward with roll-out plans that are slightly less ambitious in terms of the expenditure required to fund them.”

“Our job is to help asset managers service their clients' demands, reduce costs and operate with efficiency – if anything, this isn’t going out of fashion, it will only become more important.”

While Anthemis, Fasanara and Kin Capital told AltFi they haven’t reached a stage where they are demanding that their portfolio companies slow cash burn, Anthemis still says it would be “irresponsible not to highlight the necessity for discipline in this environment”.

“Pain in the public markets is not over,” Blader says.

‘Nail biting’

For the near term, growth expectations in the VC market are predictably modest. But VC is an asset class that distinguishes itself by its long-term outlook. VCs are advising fintechs to proceed with caution, particularly in terms of their spending behaviours – but they remain optimistic.

“Fintechs need to be more attuned to thinking ahead and extending their cash runway as much as possible,” says Hoskins. “That said, there still seems to be some pretty impressive fundraising going on, so there’s still funding to be had for quality companies.”

Anthemis Group also sees ample opportunity in the current environment, despite some “nail-biting” market conditions.

“There has never been more dry powder,” says Blader. “We are continuing to see our companies get term sheets and funding.”

One benefit of being a relatively nascent industry is that fintech companies are generally agile and quick to adapt. Anthemis, for one, expects that it will see many fintechs regrouping and continuing to grow over the coming months. Those that prove themselves resilient should be able to still obtain funding from committed VCs.  

“There was a feeling that we had a new raft of kingmakers coming into the market,” says Blader. “So now is the time to test that assumption.” 

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