By Daniel Lanyon on Thursday 30 June 2022
After a huge increase last year, the ‘herd’ of UK financial startups with a valuation higher than £1bn has grown by just two new members in the first half of 2022.
It’s hard to say why the tech industry became so fixated on creating ‘unicorns’ but the answer probably lies somewhere in the hard maths of venture capital returns.
For startups with a private market valuation of at least a $1bn, that being the common definition, the past decade has been one of explosive growth with more than 1000 global unicorns, according to CB Insights.
In the UK, and in particular, in its fintech industry, unicorns have been plentiful too with at least 24 by the last count. Incredibly, 15 of these or nearly two-thirds of these were created last year in 2021.
This year, things are looking starkly different.
So far in 2022, there have been just two newly created unicorns: GoCardless which joined the club in February after securing a $312m funding round more than a decade after launching and Paddle which raised £162m in May.
The number is only one higher than that of Bulgaria and Italy for 2022.
Of course, this year has been characterised so far by fears of a recession in the US and elsewhere as inflation has spiked to generational highs. With interest rates rising fast to combat an overheating economy, a number of commentators have warned that investors in startups may turn off the funding taps as capital becomes more expensive.
This then has led to speculation that companies such as fintechs that have seen their private valuations increase rapidly in recent years will be forced to accept cuts to their valuations as part of new fundraising activities. The dreaded 'down round'.
Professor Florin Vasvari, London Business School's Institute of Private Capital and Entrepreneurship says, however, in the first quarter of 2022 only 5 per cent of completed rounds have come in at a lower valuation than when companies last raised capital, quoting Pitchbook data.
Nonetheless, we are starting to see signs of more down rounds to come, he adds. Klarna, which became Europe’s most valued startup last March, has apparently raised a down round at a third of its previous valuation.
“It is too early to tell how badly affected the venture capital sector could be in the next 12 to 18 months. But the belt-tightening will put a new level of pressure on both investors and founders, many of whom have never seen a downturn,” Vasvari said.
“Inflation is also likely to lead to some contraction in fundraising. As capital becomes more expensive, investors will be more picky and take longer over due diligence,” Vasvari said.
This could mean that the ultimate investors in fintechs, the institutions or individuals who hand over money to venture capital firms look to other assets for a financial return.
”When portfolio companies’ valuations finally adjust, some limited partners might find themselves overallocated to alternative assets and thus in need to cut down their exposure to private funds," he added.
Money is still flowing to tech startups in the UK though at least so far this year.
In the first five months of the year, UK tech companies have raised more venture capital funding than in the whole of 2020 after a £12.4bn haul compared with 2020’s £12bn, according to data by Dealroom analysed for the UK’s Digital Economy Council.
Half of this amount actually came from US investors, who have put more money into UK companies than they did in the whole of 2020, investing £6.1bn this year compared to £6bn in 2020.
Fintech continued to be the favourite sector. for UK tech investment this year with £6.2bn raised by fintech startups and scaleups. The figure is more than half the overall amount.
“Despite the wider global challenges that have led to a slow down in public markets, private tech investment in the UK is continuing to grow. The UK has cemented its reputation as one of the best places to invest in fintech, with more fintech investment going into the country in the first part of this year compared to even the Bay Area,” said Yoram Wijngaarde, founder and CEO at Dealroom earlier this month.
“Nearly everything will be affected by the downturn we’ve entered into, but overall the UK tech sector is in a strong position than it's ever been before in terms of breadth and depth of the entire ecosystem,” he added.
There have been some ‘mega rounds’ from the likes of Checkout.com which raised nearly £800m in Series D funding in January to become the UK’s most valuable private fintech but, aside from GoCardless and Paddle none of this has pushed any fintech companies north of the unicorn benchmark.
Public vs Private
The stock market crash is often touted as a reason that starts up will find it harder to justify frothy valuations as public market exits become a tougher sell to investors.
The ferocity of the downturn in public markets is reminiscent of when the dot com bubble burst, says Per Brilioth, managing director of VNV Global, who adds there is some key differences.
“Tech companies are down in magnitudes that are reminiscent of 2001 but I think they will rebound quickly. Then there was no real market for those products - it’s very different now. Then the internet was in its infancy, now these are viable businesses with huge markets," he said.
He adds that companies that make money and have better management are still likely to raise money from investors.
“In e-commerce, in the digitalisation of banks, in B2B marketplaces - those businesses that are well run are going to get funded," he said.
While unicorn creation might well be slowing, Brilioth is still upbeat on the market for fintech.
“An enormous amount of startups are still being formed: they solve real problems. Maybe they don’t become unicorns in two seconds, but maybe that’s not a bad thing. Some of these valuations overshot on the way up and some of them have overshot on the way down," he added.