 |
| By Chris Graebe |
The world of financial technology, or fintech, has experienced rapid growth and innovation in recent years.
Major companies like Visa (V), Mastercard (MA) and Jack Henry (JKHY) get the lion’s share of investor attention in this space because of their size and global reach.
But it’s also not uncommon for companies that are not yet publicly traded to make inroads in this exciting field. That’s because they are innovating in ways that the “big guys” like so much that, in some cases, they buy the whole startup!
There are some signs right now that the industry may be entering a period of consolidation. But the fintech boom is far from over.
For the pre-IPO-minded, that means now is a great time to start seeking out which startups might have what it takes to run with the big fintech dogs.
A Sluggish First Half of 2023
The first half of 2023 has no doubt been challenging for the fintech industry. S&P Global says funding in global fintech companies experienced a significant decline of 49% year over year. That was a $23 billion loss during this period.
For early stage companies, the decline is reflected in the number of funding rounds, which dropped by 64% compared to the same period in 2022. The first half of 2023 has been the slowest quarter in the past 2.5 years.
The funding decline is particularly pronounced in later-stage startups. Mega-rounds (over $100 million) dropped from 55 in Q2 of 2022 to just nine in the same period of 2023.
Despite these challenges, there have been some standout performers.
One standup startup is Stripe, which raised $6.5 billion during the first half of the year, contributing to the overall funding numbers.
Valuations Looking Up
Funding rounds might have shrunk in quantity and size recently, but there’s a silver lining. That is, fintech company valuations have shown improvement.
PitchBook reports that share prices for recent fintech IPO companies have rebounded faster than the wider market, rising by 21.2% in Q2 of 2023. The Nasdaq and S&P 500 rose 12.8% and 8.3%, respectively, during that time.
This tells me that investors are laser-focusing on fintech’s profitability. It also appears that they favor traditional IPOs over Special Purpose Acquisition Companies, or SPACs, which debut on the public markets with the intention of acquiring a non-public company.
Another Powerful Trend
Investors are increasingly looking toward business-to-business models rather than consumer-focused startups.
Fiat Ventures reports B2B models offer several advantages in the current market environment. One notable one is the shift away from free or freemium models that prioritize customer acquisition, and a focus on more stable (and higher) revenue streams. Paywalls, subscriptions and other revenue-generating strategies can help ensure immediate profitability.
However, this does not mean that consumer-focused startups are obsolete. And startup founders — who are often natural innovators and problem-solvers — are starting to find even more new ways to generate revenue and cater to changing consumer preferences.
2 Startups to Sidestep
The current … but, I believe, temporary … slowdown in the fintech industry can be attributed in large part to the rise in interest rates and decline in personal savings rates.
These changes have dampened consumer spending and increased the cost of borrowing for companies, like Affirm and Klarna, impacting their valuations and ability to attract funding, according to Carta.
The end of the pandemic surge in consumer investing has also contributed to the challenging environment for fintech startups.
The Next Steps for Fintech
The challenges are far outpaced by optimism for fintech’s future.
According to Silverton Partners, many investors and industry experts believe the current slowdown is a natural part of the industry's evolution and that this will ultimately lead to stronger and more sustainable growth in the long term.
The second half of 2023 holds much promise for the industry. TechCrunch reports that some fintech sectors, such as online-only banks (neobanks) and payment companies, have already shown resilience and the potential for growth.
The industry is also witnessing a shift toward profitability, as companies focus on generating revenue and reducing costs.
Innovation and adaptability will be key for fintech startups. The nature of fintech has been to force finance to evolve. So, as long as that continues, we will continue to see innovations … and opportunities to invest in it.
While Stripe seems to stand head and shoulders above its startup peers, it’s not the kind of company I like to focus on. For starters, Stripe recently did a $6.5 billion fundraise.
The kind of companies I target are generally seeking funding for the first time outside of friends and family. They are innovators in any field, not just fintech, and are raising anywhere between $1.2 million and $5 million, via Regulation-CF fundraising.
With the expected resurgence of small fintech startups, this is a space I’ll certainly continue to investigate.
Happy Hunting,
Chris Graebe
P.S. Fintech startups often offer some of the best raw returns I find. However, they aren’t known for paying large dividends. In fact, as you can see in this recent presentation, even if they did, that wouldn’t be enough.
