Banking on FinTech Innovation

Background

The frothy venture capital (VC) market of 2021 is certainly starting to wane. Dollars invested, number of transactions, valuations and fundraising are all on the decline. However, one sector that has continued to show promise is the fintech sector. Continued innovation in banking, wealth management, cryptocurrency, insurance, blockchain and artificial intelligence (AI) are creating interesting opportunities for investment. In fact, many of the large global VC firms remain quite bullish on innovation in the fintech sector. In 2022, Sequoia and Andreessen Horowitz had 25% of their overall investments in the fintech space. Even though fintech funding was down in 2022 compared to the record year of 2021, it was up over 50% when compared to the dollars invested in 2020. 

The future disruption in the fintech space is definitely promising, but has the added risk of regulatory requirements, frequent regulatory changes and sanctions. Future regulation in the banking, insurance, cryptocurrency and AI spaces is inevitable and all successful investors will have to do a good job of navigating the changing regulatory environment. There have already been talks in Washington, D.C. about regulating new AI tools, such as ChatGPT. In the AI space, regulation is certainly necessary to guard against misinformation and other potential downsides of the technology. Public input is being requested on AI issues such as standards, regulations, investments and better trust and safety practices.

There is an axiom in the tech space to “move fast and break things.” One of the fintech spaces that is ripe for disruption is the old-line insurance industry. Disruptive technologies have appeared in the insurance industry to assess risk, make pricing decisions on policies and utilize telematics for predictive analytics on driver performance.

What Are FinTech Investors Looking For?

By and large, VCs in the fintech sector are looking for similar characteristics as investors in the other areas of the tech space: disruptive ideas impacting large markets. They are looking for quality management teams with experience in the space who also understand capital efficiency. Finally, they are looking for companies that can exhibit a clear path to profitability and a potential exit. Being able to show growth is still important, but today being able to show profitable growth is even more important.

Lack of IPOs in the FinTech Sector

The fintech sector experienced a significant increase in funding and valuations in 2021; however, only a very small number of these companies successfully went public. The IPO market came to a dramatic halt in 2022; this has continued into 2023 and the fintech sector was subject to the same market forces. In fact, only 20 VC-backed IPOs occurred in Q1 2023. The lack of exits for fintech companies and the slowdown in the IPO market have caused a significant problem for VC funds looking for liquidity to generate fund returns and also liquidity to return capital to limited partners (LPs).

Have FinTechs Grown into Their Frothy Valuations of 2021?

Like most private and public technology companies, fintech valuations are certainly trending downward. Many fintechs raised considerable funding in 2020 and 2021 at relatively high valuations. Very few fintechs have hit milestones that would justify these sky-high valuations. Many fintechs now need to raise additional capital and many are continuing to pursue raising  private capital, since the IPO window is still closed. Many of the fintechs will be raising capital at valuations below the valuations of 2021 and will suffer further dilution as a result of the down rounds. These down rounds could be a common occurrence for fintechs and other technology companies in 2023.

Hot Areas for FinTech Investors

It should come as a surprise to no one, but the area that will be attracting the most investor attention in the fintech sector will be everything around AI. The media is giving tremendous attention to anything AI and investors are certainly looking for the next potential unicorn company in this sector.

The contents of this article were the result of a panel discussion moderated by Alan Wink at the Emerging Tech Venture Summit that took place in San Jose on May 10 and 11, 2023.

Catalyst - Our Current Issue: Q2 2023

• Banking on FinTech Innovation
• Connected Patient Concerns
• Terms of Engagement: New Rules for Negotiating the Deal