Fintech needs to grow, and fast, to survive

The financing ecosystem for fintech startups has changed significantly over the past 24 months, creating entirely new rules for companies chasing investor capital. At-all-costs expansion plans will no longer win over investors, so fintech founders must show a path to smart, sustainable, and ultimately profitable growth.

Before 2022, fintech startups they were exploding. The pandemic powered visions of agile and mobile financial services. Low interest rates have caused investors to seek returns by investing large amounts of capital in fintechs, focusing primarily on rapid growth.

Startups of all types have been a huge beneficiary, with 2021 breaking records for startup funding and 2022 setting the all-time record for second place.

But after the surge in inflation, interest rates also increased. And as the banking system briefly faltered with the collapse of Silicon Valley Bank and First Republic Bank, venture capital firms suddenly closed their checkbooks. Startup funding has plummeted by more than 50%. as investors grew more cautious. Many companies have simply been left for dead by their investors.

This conservatism in turn closed the mergers and acquisitions market, dramatically shifting the conveyor belt of seed capital as paths to successful exits diminished. Middle-market fintech companies in particular found themselves suddenly stuck, with no obvious place to turn for help.

Even though 2024 has seen an increase in M&A activity and companies like Reddit demonstrate that a successful IPO is indeed possible in a high interest rate environment, it is unlikely that startups will see a return to the pre-boom days. pandemic. Investors are no longer in the same situation they once were. Regulators, previously behind on fintech regulations, are now catching up.

Reviving fintech growth will depend on the ability of founders and leadership to comply with the new rules. The good news for fintechs is that they do not operate in a completely hostile environment. This market cooling hasn’t affected investors anywhere near the size of the losses suffered during the dot-com crash, for example. Fintech remains a high-growth, high-potential market segment that investors still find attractive, under the right circumstances.

What has changed, however, are their expectations. Once upon a time, the prevailing view was that growth was the most important criterion sought by venture capital firms. Despite in many cases having significant operating losses (and in some cases no visible or very long paths to future profits), these companies may previously move forward, with the hope that scale will drive the acquisition, regardless of profitability.

But now companies need to grow smart rather than fast. Stories of efficient and strategic growth, with strong unit economics and good customer acquisition costs are now fashionable. Venture capital firms want to see this path to sustainable cash flow and profitability.

For startup leadership, this requires a greater degree of focus. All the bad opportunities won’t be worth pursuing if they take the company off its profitability trajectory. Proving the concept on a smaller scale will improve venture capitalists’ confidence in the larger company.

As the market warms up a bit, venture capital firms are looking more favorably on experience. Founders who have great ideas but no track record will find little love from investors. But management teams with impressive and relevant resumes will find a warmer welcome. Improving the level of management can be expensive for a company, but in some cases it is essential to attract the next level of financiers.

Interest rates are still high. Borrowing is still expensive. Investors want to know that the right hires are being made and that the right leaders are at the helm. Founders who stay in place need to ensure they have a good board of directors to support them, with people who can give frank advice.

As further evidence of fintech’s maturation, regulators and lawmakers are starting to wake up to concerns around data privacy and security, especially in the world of finance. Savvy venture capitalists look around corners and have a good understanding of what’s coming.

The fintechs that succeed in raising funds in the future are those that can demonstrate that they are well prepared for that regulatory future. They can demonstrate that they have a data privacy architecture in place and that their handling of consumer data is secure.

Finally, while AI is a priority for everyone working in the tech industry today, companies looking at funding need to understand exactly what role AI plays in their strategy, both as an enabler and a competitive threat. Companies that can demonstrate that they are effectively using AI to automate processes, cut costs and optimize services have a better chance of attracting investment, assuming they don’t get sucked into the core business jaws of a company that is building a large linguistic artificial intelligence model. .

The landscape for startup financing has improved, but it will still be difficult for companies to open the purse strings to investors. Valuations will remain low, making equity financing difficult. Companies still must be prepared to make sacrifices for investor money, whether it be headcount, ownership percentage, or degrees of founder control.

Fintech companies will need to show greater focus and discipline in the face of the sector’s first major macroeconomic headwinds. Sustainable growth will be the key to achieving success.

James Lichau is an insurance partner at BPM.

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