Financial technology, or fintech, has seen the most drastic shift in sentiment this year. Several dynamics, ranging from public market exits to extreme valuations, have changed. This has left potential investors and strategic buyers in a vastly different landscape.
For several years, a confluence of economic factors created the perfect environment for fintech firms to thrive. Low-interest rates and high liquidity pushed investors and institutions to riskier asset classes such as venture capital and private debt for startups. Venture capital assets more than doubled in 2021, surging past $300 billion according to data by Ernst & Young and Chrunchbase.
A substantial chunk of this capital was invested in financial services or fintech startups. VCs deployed $134 billion in the finTtch sector last year, up 177 percent from the previous year, according to CrunchBase data.
2021 was also a record-breaking year for exits. Seventy-seven fintech companies went public last year, the highest number ever. The top eight had a combined valuation of $236 billion at their peak. By the end of the year, the average fintech’s valuation was on par with a high-growth software company – trading at an enterprise value to revenue (EV/Revenue) ratio of 24.
The market has completely reversed this year. Publicly-traded fintech stocks have underperformed the broader market while venture capital investors have pulled back. “With the pause in the IPO market and disappearance of SPACs, exit options remain limited to private sales or recapitalizations,” says Pete Gougousis, a managing director with Alvarez & Marsal’s transaction advisory group. “Buyers are cautious where they want to place bets amid an uncertain macroeconomic cycle and interest rate environment.”
Higher rates have also squeezed margins and profitability for these firms, according to Gougousis, which is another factor that has pushed valuations lower. According to data from CapIQ, the industry’s EV/Revenue ratio has dropped from 25 to just 4 this year.
Lower valuations and distress have attracted more strategic buyers. “Declining valuations have also invited more demand from buyers as they try to bridge the valuation gap with seller expectations,” Gougousis adds. Bargain hunters closed a record-breaking 591 fintech M&A deals in the first half of 2022 – up 46 percent from the first half of 2021, according to data compiled by corporate finance advisory firm Hampleton Partners.
Gougousis believes buyers are not just looking for bargains, but also profitability. “Exponential growth is no longer the most important criteria for making deals,” he says. “Buyers are focused on fintech’s ability to earn a profit.” That means crypto-related firms, buy-now-pay-later (BNPL) providers and mortgage platforms are out of favor, while profitable firms focused on insurtech, payment processing and investments & capital markets are attracting more attention.