This is a continuation from our last article on Fintech valuation in the previous edition. In this article, I explore the drivers of valuation and strategies you can use to significantly enhance the valuation of your Fintech venture, regardless of whether this is a start-up, a venture that is already growing fast or a corporate initiative to venture down the Fintech path.
Valuations matter, because it will determine how much of your company you give away to an angel investor or a private equity firm during a fund raising round. It will matter hugely when one day you decide to sell the business or be acquired by a larger organisation, or indeed exit through an initial public offering (IPO), as many unicorns are contemplating. For investors or potential acquirers, valuation matter hugely, because you don’t want to get caught up in the hype and over pay for your acquisition. Valuations also help you compare potential acquisition targets.
The Valuation Trajectory
It’s important to understand where you are in the cycle to best time fundraising or exit. I explored the potential trajectory of Fintech valuations using a “hype curve”. Had you been raising funding in the hype curve, then count your lucky stars because this was a market favouring Fintech entrepreneurs. Beyond 2016, however, the pendulum may be swinging to an investor led market, because of the plethora of new Fintech firms coming to the fore.
Over time valuations will stabalise and investors or acquirers will move to a more objective valuation approach. At this point, you as the Fintech entrepreneur can take control over how your firm is valued, rather than the hype of the market dictate this.
Investors, factor in the ability of your investee to weather risk and regulatory storms. Fintech firms, you should develop this asset and factor it into your valuation – don’t throw away value.
Fintech Valuation Drivers
So assuming the market stabalise to rationality, and doesn’t unfairly favour the entrepreneur or investor (or acquirer), then what really drives the value of a Fintech firm? Remember, these firms are typically young, with little track record, and promising exceptionally high growth in the future. Because of this very fact, valuation is more art than science and traditional valuation methods (such as discounted cash flow analysis) may not always work. However, there are certain fundamental drivers of revenue that be influenced as levers to drive up (or in deed down) valuation of your Fintech firm.
In simple terms however, what drives value can be simplified to a formula that most in the industry would understand:
Valuation = Revenue x Multiple
For traditional companies, Revenue – EBITDA (Earnings Before Interest Tax Depreciation and Amortisation) or net revenue. Most Fintech firms aren’t generating profit, so investors typically rely on gross (top line) revenue or turnover. Going forward however, rational investors will demand profitability and healthy cash flows. Stable, recurring and predictable revenue streams is what investors and acquirers are looking for. The Multiple is a factor that is typically set by the industry as a benchmark, and valuation multiples are either driven up or down depending on various assets that can be utilised to drive consistent high growth into the future.
In this article, we focus on how firms can manipulate the Multiple to drive their valuation. A word of caution! Whilst Fintech entrepreneurs will look to drive up the multiple, investors and acquirers will be looking to drive down this multiple, because of perceived risks. You therefore need to address those aspects of your business that can drag down the multiple.
We explore three factors that drive up the multiple and three that could dampen it, and we also look at practical ways to manipulate this multiple, leveraging work done by Shirlaw, together with my insights working with our clients.
3 Factors Driving up the Multiples
Remember, these factors are cumulative. In other words, you need to achieve the first to get value from the second and so forth:
1. Culture, Capability & Talent:
An office “buzz” creates the right culture to attract the best and brightest talent, a crucial ingredient to build and grow an innovative financial services firm. The right team creates the firm’s superior capability to execute a strategy of sustainable high growth. The right team also allows the firm to scale into other innovative products and different geographies.
2. Intellectual Property & Innovative Systems:
Intellectual property may be the only assets in the early pre-money days. Ensure its protected and don’t overlook patent protection, trademark or design registration. Investors (& acquirers) will also be looking for innovative technology that allows you to deliver a better, faster and cheaper product of service compared with traditional players. Systems must be well documented and repeatable, allowing for rapid and predictable expansion without the day-to-day involvement of founders.
3. Expand Products, Services & Geographies:
Optimise existing products and service, then develop new and innovative ones quickly using repeatable processes (covered in 2 above). Expand into new markets and geographies, using the systems and the capability of a string team.
3 Factors Driving down the Multiples
Investors and acquirers will be looking for anything that can put future cash ow at risk. So it’s good to anticipate and address any objections that could be raised. We explore three factors that can drag down the multiple, and what could be done to avoid it.
1. Ability to Protect Reputation & Manage Risks:
In AON’s 2015 risk survey, reputational risk was highlighted as the no. #1 risk by 1,481 executives from 28 different industries. Reputational damage can ruin even the world’s largest firms, especially in this digital age of openness and transparency. Being able to demonstrate that the firm can effectively anticipate and proactively manage reputational and other risks, will give investors and acquirers comfort and help to prevent a reduction in the Multiple.
2. Ability to deal with Regulatory Change:
Fintech firms operate in one of the most highly regulated industries in the world. Regulation have been light touch, but are expected to intensify because the risks that consumers are being exposed to. Regulators can close down any non-compliant business (valuation of zero). The firm must be able to demonstrate that they can comfortably handle a barrage of regulatory change.
3. Strong Leadership Team & Succession Planning:
A good leadership team will continually thrive to explore and effectively exploit super growth opportunities. A leadership team that is lacking certain core skills or is not a cohesive team working towards achieving the firm’s aggressive high growth goals, will start to leak value and potential acquirers or investors will spot this and move to reduce valuation. Dependence on any key individual is another significant leadership risks, so is the lack of a well-defined and executed succession plan. Investors will want evidence of the next layer of management that are going to be able to drive that growth.
I present a brief synopsis of ways Fintech firms can enhance valuation. This is a complex and extensive topic that will receive more attention in the future. However, for a more in-depth analysis, opportunity to discuss or ask question, visit this page.
Alternatively email me at [email protected]
[author title=”Jay Tikam” image=”http://i68.tinypic.com/2wduc9h.jpg”]Jay Tikam is the CEO of Vedanvi Ltd, a professional services firm dedicated to help Fintech and Alternative Finance firms overcome strategic, risk and regulatory barriers and in so doing, enhance its long term valuation.[/author]