European growth investor Finch Capital has released its eighth ‘State of European Fintech’ report, exploring the impact of the investment environment on the fintech sector; the state of fintech in key European countries and thematic trends expected to see strong momentum in the next year.
The European fintech sector has been heavily impacted by a change in the funding environment, with a total of €4.6billion capital raised in the first half of 2023, down a dramatic 70 per cent when compared to the €15.3billion raised in H1 2022; the Finch Capital report found.
Finch Capital explained that while in 2021 and 2022, the top 20 funding rounds in Europe accounted for 50 per cent of the market, they now account for over 60 per cent of the total deal volume – despite having decreased in size. Meanwhile, seed rounds continued to attract funding, but companies in the Series A to C stages were squeezed the most.
Sector-wise, the biggest surprise was seen in payments. Despite traditionally being a resilient sector which saw record amounts of capital deployed in 2022, investors were cautious about valuation inflation in the sector. The crypto sector emerged as the main benefactor as investors flocked to early-stage businesses.
Fintech funding drops
Although the Finch Capital report highlighted a 70 per cent drop in funding value across major markets including the UK, Germany and France, the share of the UK in the total funding accounted for 50 per cent of the total capital raised in Europe, up from 45 per cent.
It also appears that the US-based investors that were previously active in these markets have also taken a step back. In 2021, there were three US-based firms in the top five investors in the UK – but in 2023, none were present.
Later-stage valuations have fallen much more dramatically having seen in some cases up to a 50 per cent drop. Earlier stage fintechs were more resilient, as valuations remained relatively flat. There is hope for the ecosystem though, as valuations stabilised in the first six months of 2023 after a low in December 2022.
These findings appear to suggest that the fintech sector in Europe has entered a period of contraction. Finch Capital explained that a focus on building profitable businesses at sustainable valuations will drive economic value to all stakeholders in the next phase.
Lay-offs to continue
As companies fight for profitability most companies made lay-offs, except half of the European Unicorns, which are still expected to start laying off in the second half.
The fight for profitability came into real focus in the past year as the industry suffered from more than 3,000 announced layoffs. Despite the backdrop described above, the sector is still hiring, with the 10 fastest-growing fintech companies having hired over 1050 people in the past year (50 per cent of the employee base). Demonstrating a shift towards a less-well-funded and more competitive landscape, some companies have decided to hire for cheaper junior positions and lay off senior salespeople who have gotten too expensive over the last few years for today’s market conditions.
Long-term sustainability versus short-term gains
Radboud Vlaar, managing partner at Finch Capital, commented: “Since mid-2022 we have seen an increase in investment discipline in public and private markets, resulting in less funding, lay-offs, less IPOs, flight to quality and focus on capital efficiency.
“This will continue to be painful for the next 12 months but will result in a more healthy and sustainable start-up, hiring and investor ecosystem.
“With investors bridging overvalued portfolio startups to bring them to profitability and struggling to find attractive exits in a grossly devalued market, we are likely to see a period of consolidation in the fintech space as many verticals are highly fragmented, creating a smaller but more sustainable ecosystem.
“We should also start to see a slow recovery of the IPO market in the next semester as valuations have started to slowly pick up and inflation is declining.
“Last year’s shake-up with valuations coming down, fundraising slowing down and the exit window closing up, was painful yet necessary. Consolidation and more competitive investment flows, combined with still significant levels of undeployed capital, will bring maturity to the fintech sector. This new normal level of activity demonstrates the refocus of the fintech ecosystem on long-term sustainability versus short-term gains.”