There’s always a conversation to be had around company valuations, either they’re too high, or there’s not enough of them, or someone just made Unicorn status, or Unicorpse status, it’s a background chatter.
But fintechs are different. And here’s why. Nowadays, the valuation of fintech companies isn’t so much dependent on their economic valuation, revenue or profitability. Their valuation is based on the probability of future higher valuations and ultimately liquidity for the investors. A quick reminder of where the exit doors are located.
Management Buyout: Probability – Zero to very low.
IPO: Probability – Low.
Further Rounds of VC Investment: Probability – High. Private Equity firms and late stage VCs are now considering qualified fintechs as potential opportunities.
Bank / Institutional Acquisition: Probability – High. Tier 1 banks are the more natural buyers of these new type of ventures.
Acquisition by competitors in a concentrating market: Probability – High (but not for a few years).
Focusing on Bank Acquisitions: Fintechs are a distinct type of startup. They are born with a clear exit visible. If they are a fintech that facilitates bank operations in some way, the value isn’t how much will a bank pay for a service, the value is how much will a bank pay for the company. If the fintech could save a bank £10M a year in operating costs, how much is that worth to the bank? What is that opportunity worth? That’s the valuation of the company.
Other fintechs, a minority now, are directly competing with the banks.
Does this fintech present a real competitive concern? If so, how much does it cost to remove this threat, and convert it into an asset? One reason the banks aren’t worried about fintechs is they have an underlying attitude of ‘if they do become a serious threat, we’ll just buy them anyway’. This is their final option, and it’s a bit of a no lose situation for the banks. If they’re a genuine concern, they end up owning them. Good for investors. The stick in the mud for banks would be an emergence of a competitor that had no intention of selling, the banking equivalent of Facebook or Uber, someone going for market takeover. Bad for banks, ultimately a very big win for investors.
Focusing on acquisition by a competitor: Another possibility is liquidity through market acquisition. There’s a glut of money transfer companies. Sooner or later, the biggest will raise capital to acquire the lesser ones, acquiring market share and benefitting from the economies of scale and efficiencies. Good news for investors.
In conclusion, a good company may make healthy profit, but have little chance of being sold. A good investment may have zero revenue, but be a great acquisition opportunity for a tier 1 bank.
When considered in these terms, high fintech valuations make sense, they are at least a rational, rather than a hype based response to the risk and rewards of the market.
By Antoine Baschiera, CEO and Co-Founder of Early Metrics, the first rating agency that aims to detect and rate innovative startups, providing the analysis results to its clients which are global corporations, investment funds and banks. Rating is free of charge for startups and based on the three extra-financial pillars: the management, project and the market.