A slowdown in economic growth, a weak credit market and challenging geopolitical problems led to gloomy reading for startup financing and M&A markets in 2022, but can things improve in the year ahead?
Surya Pochareddy is executive vice president, head of mergers & acquisitions and strategy at IDIQ, an identity theft protection and credit report monitoring company. He is responsible for spearheading company M&A including supporting expansion through market development, target identification, strategic positioning and risk assessment.
As part of our January focus on ‘moving fintech forward’, Pochareddy shares his thoughts on the current fintech investments landscape.
The fintech boomtown has been in full force over the last decade, with start-up investments and mergers and acquisitions activity in tow. Over 250 fintech unicorns walked the world in 2022 – there were more unicorns created in 2021 than 2012-2020 combined. Until recently, M&A volume similarly kept pace with 2021 deal volume, peaking at around 50 per cent over prior year highs.
Throughout 2022, macroeconomic and geopolitical headwinds, rising interest rates, and related uncertainty about the future placed a damper on start-up financing and M&A markets.
Public market valuations, after rising to all-time highs in 2021, faced a rapid contraction through 2022. M&A and startup financing dollar volume retrenched to pre-2020 levels. All-in, current consensus on go-forward outlook is a muted level of financing and M&A activity across the board, including in fintech.
Confidence in fintech
Despite the recent slump, there is much to remain positive about as we look ahead. First, fintech is vast – finance, insurance, real estate and leasing, the primary industries fintech is focused on, have historically accounted for about 20 per cent of gross domestic product.
Further, fintech has a uniquely interconnected set of offerings. Financial products are deeply important to all individuals’ and business’ day-to-day activities, ensuring that fintech has sprawled beyond core financial services and into e-commerce, cybersecurity, healthcare, and more.
This level of scale and interconnectedness offers vast growth potential, a broad buyer and investor universe, and significant opportunities to add value via M&A, over-and-above many other industries. That said, it is useful to revisit various components of the fintech landscape, each with its own scenery.
Temperate vs. tropical
Fintech, broadly defined, refers both to traditional financial services digitally delivered, as well as to technology offerings augmenting financial processes.
The former are financial services companies subject to interest rate fluctuations, financial product volume, and capital constraints. These include your digital banks and insurers, online lenders, and lead provision firms. Post giddy investor valuations in 2020 and 2021, many of these high-flyers have now been grounded alongside their more traditional counterparts.
For them, liquidity crunches, a necessity to merge or diversify in light of poorer revenue prospects, or a desire for a larger business’s resources may compel M&A activity. However, a buyer’s uncertainty in future prospects, or a seller’s unwillingness to accept bottom-of-the-market prices, will be roadblocks to agreements.
Additionally, it seems unlikely that investors’ prior disregard for business fundamentals, mis-bucketing (of financials businesses into technology), and cyclicality will continue, adding to capital markets headwinds.
Fintech companies that fit the second part of the definition, technology offerings adding to financial process, are typically better poised for a downturn. Although there is exposure via end user bases, whose finances are directly impacted by macroeconomic conditions, these types of offerings are relatively more inelastic and boosted by secular growth drivers.
Such businesses range from financial software and payments infrastructure, identity verification and protection tools, and customer retention and engagement offerings. In theory, buyers and sellers should have more comfort on the outlooks for such businesses, enabling a more likely meeting-of-the-minds throughout market environments. On the flip side, a re-rating or bottom-of-the-market valuations adds impediments to both buyers’ funding capabilities and sellers’ desire to transact.
Over the course of 2022, the deal world has been exchanging maxims on the state of the markets, namely that while the heady dealmaking of years prior may be harder to come by, there should be deals to do as buyers and sellers come to a new normal. Market fluctuations, inflation reports, and continued rate hikes have only extended the runway to a new normal and placed businesses in downturn planning mode.
Both during this runway and afterwards, fintech is uniquely positioned to continue its transaction flurry. Its broad reach and unique touchpoints across the business and consumer landscape lend itself to material growth and capital markets opportunity.
Ample private investor dry powder and larger strategics flush with capital will further push transaction activity. There are some bright spots in the current market – FT Partner’s Q3 2022 report displayed that the number of fintech financings, and even the number of M&A transactions YTD, has held up to recent years’ activity levels, suggesting that smaller deals are still closing at a historically frenetic pace.
Only time can confirm market outcomes in fintech investments and M&A, but the underlying drivers of buzz in the space remain largely unchanged, and companies will continue to look to M&A to rapidly enter new markets and products or gain scale.