The London tech sector continues to attract an unprecedented level of investment from venture capital firms. According to London & Partners, the Mayor of London’s promotional company, 2015 saw a record $3.6 billion in technology firms.
Notably, the Fintech sector accounted for a quarter of all investments raised by London based technology companies.
The rate of investment has led to a sharp growth in the valuation of several high profile firms that have reached Unicorn (start-up firms valued at over $1 billion) status, namely, Transfer Wise and Funding Circle. However, is this trend likely to continue?
Black Clouds Gather on the Horizon?
According to the Financial Times article (3 April 2016), many fund managers that previously piled into technology firms were forced to write down their investments in start-ups in the final three months of 2015. There is concern of a tech bubble emerging and that may lead to so-called unicorpses – unicorns that die.
In the United States, the Securities & Exchange Commission (SEC) have also expressed concerns about eye-popping valuations of some of these tech unicorns. According to a recent KPMG and CB Insights report, investment activity in Fintech may have peaked, even in the UK. Investor caution is likely to be the trend over the coming months, although Fintech still remain an attractive proposition for these investors. So for high growth Fintech firms, raising funding may not come as easily as it has in 2014/2015, however investors are still out there – just more cautious.
As a Fintech pioneer, however, you may prefer to grow your business organically. After all, it has many bene fits to offer.
Organic Growth is Attractive
The maturing Fintech market is attracting more sophisticated and well-funded entrepreneurs who are able to sustain the capital demands and strains of the start-up phase. These entrepreneurs are less reliant on external funding to grow their business in the early days. There are many advantages this brings:
- You as the entrepreneur have complete freedom to manage and grow your business in any way you choose;
- You have complete control over the day to day running of your business;
- The founders retain all the benefit arising from entrepreneurial risk taking – imagine the big payoff on exit – you get to keep it all;
- You avoid the time and effort required to prepare for fund raising – at least 6 months of dedicated effort that takes your focus away from revenue generating activity.
But can the Business Scale Up?
Whilst organic growth is attractive, especially for technology based financial services companies, I would argue that high and sustainable growth is impossible without external funding at the right point in the business cycle. Rather than growing linearly, most businesses in this space grow in spurts, requiring investment in financial and human resource to reach the next level of performance. Let’s take a closer look at the need for funding at various stages of the business.
Unlike many other technologies based industry, Fintech firms operating in a highly regulated market. Many will need regulatory authorisation before they can even start to trade. Licensing is a complex and long winded process, requiring an investment of time, effort and cash. Firms have to demonstrate to their regulator that they are in a position to start trading when they submit their application for authorisation. This regulatory process can take anywhere between 6 to 12 months in the UK, so initial investment to set up the business will only start to yield returns after this period. Bootstrapping the business may compromise standards and won’t get you through the regulatory process. By way of example, you will need to invest in developing the technology and document systems and processes, and spend on having lawyers draft Terms and Conditions way before you start to trade.
Depending on the nature of your business, the regulator will also want to see robust compliance, governance and a strong Board. This is something that only medium sized businesses start to consider when they are big enough, yet for financial services firms, this is an investment required very early in the life of the business.
Often, the entrepreneur will need to fund this phase of the business and this investment requires aggressive selling to reach break- even point. Founders run out of cash to invest in the business and the business has generated revenue to sustain itself.
Lack of funding will often trap founders doing everything in the business because they can’t employ staff. A business totally reliant on the founders can’t scale to the next level.
Whilst a disruptive business model and innovative technology helps the Fintech firm power through the start-up phase, they are forced to spend more and more on continuously improving both to ward of competitors who are now attracted to a seemly lucrative market segment.
During the growth phase, the firm needs investment to develop management layers, and to instill a culture that is conducive to high growth firms – i.e. everyone aspiring to a common vision and living the values set by the firm. Developing such a culture requires investment in being able to recruit the best and brightest, and providing classroom, online and on the job training.
To scale, the high growth Fintech firm will need to invest in developing more products (so its not a “one trick pony”) and a product ecosystem to attract and retain customers, ensuring there is a product of every stage of their clients’ lifecycle and clients become repeat buyers.
The products will require new and innovative channels to market. These channels only open up if the Fintech firm is seen to be a highly visible player in the market space. To become a known entity, requires an investment in developing the firm’s market positioning and building the brand.
Finally, high growth requires the pursuit of new markets both locally and internationally. Without substantial investment, this is a challenging task for less well funded Fintech players.
In conclusion, as much as Fintech entrepreneurs would prefer treading their own path of freedom, to scale, they will have to be open to external investors. In the next issue, we will focus on how to attract cautious investors in a way where they are chasing you because of the opportunity you present, rather than the other way around.
Jay Tikam is the Managing Director of Vedanvi, a professional services rm exclusively helping Fintech rms to start and rapidly take their business to the next level. Contact Jay if you want to learn more about how Vedanvi can help prepare your business for high growth.