The year 2015 has been a fantastic year for Fintech, especially in London.
According to London & Partners, an initiative by the Mayor of London to promote investment in London, Fintech firms raised £357 million venture funding. Together with Business Insider UK, London & Partners profiled a few of the larger funding rounds, including Funding Circle (£97m, valuation £640m), World Remit (£64.8m, valuation £320m), Transferwise (£37.4m, valuation £640m) and Ratesetter (£20m, valuation £150m)). Lending Club in the US was valued at $5.4bn during its initial public offering at the end of 2014.
Sky News picked up rumours in December 2015 that Zopa may be looking to raise £70m in 2016, which could see the company valued at over £500m.
High Valuations Multiples
In 2014, both Funding Circle and Zopa made post tax losses of £19.4m (£13.1m revenue) and £5.6m (£11.5m revenue) respectively. Funding Circle is valued at nearly 48x revenue and Zopa at 43x revenue. As a comparator, at the time of its IPO, US based Lending Club was valued at 30x revenue, which was higher than its comparative rivals at the time.
Lending Club’s share price debut at $15 at the point of its IPO. As at January 28, its share price plummeted to $7.39.
Is it all a BIG “Hype”?
So, is this a bubble about to go “Pop”?
Using the concept of the “Hype Cycle” developed by Gartner to understand the lifecycle of hot new technology, I believe that following a corrective, the market will continue on a steady growth path.
Reward Phase – At this stage in the lifecycle of Fintech, there certainly is significant amount of Hype fueling valuation Current inflated valuation are driven by:
the genuine disruption brought about by Fintech startups and unicorns;
high investor demand in a yield starved environment;
the fear of “missing the boat” – Fintech firms are oversubscribed (investor demand exceed supply of quality Fintech firms despite a plethora of new entrants), dictating the price;
investors expect double digit returns on exit within the next 3 to 5 years
a light touch regulation (at least in UK) with massive Government support.
Valuation is drive by Reward and Risk, which push and pull to drive the market either up or down. Rewards expectations are the biggest driver, pushing up valuations. Investors discount risk seeing long term potential. Fintech firms chase revenue and growth in a rising market, neglecting to pay attention to risk management.
Pendulum Swings to Exaggerate Risk
At some point reward expectations peak (Peak of Inflated Expectation) and investors as well as Fintech firms realise the “too good to be true” story. The market is subject to a significant correction, driving the hype out of the system. Market correction are fueled by:
Investors and Fintech firms waking up to risks, for example:
The consequence of diluted buy cheap levitra online reputation (a recent AON risk study highlighted that reputational risk is ranked number 1 by more than 1500 global executives across multiple industries);
The danger of cyber-crime in this digital led world;
The dampening effect of economic slowdown and failure by firms to create extended product sets and distribution channels;
The disrupters get disrupted by new competitors who come not only with better tech solutions, but also with more capital and network of high powered contacts that get them flying fast through the startup phase;
Severe shortage of talented employees who are vital to fueling rapid growth;
The firm being used in the chain of money laundering or terrorist financing.
Regulatory landscape tightens up significantly, increasing cost of compliance and exposing the firm to a greater threat of non-compliance;
Like many startups, weaker Fintech players fail and the market consolidates through large scale mergers and acquisition;
Early stage investors cash out, reducing demand and increasing supply.
The Risk Phase follows a market equilibrium when market players are enlightened and the push of reward is balanced by the gravitational pull of risk, and the market now reaches sustainable growth to maturity. Firms and investors, both become wiser to identifying, evaluating, pricing and proactive managing of risks.
Enlightened Leaders Harness Risk to Boost Valuations
In a hype phase, no one wants to hear bad news, and risks looming can go unnoticed, because Fintech firms and investors are blinded by this hype. Enlightened Market Leaders will build systems, supported by the right executive led culture, to unearth, anticipate and proactively mitigate risks, and effectively deal with regulatory change. These Fintech leaders can significantly dampen the effects of the risk phase and emerge to grow above market equilibrium position, and go on to dominate their space. Investors investing in such firms can protect their investment and exit without being subject to huge market swings.
Superior risk management capability and systems is an off balance sheet asset that, once realised and communicated effectively in a due diligence process, can significantly ramp up the valuation multiple (Valuation = Revenue * Multiple). McKinsey proved in a research study that an effective enterprise risk management capability can add as much as 25% to the share price of insurance firms.
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.
[author title=”Jay Tikam” image=”http://thefintechtimes.com/wp-content/uploads/2016/02/Jay-Tikam-Vedanvi.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.
For a more in-depth analysis, go to www.vedanvi.com or get in touch if you want to learn more by emailing [email protected] [/author]