The European funding landscape in focus

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According to numerous reports and market analyses FinTechs have never had it so good – as CNBC announced last week that the payments industry by market capitalisation was now greater than that of the banking industry ($1.07 trillion Vs $900 billion).

However, perhaps not all that glitters is gold. Fuelled by generous amounts of venture capital funding, last year 24 financial services startups hit a valuation of more than $1 billion, bringing the global total of such highly valued “unicorns” to 58.

The emergence and spread of COVID-19—in the first place a world health crisis—is also causing unprecedented economic damage across the globe. Most McKinsey COVID-19 scenarios show European economies contracting by 11% in 2020 and not returning to pre-crisis levels until 2023. FinTechs are already feeling the squeeze.

Venture capital funding has slowed, business model vulnerabilities are being exposed, and competitive dynamics are shifting. This has brought the sector’s underlying profitability and long-term business model sustainability into sharp focus—to a point where it is thought the path to profitable scale for many FinTechs has been structurally altered.

This is not at all to write off the sector, as a McKinsey paper states. FinTechs have several long-term advantages—they are native to the digital arena, with more efficient cost structures, organizational agility, and, most importantly, higher customer loyalty.

Consumers are now accustomed to quick, easy, low-cost financial transactions, and we believe there is no going back. In this article, we explore how the dynamics for FinTechs have changed (particularly in Europe), the opportunities and implications for financial services incumbents, and how FinTechs can weather the storm.

Scarcity for sector

In a matter of weeks, venture capital funding for Fintech companies went from surplus to scarcity. After growing more than 25% a year since 2014, investment into the sector dropped by 11% globally and 30% in Europe in H1 2020, compared to the same period in 2019. In July 2020, after months of COVID-19-related lockdowns in most European countries, the drop was even steeper—18% globally and 44% in Europe, versus the previous year.

This constitutes a significant challenge for Fintechs, many of which are still not profitable and have a continuous need for capital as they complete their innovation cycle: attracting new customers, refining propositions and ultimately monetizing their scale to turn a profit. The COVID-19 crisis has in effect shortened the runway for many FinTechs, posing an existential threat to the sector.

Analysing fundraising data for the last three years from Dealroom.co, as much as €5.7 billion will be needed to sustain the EU fintech sector through H2 2021 – a point at which some sort of economic normalcy might begin to emerge. It is not clear where these funds will come from.

Fintechs are largely unable to access loan bailout schemes due to their pre-profit status. In addition, government-backed wage support/furlough packages have income caps well below the typical salaries of Fintech engineers and other skilled talent, which represent a large proportion of the fixed costs of these businesses.

While the VC and growth investment community will continue to back some companies, they cannot meet the aggregate demand on their own. European governments have stepped in to help, but they too are only a stopgap. For instance, the UK created a coronavirus Future Fund to invest in growth sectors of the economy, of which £320 million has been dispersed to FinTechs through a convertible loan that matches funds raised from venture investors. Germany and France have also launched similar funds.

Sub-sectors such as digital investments, digital payments, and RegTech, which have had tailwinds from crisis-related changes in behaviour, appear set to take a greater share of the funding pie. For example, US-based retail trading app Robinhood raised $200 million in August 2020, increasing its valuation from $8.6 billion in July 2020 to $11.2 billion. In addition, there appears to be a surge in corporate and incumbent activity. For example, American Express recently acquired Kabbage, that offers credit and cashflow management solutions to SMEs.

In short, despite the positive protestations from the market place that everything is ok, PCM has first hand knowledge of Fintech entrepreneurs who are genuinely worried about their prospects to survive this particular storm if the investors do not come back to the gaming table.

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