After the highs of 2021, fintech funding came crashing down. As 2022 rolled out, it became clear the bubble was no more. As inflation started to creep up, cash-strapped startups started to fall, and the drops seen in public markets started to ripple into private.

At the beginning of this year, the trend continued. Valuations dropped across the board, and funding round announcements matching those in the 2021-early 2022 fintech frenzy became increasingly sparse. VC “dry powder” mounted, ready to deploy as investors scaled back on their “FOMO” from the years prior and adjusted their risk appetite.

“We’re still in the middle of it,” said David Jegen, Co-Founder of Fintech Sandbox and a Partner with F-Prime Capital. “There is more conservatism in investing (this year). While there is a lot of capital still ready to be invested and has been invested, people are more careful about the kinds of risks or how much risk they take. I think that until we feel that there’s more of an understanding of where the floor is, there will be some more attention to those lower risk factors.”

However, he explained, there are still some fintechs that have broken the mold. 

“I’m experiencing the greatest dispersion in valuations and kind of company performance that I’ve seen in a long time,” he continued. “There are some valuations that look like 2021 valuation and reflect a certain enthusiasm, where people feel like there’s something really exceptional here and warrant that. Then others have clearly corrected to something that looks like an earlier era.”

A Shift in Attitudes Towards Risk

 Harsh conditions surrounding fintechs, while affecting different sectors disproportionately, have shifted executives’ and VCs’ attitudes to risk. No longer pursuing the “growth at all costs” mindset, the focus has settled on the foundations of their business. For some, this shift has been more difficult, and many startups have failed as a result.

“I think 2021 is an aberration and probably, on most levels, reflected excessive excitement,” said Jegen. “It just happens in markets where everybody kind of moves in a group thing for a while.”

Jegen said that investors are continuing to fund companies that show strong business models, and while fundraising may take longer, there is still an appetite to invest. Attitudes had shifted over the past two years, and while seed companies had continued to attract active investment, later-stage companies had felt funding reduce as time passed. Now, C and D-stage companies, like those F-Prime focus their funding on, were attracting valuations often at a 50% reduction to prior rounds.

“I think the really strong companies are still bracing throughout this whole time. They are fine, even if it takes a little longer,” he said. “It’s that middle group where we’re going to have the greatest work to help those that are good companies to find homes or raise capital at reduced rounds and work their way through that.”

Payments Still a Favourite

Jegen also explained that interest had focused on particular sectors. Fintechs in sectors such as lending were heavily affected by macroeconomic factors and, therefore, had attracted less interest from VCs. Other sectors, while still affected, had continued to remain strong.

“The ones with the most durable business models remain great sectors and are still a great place to continue to build a business, “ he said. “Payments is a wonderful category for lots of reasons. There’s the established framework around how parties can make money, the size of that marketplace. And the way that payments, frankly, are only becoming more fragmented, more intermediated, and more embedded in software.”

He explained that this fragmentation had also brought investors to pay particular attention to vertical SaaS incorporating fintech. In trade sectors challenged by macroeconomic conditions since 2019, these businesses have become a lifeline and contain a capacity for diversification and flexibility that could make their business model more durable.

Sectors such as payments have been referred to as saturated, making competition high and challenging for smaller companies to break through. However, Jegen explained this has not deterred investors, and the sector is no more saturated than others in the fintech ecosystem. 

“Every fintech category, and most tech sectors as a whole over the last five years, were in some way saturated,” he said. “It’s true that there are lots of startups pursuing things in payments. I think we hit that point where if it was a good idea, so much capital flew, float in to support too many startups going after a similar idea.”

“What makes it less saturated is that we have verticals, and payments are being incorporated into software vertical by vertical.” He explained that, as a consequence, fintechs had built business models focused on specific niche markets, such as laundromats or salons, where the focus had been put on software to meet the distinct needs of the market. Payments tech had been incorporated into the software, which meant companies could differentiate themselves from other payments businesses.

“It’s primarily about the software and then secondarily about the payments,” he said.

What are VCs looking for going into 2024

Despite later-stage startups making a slight comeback as 2023 comes to an end, VC funding has still progressed to all-time lows. Jegen said that 2024 is unlikely to look much different.

“We are still in the middle of a correction,” he said. “I think it is one of the slowest corrections I’ve seen on the private side and I believe it’s going to be another year or so before we see kind of a floor for private fintech, private tech in general.”

“Unfortunately, I think we still have a thousand or more startups that will probably wind down or be acquired over the next couple of years because they will finally hit funding runways.”

However, success stories are still appearing, and VCs have an appetite for investment. Their priorities, however, have shifted.

“Recurring revenue is probably their number one priority,” said Jegen. “But so are high gross margins. The 80% gross margin of a tech business is more attractive right now than the 50% of a tech-enabled services business…Fifteen years ago, VCs did not invest in tech-enabled services, but over the last five to seven years, we saw a lot of that, for good reason. But we have all found there’s a ceiling on those gross margins. When you have lots of people in the mix, you might be making them way more efficient with a better experience, but if you still need the human, there’s a certain gross margin optimal maximum.”

Those companies that are highly reliant on a human workforce may still have a difficult time ahead for VC funding.

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• Source: https://www.fintechnews.org/rough-time-ahead-for-vc-funding-in-fintech/