Fintechs have attracted the attention of investors in 2020 as contactless payments surged in popularity, lenders boosted their product offerings and credit scoring companies became more valuable. This resulted in a number of mega-deals being announced despite the surge of the coronavirus pandemic. Industry observers believe high valuations could signal that some companies in the fintech industry are overvalued.
The year started off with a massive deal when Visa said it would acquire Plaid, a San Francisco-based fintech that enables applications to connect with users’ bank accounts, for $5.3 billion in January. The following month Intuit revealed plans to buy San Francisco-based Credit Karma for $7.1 billion. Then, Mastercard said it planned to acquire Salt Lake City-based Finicity for nearly $1 billion in June – a deal that got the DOJ green light last month. The three mega-deals total $13 billion and two of them are facing headwinds as the U.S. Justice Department’s antitrust attorneys take a closer look.
“Valuations are too high and it very much feels like a bubble, but it’s also a reflection of the public markets,” said Don Butler, managing director of Thomvest Ventures, an evergreen cross-stage venture capital fund based in San Francisco with $500 million in assets. Thomvest Ventures was founded in 1996 by Peter J. Thomson, a director of Thomson Reuters Corp.
Other tech industries are following suit. Companies such as Lemonade, a New York-based (and deeply unprofitable) fintech insurance carrier that uses artificial intelligence and behavioral economics to offer renters, homeowners and pet health insurance, are trading at very high valuations after going public.
This causes a domino effect and other insurtech companies “point to those as the benchmark for what can be achieved and hence the public market valuations are being reflected in venture valuations,” Butler said.
The billion-dollar deal sizes are noteworthy, but VC investment in the late stage for all industries tends to be higher valuation as the exit markets improve, said Mitch Kitamura, managing partner at DNX Ventures, a Tokyo and San Mateo, California-based early-stage VC firm focusing on B2B startups.
While the valuations appear to be high, it is unlikely the recent trend of mega deals “qualifies as a bubble since many of them include fintech startups that make money and have been growing at a steady pace,” he said.
Investors are also nervous about the stock market and concerned about a decline in 2021 as growth in the economy contracts and are instead stashing their investment dollars into private companies. Some investors prepare for downturns, Kitamura said.
Entrepreneurs should view this time as an opportunity for the rapidly growing, high performing startups to acquire ones that are failing to compete but have an innovative product or service, he said.
“So they do need money to acquire startups from their VC investors to not only fuel growth from a product perspective but as well for acquisition,” Kitamura said.
The fintech industry is likely to see more mergers and acquisitions since every downturn has resulted in consolidation in the banking sector, Butler said. Banks will likely target fintech lenders or neobanks or vice versa. The trend started with companies like LendingClub acquiring Radius Bank.
“This consolidation between fintech challengers and banks will be one of the major narratives of 2021,” he told FinLedger. “Banks need to shift to the cloud and the fintech companies are finding that the balance sheets they can access via deposits or other means is a game-changer when it comes to the cost and stability of their capital base and it gives them more freedom to control their own destiny.”
The amount of capital to back financial service companies remains immense. A16z, also known as Andreessen Horowitz, announced in November that it closed two massive new funds, part of which will go toward backing financial services companies. The firm raised $1.3 billion in an early-stage fund, called “Fund VII,” to invest in financial services technology, consumer and enterprise startups. It also has raised $3.2 billion in a separate fund, called “Growth II,” that will invest in its vertical domains including, financial technology, bio, crypto and others.
The well-known venture firm has backed fintech startups for over a decade. Founded in 2009, a16z invests across all stages and has backed hundreds of companies over the years, including fintechs such as Plaid, Earnest and Seed. a16z also backed alternative payments startup Affirm that offers installment loans to consumers at the point of sale, which filed its S-1 recently and raised over $1.3 billion since its 2012 inception from backers such as Khosla Ventures, Founders Fund, Lightspeed Venture Partners, Spark Capital and Fidelity.
Other funds are also raising capital: Financial Venture Studio closed a $13 million fund and Better Tomorrow Ventures closed its new $75 million fund.
The amount of capital allocated for first-time entrepreneurs could be hampered by the pandemic and the ability of seed investors to assess the founders and companies, Butler said.
“If you have had some career success already, whether that be as a serial entrepreneur or someone who distinguished themselves at a leading company, there is more money available and in greater amounts,” he said.
The post-COVID market will appear very different from pre-Covid because there will be many more chances for startups to succeed, Kitamura said. Right now is a “great” time for serial entrepreneurs to launch new business due to their familiarity with the fluctuation of the market and knowledge of how to secure investments from the right VCs, he added.
First-time entrepreneurs will have a harder time launching a new company and raising capital. One looming issue that investors should factor in is whether regulatory issues could stymie the growth of some fintech startups, said Mark Zyla, managing director of business valuation firm Zyla Valuation Advisors and chairman of the International Valuation Standards Council (IVSC). Since these technologies are being developed quickly, including consumer loans like the ability to buy now and pay later, the current regulations are not catching up.