Investments into FinTech startups recently quadrupled, growing from just over $3 billion in 2013 to over $12 billion in 2014. And consider alongside that another trend showing that crowdfunding will surpass VC in 2016 as a funding source–given that crowdfunding itself is a segment of the FinTech market.
The growth of capital being invested in FinTech startups underlies how technology and the Internet are radically changing the nature of money and financial services. From the ways that people save, to how they spend, to the tools they use to invest their money – all of these are changing more rapidly today than ever before.
As money becomes increasingly stored as digital data and moves with us on our mobile devices, it will flow fluidly, and at a far lower cost from person to person; from consumer to vendor; and from investor to business. As this happens, the traditional revenue streams big banks and brokers have enjoyed monopolistic control over will be challenged — money transfer fees, account management fees, trading fees and more — as the banking technology they have charged us to use is rebuilt and improved by FinTech entrepreneurs and simply downloaded to our phones. To better understand where your financial life is headed, and what that means for you and the startups and investors driving innovation in these new markets, let’s first look at the recent events that brought us here.
The financial crisis of 2008-2009 was a major inflection point surrounding the level of trust consumers held with brand-name financial institutions. This crisis, and how big banks responded to it, helped open the door for smaller companies to serve businesses and consumers who may not have trusted “startups” in the financial services and technology sector with their money.
As an example, the response of commercial banks in the 2008 financial crisis, and the practices that they undertook leading up to it, created massive opportunities for FinTech entrepreneurs to challenge them. The banks then severely limited home, small business and subprime loans, which translated to paltry interest rates for savings accounts.
That prompted entrepreneurs like Gary Zimmerman to start Max My Interest, which allocates cash to e-bank accounts intelligently to produce a higher interest rate on your cash. Alternative lending channels like Prosper and Lending Club were able to take root and begin taking real market share in loan origination. And it started eroding the paradigm of using one bank for all your services, something banks rely upon to drive profits and maintain their competitive advantage. Without the financial crisis (and the role that big banks played in creating it) FinTech companies would be less likely to pose such a threat to the status quo of these big banks.
But because of their progress and disruption, the idea of simply limiting our choices as businesses or consumers to working with one big bank in each of the three buckets of “checking,” “savings,” and “investment” has become antiquated, and often times means receiving inferior services at less favourable terms. Thousands of new FinTech startups are innovating on both price and service.
The match has been lit, and FinTech is undergoing explosive growth. The number of investments and acquisitions is increasing year-over-year at an incredible rate. And because the way we pay for things, invest, and manage money is something that touches our lives daily, the mass interest in FinTech has leaped dramatically. According to iQ Media, the number of mentions for Fintech on social media grew 4x from 2013 to 2014, and will probably double again in 2015.
Whether the change comes from a startup, incumbent, or a partnership of the two, the areas that I see being re-shaped the most are Payments, Deposits and Lending, Capital Raising and Investing, and Cryptocurrencies via the blockchain. Below is a snapshot of the key drivers creating change within each area. In subsequent posts, I’ll be covering each of these sub-industries in more detail, so stay tuned.
The paradigm of consumers pooling their cash at banks, and earning interest when banks lend their money to borrowers, is undergoing massive disruption. Alternative lending platforms have lower cost structures due to 1) being virtual versus brick-and-mortar and 2) using more technology than manpower to determine creditworthiness. Which means they can pass these savings to depositors in the form of higher interest rates, even for loans with equal risk. Which is why they’ve made significant inroads in the subprime market, and are moving closer to the traditional banks’ bread-and-butter, prime lending.
Emerging FinTech companies are giving investors unprecedented access to almost every asset class under the sun. Uprise and Patch of Land let anyone invest in real estate deals for as little as $5,000; DarcMatter gives retail investors access to hedge funds and venture funds; and companies like Wealthforge are building the infrastructure for e-investing to be as ubiquitous as e-commerce.
Why UK investors have warmed to tech firms?
London has all the ingredients to remain an attractive location for technology companies to grow and seek investment. The capital has thriving public markets that have warmed to tech stocks. More and more VCs are putting money into London startups. There’s a greater number of incubators and accelerator programmes around. UK investors have also become better at analysing tech firms. For instance, ARM was for many years viewed as purely a hardware business but, over time, investors understood it had developed world class IP and they began to appreciate how valuable such a business can be.
Alongside global leadership in some key niches, such as healthcare, education and financial technology, the UK has developed a broad tech ecosystem with 344 technology companies listed on Aim and the main market in June 2015 (73 having software activities).
Indeed, the Aim market remains a big advantage for the UK. For growing businesses, the ability to benefit from a lighter touch regulatory environment compared to the main market combines with significant tax advantages for founders floating businesses and retaining stakes. Most important is choosing the right adviser: regulation is decentralised from the exchange to the Nomads, so it’s vital to select your adviser carefully to ensure the “right stamp of quality”.
Some of the technology IPOs which have come to market in this most recent IPO “window”, particularly those that listed in early 2014, came to market with huge valuations, based on very high growth expectations and promises of margin expansion. While a few IPOs have underperformed the expectations they set the market at the time of the IPO, many have delivered on growth forecasts and have been justly rewarded: managing expectations properly remains the key tenet of any successful IPO.
The IPO market has evolved. The second wave of flotations which arrived after the initial flurry in the first half of 2014, and following nervousness around the Scottish referendum last year, has predominantly been of quality companies with more realistic valuations. Businesses like FDM and Gamma Communications, whose flotations we ran, have managed expectations well and have traded up very positively since IPO. There’s a lot of money chasing growing tech firms – and as we are still seeing plenty of technology businesses being taken private, these increases help gain attention from fund managers seeking to deploy capital into technology companies. But it’s also the better quality companies (in terms of growth, recurring revenues, quality of management) that are now receiving disproportionately better ratings.
How does the UK stack up against the US? The size and scale of the US giants – which have the benefit of a huge domestic market – is clearly of a different magnitude to Britain’s tech firms, which are more reliant on exporting their technology overseas. Recent developments, however, give us reason to be more positive. In the past, promising UK firms might receive VC backing, get to a £200m valuation, but then be snapped up by US corporates or private equity. Now it seems UK tech businesses can find the right support at many stages of their life cycle – with interesting ideas backed at the early stages by family offices and small cap VCs. The public markets are now willing to support high quality companies at high valuations allowing them to stay independent. Consequently, UK firms are no longer so keen to be snapped up – and with luck we’ll likely see more and more $1bn London unicorns.
Andrew Pinder is head of the investment bank at Investec and also leads the technology advisory business. This article is provided for information purposes only and should not be construed as advice of any nature. The views and opinions expressed are subject to change without notice.
Chance Barnett is the CEO of Crowdfunder.com, have been a participant in JOBS Act legislative and regulatory efforts, as well as a startup founder and early stage angel investor.