Finch Capital’s 8th Annual State of European FinTech Report 2023 finds that the return of funding discipline resulted in a fight for profitability to survive for the entire ecosystem.
- While the mergers and acquisitions (M&A) market remains active, larger deals have become difficult to execute, creating issues for the European Unicorns.
- For the larger exits, Finch Capital expects 2023 to be a lost year, with 2024 looking more promising. On the investor side, US, Asian and strategic investors have become less active.
- Eventually, the transition in the next 12 months will result in a healthier ecosystem for those that survive.
In their 8th State of European FinTech report, Finch Capital takes a closer look at three core areas and provides an analysis of the sector with a forecast of trends that will likely emerge including: (1) impact of investment environment (2) key European countries and (3) thematic trends with strong momentum over next 12 months.
The European fintech sector has been heavily impacted by the new funding environment, with a total of €4.6 billion ($4.9bn) capital raised in the first half of 2023, down 70% from €15.3 billion in H1 2022.
In 2021 and 2022, the top 20 funding rounds in Europe accounted for 50% of the market, they are now accounting for over 60% of total deal volume whilst having largely decreased in size. Across the investment ecosystem, the long tail of deals outside of the top 20 have been squeezed in total capital raised, and like any previous cycle corporate investors are retreating in the face of macroeconomic uncertainty. Seed rounds continued to attract funding, but companies in the Series A to C stages got squeezed the most.
Sector wise, the biggest surprise has been in Payments, which traditionally has been a resilient category that saw record amounts of capital deployed in 2022, as investors took caution to the valuation inflation in the sector. Crypto has been the main benefactor as investors flocked to early stage businesses.
Finch Capital’s report shows a drop of 70% in funding value across major markets such as the UK, Germany and France, although the share of the UK in the total funding accounted for 50% of the total capital raised in Europe, up from 45%.
US based investors that were active in these markets have also taken a step back. For instance, in 2021, there were 3 US based firms in the top 5 investors in the UK, while in 2023, there were none.
The trend of a shift to software and B2B fintech continues in 2023
The shift from consumer to B2B finteech has been taking place over the last couple of years and now that trend is here to stay. Lending/balance sheet business in general have been affected, as cost of funding increases and loan portfolios worsen. The saving grace for some of the B2C fintechs has been the increase in interest rates, which allows a healthy interest income revenue line to exist.
As payment and open banking consolidate, regulation technology is driving increased enthusiasm in the B2B fintech sector. KYC and AML are becoming complex and further tailwinds from government driven initiatives are resulting in renewed interest from investors. With the generative artificial intelligence (AI) boom, retail banking and insurance seem to be prime candidates for adoption. Finch Capital expects the chief financial officer role to become even more important in an organization and the tools they use will only expand.
Key areas in the next 6 to 12 months are:
- Revisit of the payment investment landscape, with accelerated consolidation expected to boost profitability and growth
- Regtech continues to show attractive growth in KYC and AML
- Consolidation of open banking and Banking as a Service continues
- Generative AI will get at scale in insurance and banking
- Automation and digitalization of the CFO and HR function continues to increase control and efficiency
Radboud Vlaar, managing partner at Finch Capital, said in a statement: “Since mid 2022 we have seen an increase in investment discipline in public and private markets, resulting in less funding, lay-offs, less IPOs, flight to quality and focus on capital efficiency. This will continue to be painful for the next 12 months, but will result in a more healthy and sustainable start-up, hiring and investor ecosystem,
“With investors bridging overvalued portfolio startups to bring them to profitability and struggling to find attractive exits in a grossly devalued market, we are likely to see a period of consolidation in the fintech space as many verticals are highly fragmented, creating a smaller but more sustainable ecosystem. We should also start to see a slow recovery of the IPO market in the next semester as valuations have started to slowly pick up and inflation is declining,
“Last year’s shake up with valuations coming down, fundraising slowing down and the exit window closing up, was painful yet necessary. Consolidation and more competitive investment flows, combined with still significant levels of undeployed capital, will bring maturity to the FinTech sector. This new normal level of activity demonstrates the refocus of the fintech ecosystem on long term sustainability versus short term gains.”