The VC’s Guide to Investing in FinTech During a Down Market

Over the past decade, the UK fintech ecosystem has flourished. From a global perspective, the UK punches well above its weight, accounting for 10% of the global fintech market. according to the recent Kalifa Review.

The symbiotic relationship between investors and entrepreneurs is critical to this success. Venture capital and growth capital firms are looking to the UK as a place to find and invest in cutting-edge fintech businesses with huge growth potential, driven by their proximity to the City of London and the willingness of British consumers to embrace new financial technologies.

Fintech founders see the UK as the perfect place to start a new business, with easy access to funding and guidance from experienced investors who have backed numerous other success stories.

This “virtuous circle” dynamic – promising businesses attract funding, which in turn attracts promising businesses, and so on. – led to record high levels of investment in fintech companies in the UK. The United Kingdom reports almost half total European fintech investment last year. In the first six months of this year, it ranked second only to the US as the largest center for fintech investment, according to Innovate Finance.

But the mood music in the private finance markets has changed in 2022. Fintech investors are asking a very different set of questions than before. We experienced this shift in focus ourselves when we raised our $110 million Series C last November and then, with global financial markets down in many cases by more than 80%, we successfully completed a rewrite $50 million surcharge until this round this summer. This amounts to a total of $160 million in equity without the need to reduce our previous valuation of $2 billion.

Market volatility

Historically, venture capital funding has been directed at – and then used to subsidize – fintech companies that could demonstrate rapid growth. Aggressively expanding your customer base was the primary concern for founders and investors alike.

In digital banking, Revolut last year secured the highest valuation of any UK tech company – quintupling to $33 billion – after surpassing 16 million users globally, despite mounting annual losses year-on-year.

We experienced a similar dynamic. Our customer acquisition rates that had passed us by one million customers several months earlier, were central to our discussions with investors around our Series C round.

Then came the market volatility of early 2022 and everything changed. Rising interest rates, rampant inflation and falling public market valuations had an immediate effect on how investors viewed and valued private fintech companies seeking to raise new capital funding. There were two main areas where fintech businesses – especially those offering a consumer-facing product – were suddenly being watched much more closely.

Fintech investors are focusing on new metrics

First, what is the nature of your relationship with your customer base? It’s all well and good that you’ve reached millions of customers, but those numbers can be deceiving. Do you own the relationship with these customers or are you relying on other companies to refer them back to your product? Are you offering them a unique proposition that they are loyal to, or are they constantly on the verge of jumping ship to a competitor offering the same commoditized service?

Longer-established and traditional operators in the buy-now-pay-later space find themselves facing this particular dilemma. Because they effectively finance the purchases made by the customers of the retailers for whom they process payments, they do not own the relationship with those customers.

If their largest retailers choose to put a different BNPL supplier button on their checkout page, a chunk of their customer base disappears overnight. The biggest operators suffered a dramatic drop in grades in recent months, in no small part for this reason.

The second area of ​​increased attention from investors is whether a company’s product is monetizable and its margins are sustainable. When we talked to our investors over the summer, they placed a lot more emphasis on the net transactional margin of purchases made by our customers and our path to profitability.

Any fintech business looking to raise more capital will need to have answers to exactly these questions. Of course, it wouldn’t hurt them if they saw strong growth at the same time. But this will no longer be enough. Customer loyalty and commercial viability are increasingly preferred by private fintech investors.

Philip Bellamant is the CEO and co-founder of Zilch.