For many years now, financial technology, or fintech, has been an exceedingly well-capitalised sector. However, the first quarter report of 2022 indicated that the global fintech market experienced its largest funding drop in 3 years.
The problem is relatively obvious considering this period of economic uncertainty we are currently in. Investors are anxious about the recent inflationary pressures placed on economies around the world. There are predictions that a public market slowdown will help catalyse not only increased interest rates and skyrocketing inflation across Europe, but also a global recession.
Impacts have already rippled throughout the sector. One of Europe’s most valuable fintech companies, Klarna, made it clear that they, too, are susceptible to the effects of a slowdown when they let go of 10% of their global staff.
Some experts are advising companies with more spare capital to use the slowdown as an opportunity to buy smaller and cheaper contenders. This would act as a way of poaching talent, nabbing customers, etc.
Evidently, some fintech subsectors will see consolidation within the next few months. Therefore, it is imperative to both have an understanding of the markets and keep a keen eye out for any clues as to which way this will go.
In 2021, venture capitalists put over $1 billion into funding the sector. This has resulted in the existence now of more than 30 open banking firms in Europe. However, the sector has become crowded with companies like Tink, TrueLayer, and Yapily being some of the best funded fintechs within the space.
If companies lack differentiation, they may become acquisition targets. This may be true for the several smaller application programming interfaces (APIs) who are less well-capitalised. This was the case when Yapily acquired FinAPI, a German open banking company.
Some open banking start-ups may even be acquired by traditional banks and neobanks with better funding.
Neobanks are fintech firms that streamline mobile and online banking by offering technologies like apps and software. They typically specialise in products like current and savings accounts. Additionally, they usually provide more transparency than megabanks.
Over the last decade, neobanks have found success in Europe. There are reportedly around 52 customer-facing neobanks across the continent. Large amounts of fundraising have allowed neobanks to hire aggressively and expand into several geographies. However, this has led them to, essentially, vie for the same customers.
The market is extremely competitive. Customer acquisition costs have consistently been on the rise, so neobanks have been spending exorbitant amounts as they pursue growth. Currently, Zopa and Starling are the UK’s only profitable neobanks. Revolut, N26, and Monzo are some of the frontrunners in terms of market share.
A turning point for neobanks may come soon, as the reductions in consumer spending have already outrun European analysts’ expectations. This will impact neobanks because a large portion of their income comes from interchange fees. Once this happens, the companies whose valuation has been less than stellar will be weeded out. This means that smaller players will either sell for cheap and get a bit of equity in a bigger player, or they will acquihire a competitor. Neither option will come without its challenges.
Buy now, pay later
Since 2019, European buy now, pay later (BNPL) start-ups have received $3.9 billion in funding. This makes up for more than half of all European payment start-up investments. However, Klarna, a BNPL firm which has been dominating the space, has recently been impacted by the economic downturn. As aforementioned, they have already had to lay off a significant number of employees. This may cause a ripple effect throughout the rest of the sector.
BNPL firms are especially vulnerable to headwinds because when interest rates rise, their margins hurt. This is also related to the fact that consumer spending has fallen considerably as inflation in Europe rises. The BNPL business model is reliant on consumer spending.
If this continues, BNPL companies will need to diversify their revenue streams. Otherwise, they may be acquisition targets for Neobanks and incumbents. Or, they may decide to completely pull out of markets like Australia’s Openpay did in Europe back in March. Klarna has already implemented a B2B service, bank accounts in Germany and Sweden, and a shopping app.
This subsector has been trending because they offer capital in return for anywhere between 5 and 20% of their future sales. Since 2019, 18 revenue-based financing start-ups have emerged in Europe. American players have also entered the European market.
However, profitability may prove to be an issue as some firms have been unable to acquire enough funding to provide loans. Their success will largely be dependent on how efficiently and accurately they can deploy capital, or whether they implement added services like business banking ploys. Spain’s Clicfunds was forced to cease their lending services and was subsequently acquired by Outfund who is currently looking to acquire additional smaller players to enter other European markets.
Those who struggle to find larger firm to buy them out may need to cut costs in other ways, like by reducing their workforce. This has already been the case for fast-growing European start-up Uncapped.
Implications of fintech consolidation
While consolidation may seem like a red herring, a more competitive fundraising landscape may turn out to be a net positive for the industry. This may also be true with regard to drops in valuations. This is because the result will be less competition, and those who remain will be forced to strengthen their operations. Of course, consumers will not win as big, as they will not have as many discounts and offers to take advantage of.
There will likely be more hiring freezes, which may have a lasting impact on investors’ perception of the sector at large. If the traditional sector appears to be more stable, then they may lose some interest in fintech.
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