Investment in FinTech businesses has grown exponentially over the past decade and continues to do so. 2018 global FinTech investment saw a substantial increase on the previous year, with deal value more than doubling to a total of $112bn, according to Pitchbook. Within this growth, we have seen a number of big-ticket, megadeals, including Ant Financial’s $14bn VC raise. These landmark FinTech transactions are both grabbing headlines and attracting the attention of investors, a trend that is anticipated to continue going forward.
So, who are the capital providers writing these lovely big investment cheques?
Over the past few years we have seen the typical pools of capital investing in FinTech both growing but also changing. Whilst traditionally US venture capital has led investment in FinTechs in Europe, over recent years we have observed more European home grown funds investing in the sector, as local markets respond to the high returns being generated by FinTech investments.
We have also seen a material increase in financial institutions investing off their own balance sheet directly into these high growth businesses, as they see investment in FinTech as a ‘must have’ in order to compete in the marketplace of the future. In fact, corporate and corporate venture vehicle participation now accounts for one third of the total investment in FinTechs by value, as highlighted by CB Insights.
Finally, FinTech businesses are beginning to attract investment from private equity as they are seen as key disruptors to the financial services industry, demonstrating high growth and achieving scale in 2-3 years versus what would previously have taken 2-3 decades.
As a result, over the past 12-24 months we have seen fierce competition for the FinTech stars and prized assets, which is creating highly aggressive valuations.
So what should you do if you are an owner of a FinTech business looking to raise capital and how do you attract the valuation of a FinTech star?
There are no hard and fast rules for raising capital from investors, however there are a few guiding principles that can help you differentiate yourself from the numerous other FinTechs competing for that equity cheque…
First and foremost, you need to understand what investors are looking for:
- Consider the growth potential in your chosen markets. Investors are seeking high growth businesses, operating in high growth markets with room for expansion and with the skills and scalable infrastructure to grow.
- Are you a differentiated business with a market leading proposition or do you have the potential to become one? In order to stand out, you must be able to demonstrate unique and defensible unique selling propositions (USPs). We have seen particularly exaggerated valuations when strategic buyers compete to acquire unique and market leading skills and technology.
- Do you have a well-defined go-to-market strategy? What is your product or service offering? How are you pricing it? How are you taking it to market? What are your distribution channels, and do you have the right relationships to deliver this?
- What does your revenue look like? The ability to demonstrate a proportion of your revenue as recurring, such as through licensing of technology or a sticky customer base, provides investors with additional comfort around the sustainability of future revenue streams. This will improve the predictability of forecasts and could attract a greater multiple on investment.
- Talent and skills. Both financial and strategic investors will be interested in the quality and skills of the people in the business. They may not have the equivalent knowledge in-house and will therefore be dependent on your employees and management to make the business a success.
- Defensible IP. Corporates in particular may be looking at the acquisition as an opportunity to acquire skills and technology to improve their operations and business models. They will seek a business that is able to develop its technology mostly in-house and not be overly dependent on a third party to do so.
So that’s how to attract investment, but what are the common pitfalls made by high growth businesses in the fundraising process itself?
Too often, failed processes are not necessarily due to the quality of the business, but the result of poor planning and execution of transactions. Common errors made by businesses going to market include:
- Lack of preparation for sale. Don’t make hasty decisions. If you receive an inbound approach from an investor, take a step back to reflect on the offer and on your investment objectives. Consider carefully whether now is the right time to start an investment process before you react. Make sure the management team is fully prepared, bought in and on message.
- Misaligned value expectations. There are two elements to this. First, whatever valuation you are targeting, ensure that the valuation in your mind is backable by robust and credible financial forecasts that can stand up to diligence and investor scrutiny. Second, if you are expecting a knockout price based on aggressive forecasts, be prepared to take part of your consideration in the form of an earn-out.
- Target your investor approaches. Put simply, ensure that you are approaching investors with relevant sector experience and a genuine interest and track record in investing in similar businesses. You only have one shot to get this right, the longer you are on the market selling to the wrong people, the less interest you will get when you finally find the right investors.
- Lack of succession planning. Plan for your exit five years ahead. Who do you see as the next leadership team? What role do you want to play in the business going forward, if at all? How will the company and the culture adapt from being an owner managed business to instil governance and infrastructure that is better suited to a corporate organisation?
- Poorly timed processes. Get the timing to market right. Where is your business and the market at the time of seeking investment? Is the market growing, is there excitement in the industry and is your business on the right trajectory? Be honest about where you are and realistic about contracts and partnerships in the pipeline. Investment processes often take several months, during which time your pipeline will be tested, and trading updates will evidence the credibility of your forecasts.
- Poorly defined objectives. Define what you want before you ask for it. How much capital is required and how do you intend to deploy funds? What is your ideal deal structure? How much are you selling? Are you willing to give away a majority interest in your business? Are you rolling over into a Newco or seeking a clean exit? It will be hard to negotiate terms and compare offers if you aren’t clear in your own mind of your objectives and investment preferences.
- Finally, pay attention to the hygiene factors. Get your books and records in order, test the robustness of your business contracts and property leases and get early input from legal and regulatory advisors. What you might consider to have been small regulatory and compliance issues for the business can quickly turn into deal breakers for investors.
So in summary, be prepared, start the process early, and learn from these mistakes so that you can get it right the first time (or hire an advisor to help you do so!) as you don’t often get a second chance without significantly impacting your value.
There are plenty of reasons to be excited about being a FinTech in this developing and disruptive market, matched with strong drivers for investment in this high growth sector. The conditions for start-ups raising capital to expand have never been as favourable. The biggest rewards will go to the founders and firms able to learn from the mistakes of others and get the fundamentals right.
If you would like to find out more about how to successfully raise funds for your start-up, please do not hesitate to reach out to me.