The fintech startup funding ecosystem has changed significantly over the past 24 months, creating an entirely new rulebook for companies chasing investor capital. Plans to scale at all costs will no longer win over investors, so fintech founders need to show a path to smart, sustainable and ultimately profitable growth.
Prior to 2022, fintech startups were exploding. The pandemic fueled visions of agile, mobile financial services. Low interest rates meant that investors were chasing returns by deploying large amounts of capital into fintechs, focused primarily on scaling quickly.
Startups of all kinds were a huge beneficiary, with 2021 shattering all records for startup financings and 2022 setting the all-time mark for second place.
But after inflation spiked, so did interest rates. And as the banking system teetered briefly with the collapse of Silicon Valley Bank and First Republic Bank, venture capital firms slammed their checkbooks shut. Funding for startups plunged more than 50 percent as investors grew more cautious. Many companies were simply left for dead by their investors.
That conservatism in turn shut down the market for mergers and acquisitions, dramatically shifting the startup capital conveyor belt, as paths to successful exits diminished. Mid-market fintechs in particular were suddenly stranded with no obvious place to turn for help.
While 2024 has seen an uptick in merger and acquisition activity, and companies like Reddit prove that a successful IPO is actually possible in a high-interest rate environment, startups still aren’t likely to see a return to the pre-pandemic boom days. Investors are not in the same headspace they once were. Regulators, previously behind the curve on fintech regulations, are now catching up.
Fintechs, to get their growth back on track, will depend on the ability of founders and leadership to play by the new rules. The good news for fintechs is that they’re not operating in a completely hostile environment. This market chill hasn’t hit investors with anywhere near the magnitude of the losses incurred during the dot-com bust, for example. Fintech remains a high-growth and high-potential market segment that investors still find attractive, under the right circumstances.
What has changed, however, are their expectations. Prevailing wisdom used to be that growth was the single most important criterion that venture capital firms were looking for. Despite in many cases having significant operating losses (and in some cases no visible paths or very long paths to future profits), these companies could previously plow forward, with the hope that scale could drive acquisition, regardless of profitability.
But now, companies need to scale smartly rather than rapidly. Stories of efficient, strategic growth, with strong unit economics and good customer acquisition cost are now fashionable. Venture capital firms want to see that path to sustainable cash flow, and profitability.
For startup leadership, that requires a greater degree of focus. Not every errant opportunity will be worth pursuing if it takes the company off its profitability trajectory. Proving the concept at a smaller scale will improve venture capitalists’ trust in the broader company.
As the market warms a bit, venture capital firms are looking more favorably at experience. Founders who have great ideas but no track record will find little love from investors. But leadership teams with impressive and relevant resumes will find a warmer reception. Upscaling the C-suite can be costly for a company, but in some cases it is essential to attracting that next level of funders.
Interest rates are still high. Borrowing is still expensive. Investors want to know that the right hires have been made and the right leaders are at the helm. Founders that are staying in place need to ensure that they have a good board backing them up — with individuals who can give frank advice.
As further proof of fintech’s maturation, regulators and lawmakers are starting to wake up to the concerns of data privacy and security, especially in the world of finance. Savvy venture capitalists are looking around corners and have a pretty good understanding of what’s coming.
The fintechs that succeed in fundraising going forward are those that can prove they’re well prepared for that regulatory future. They can show they have the data privacy architecture in place, and that their handling of consumer data is secure.
Finally, while artificial intelligence is top-of-mind for everyone who works in tech these days, the companies looking towards financing rounds need to understand exactly what role AI plays in their strategy, both as an enabling tool and as a competitive threat. Companies that can show they are effectively using AI to automate processes, cut costs and optimize services have a better shot at attracting investment, assuming they are not being sucked into the maw of the core business of a company building a large-language-model AI.
The landscape for startup financing has gotten better, but it’s still going to be difficult for companies to open investors’ purse strings. Valuations will remain lean, making equity funding challenging. Companies still need to be prepared to make sacrifices for investor dollars — whether it’s headcount, ownership percentage, or degrees of control for their founders.
Fintech companies will need to show more focus and discipline in the face of the industry’s first major macroeconomic headwinds. Sustainable growth will be key to achieving success.
James Lichau is an assurance partner at BPM.