Where VCs decide to channel their cash is usually a good indicator of ‘who hot and who not’, as The Notorious B.I.G. suggests.
Innovate Finance figures revealed at the start of 2019 that the U.K. had retained its top three spot for fintech investment behind the U.S. and China, having increased by a staggering 18 percent to $3.3 billion in 2018.
The data also highlighted an increase of 57 percent to $1.6 billion for private equity investment and a slight dip to $1.7 billion for venture capital due to Brexit uncertainty and the evolution of the market.
While the $3.3 billion spend was spread across 2,304 deals, challenger banks were responsible for 27 percent of the total investment with personal finance and wealth management fintech firms following close behind.
In conversation with Charlotte Crosswell, CEO of Innovate Finance, she said that the U.K. “has a unique position across financial services, technological innovation, regulators and government which has played a crucial role in this impressive growth journey. From a regulatory perspective, investors have been encouraged by their balanced method and recognize the potential this brings for rapid adoption and scaling of new approaches.”
Capital and investment will be a big topic at this year’s Innovate Finance Global Summit, to be held on 29th and 30th April 2019 at The Guildhall in London, and ahead of the event, I spoke to OakNorth’s Joel Perlman, Octopus Ventures’ Alliott Cole, Augmentum’s Tim Levene, Seedcamp’s Reshma Sohoni, RitMir Ventures’ Henry Richotte, Teja Ventures’ Virginia Tan and Accel’s Cris Conde.
Brexit holding the UK back
Ever the ambitious industry, Innovate Finance will be hosting a panel session on ‘Coming Up Short: What is Holding the UK Back in the Global Investment Landscape?’ and I put this question to the speakers I interviewed.
Joel Perlman, Co-Founder of OakNorth, disagreed with the sentiment that the U.K. is being held back when it comes to fintech investment and referenced the Innovate Finance data, highlighting that “the only two countries that raised more than us last year were China and the USA, which are the two largest economies in the world.”
Octopus Ventures CEO Alliott Cole had a similar attitude and said that “the U.K.’s share of the European venture capital industry has grown hugely over the last decade, placing us far ahead of our counterparts in Europe. So rather than ask what is holding the U.K. back, we should be focusing on the growth of British business and the pioneering innovations constantly emerging” – which Octopus Ventures have done themselves with their latest £83 million follow-up fund to help portfolio companies expand.
Cole added: “The one pointer I would suggest, is to retain its place as a leading force the U.K. must continue to attract high-class technology talent from across the globe.” Retailing high-class technology talent from across the globe is a problem that many fintech companies are facing, and is thought to be amplified once Brexit is underway.
Augmentum Fintech’s Tim Levene pointed out that U.K. venture capital has evolved at a dramatic rate over the past 20 years and the space is a lot different to what it was in the early 2000s. “The European Investment Fund was the largest funder of U.K. venture capital prior to 2016 and that capital has dried up since the Brexit referendum.
Levene continued: “Despite the British Business Bank’s attempt to fill the void, they alone cannot satisfy the significant opportunity that exists today in U.K. venture. U.K. pension funds have a tiny allocation to venture capital relative to their U.S. peers and if a small percentage of their funds can be allocated to this asset class then it will have a significantly positive effect on the ecosystem. It remains a mystery as to why the pension funds remain so risk averse, when returns from Venture over time have outperformed most other asset classes.”
Seedcamp co-founder and managing partner Reshma Sohoni also states that “Brexit chaos” could be holding fintech investment in the U.K. back – markets always having the potential to “make their way through clear rules and regulation, but not political volatility.” Sohoni went on to explain how post-Brexit, the U.K. will be scrutinized to see whether it can continue to be an “incredibly open, stable and clear place to invest or whether it closes off to the world outside of our island.”
Honing in on the recruitment point, Sohoni indicated that for the economy to operate in an efficient manner, there needs to be movement of people, goods and services because talent will go where they can grow.
“Startups in the UK have no shortage of ambition. But as we are an island, we must scale outside our borders and that requires the U.K. to be able to build strong trade agreements, including our ability to sell our products and services freely outside the U.K.” However, Cris Conde, Senior Adviser at Accel had a different view and said that the “tech investment climate in the U.K. is very strong and is perhaps one of the few sectors not impacted by Brexit. Continental Europe is growing faster, albeit from a far smaller base, so comparing growth rates by themselves doesn’t tell the whole story.”
On the flip side
On the other hand, fintech startups and larger players in this new financial sector need to ensure that those who are investing in them can also offer support in several different ways – not just with millions of dollars of cash, although that may seem the most helpful at the time. Henry Ritchotte, founder of RitMir Ventures posed the following questions for fintech firms to think about: “What makes you at least 10 times more attractive than alternative opportunities in your sector? How do you create long term moats which protect your market niche from legacy providers or new entrants? Avoid me too ideas and marketing buzzwords.”
Perlman advised that the right investor is one who “will be willing to stick with you as you continue to scale. “The challenge I’ve always found with traditional private equity investment is that as soon as you sign the docs, they’re thinking about how soon they can exit with a good return. They’re not long-term company builders.”
Cole said that he would advise a fintech company in the same way that he would any early stage company also trying to attract capital – “make sure you can point to the signs that customers love your product, or will love your product. This might be in the form of hockey-stick growth in revenue or sign-ups, or extremely low churn, or other proxies if you’re pre-launch.
“For consumer fintech, investors are acutely aware of the potentially high cost of customer acquisition so if you can demonstrate why your company will have an unfair advantage in being able to attract customers cheaply you will be placed in good stead.” Levene had a similar point and said that “a great idea is not enough to stand out from the crowd, and tech entrepreneurs need to recognise that VCs invest in about one percent of the companies they see.”
It is clear that the fintech industry is not what it once was and with that, companies need to ensure that they look for the right stage of capital for their business, not aiming too high or too low. Sohoni detailed that fintech companies should understand and present how they have evolved to meet the requirements of the industry as it has transformed.
“One thing tactically to do is to do your homework and find the right stage capital for the right stage of your business.”
Filtering through the funding
But how do we filter through all the funding news to figure out which deals will make the most impact on the companies involved and the industry as a whole? – it can’t just be the amount alone. Cole highlighted that while everyone seems to be raising funds and funding rounds are growing larger and larger, “it is hard to ignore the likes of Monzo, Tandem and Revolut as they continue their race to the top with huge fundraising rounds,” – again pointing to the Innovate Finance research that found that challenger banks had the lion’s share of investment last year.
Cole continued: “Looking elsewhere in the fintech scene, it is interesting to see the re-emergence of blockchain and cryptocurrency as a key area of investment, after a steep fall over the last few months.
“Within the healthtech space, it is great to see companies such as Elvie, who are fighting for women to be able to take back control of their bodies, raise such huge amounts. Their recent $42 million raise, which we were proud to be a part of, was the largest round in the history of femtech. This is a trend we hope to see flourish. The current diversity within the market is a signal of the level of ambition and innovation emerging from UK businesses at the moment.”
Levene added that “a great deal of capital continues to find its way to the digital banking space both across the Consumer and SME spaces. Monzo, Monese, iwoca, Starling and N26 have all seen some of the biggest fundraises over the last year. Other areas within Financial Services have been slower to be disrupted relative to areas such as payment and remittances, but rest assured you will see increased levels of capital deployed across the insurtech, regtech and wealthtech industries in the coming years.”
Conde referenced CBInsights data that showed that fintech accounts for over 10 percent of all investment into technology, which is a significant increase from a decade ago. “While it’s true that a handful of huge financings account for much of that percentage, it’s always been true that a small number of financings have accounted for a great proportion of the total, so the increase in fintech investment is real.
“What used to be a friends and family angel seed round in the hundreds of thousands is now in the millions, and what used to be a $3-5 million A round can be $10-25 million. Bottom line, outstanding teams are getting financed faster than ever, and it has never been better to be a fintech entrepreneur or fintech investor.”
Virginia Tan, founding partner of Teja Ventures offered a view on Asia, where she sees companies who are aggregating and leveraging big data to provide goods and services are successfully raising funds in particular companies which are changing the everyday experience for consumers – such as ride sharing, online groceries, smart supermarkets, social commerce, etc.
Tan explained that trends are focused more on the technology and she has seen increased funding towards artificial intelligence in China, as big data is used to “reduce costs and transform traditional industries such as banking, healthcare, education, manufacturing, commerce especially in countries where physical infrastructure is weak.”
Predictions for the future
Adding to the conversation around AI, Ritchotte said that in future, there will be increased investment in “applications of a broad array of artificial intelligence toolkits to enterprise problems. This will focus on machine learning at early stages but will get increasingly sophisticated as users and providers mature. We will also see more platforms emerge which help enterprises understand their data in unique ways – combining machine learning with virtual reality for example. See Luther Systems, Arkera, Pivigo or Virtualitics.”
Ritchotte also pointed to niche lending as “firms built on more modern technology stacks attract a different type of lender, most legacy financial institutions struggle with connectivity to cloud-based customer relationship, banking and accounting providers.
“These new providers hold the key to core credit data. As Airbnb, YouTube, Epic Games and other community-based platforms grow, expect to see financing systems grow up around them. Examples here abound in the U.S. (Produce Pay for farmers, Clearbanc for e-commerce providers, Returnly for merchandisers). In the U.K. a good example is Neyber.”
The reinvention of core financial infrastructure will also be invested in as “legacy financial firms realise they need to re-engineer their core data architecture and core processes. Foreign exchange markets will come first, then certain commodity markets. More complex local currency bond and equity markets will follow gradually. See Cobalt, LMRKTS and Goldex for example.
“I see less interest in robo-advisory, neobanks and P2P lending. As those market segments mature there is less growth, more competition from legacy providers and higher regulatory scrutiny on the horizon.”