The pendulum seems to be swinging from the era of easy capital and rapid growth to a more sobering reality of value creation.
In this transformative period, Scott Dawson, a seasoned veteran with over two decades of experience in the payments industry and currently the head of sales and strategic partnerships at payment platform DECTA, delves into this transition, offering an understanding of the strategic opportunities emerging amid industry challenges.
In the middling science fiction novel Those Who Remain, author G. Michael Hopf said: “Hard times create strong men, strong men create good times, good times create weak men, and weak men create hard times.” This quote (which in modern terms obviously relates to all human beings) has become something of a catch-all sentiment for ‘decadence’.
The Great Depression in the 1930s is a good example of a time that this quote capture well: When economic turmoil challenged communities and individuals, making it necessary to adapt
innovate, and endure severe economic hardships. As a result, a hardier society emerged, giving rise to a generation that understood the value of hard work, frugality, and community support. The Metaphor works equally well if we switch ‘men’ to ‘companies’.
In fact, it sheds some much-needed light on the trajectory of business in the 21st century. In good times investors, flush with cash, invest in thousands of weak businesses, these businesses fail and investors are forced to find more reliable sources of profit and then, again flush with cash, they return to spraying billions of dollars at any Standford drop-out with a pitch deck and a hoodie.
With fintech investment now a quarter of what it was a year ago, it seems that the good times are over and the hard times are here in earnest. Key to this has been interest rates: the very same mechanism that means that fuel and food is now more expensive than ever before also means that it is more expensive to borrow large sums of money.
Following the Great Recession of 2008, many first-world nations adopted Zero Interest Rate Policy (ZIRP) as a means of boosting investment. If companies can borrow at zero or close to zero percent interest then they should, economists say, found profitable businesses, create jobs and stimulate the economy.
Theoretically, this approach is solid except for the fact that it doesn’t always work. Japan did just this, going so far as having negative interest rates, in the 1990s ‘lost decade’ and it didn’t work. But a byproduct was massive investment funds like Softbank Vision Fund, which in turn supported many of the big names of the ZIRP-era: Doordash, Uber, WeWork, Revolut, Slack, FTX and Klarna, among others. That being said, FTX has since collapsed due to fraud, while WeWork went bankrupt and Uber posted its first profitable quarter this year – despite being founded in 2017.
However, to the strategically minded, every crisis is an opportunity. Fintech now has the chance to get real about creating companies that really create value, that are of service to the community and solve real problems instead of jumping from one VC cash infusion to the next.
The fintech cycle beings again
Fintech investment in 2023 was a quarter of what it was in 2022, and a fifth of its peak in 2021. In the UK, one of the world’s great Fintech hubs, investment is down 57 per cent. This isn’t the same across the board: the percentage of VC funding going to fintech startups is down five per cent on 2022 and seven per cent since its high of 20 per cent in 2021. The creation of new unicorns is also down significantly: 59 companies had exits of over a billion dollars in Q2 of 2021 – in Q2 of 2023 the figure was only two. In short, VCs seemingly just aren’t that into fintech anymore.
This is in stark contrast with previous decade: PayPal, Revolut, Venmo, Stripe and Klarna became multi-billion-dollar businesses almost overnight and remain so by giving people access to services that traditional financial services companies couldn’t offer – instant payments or buy-now-pay-later financing. To find these diamonds in the rough the venture capital world had to burn through hundreds of no-so-shiny diamonds, often at great cost – those 59 startups with exits in Q1 2021 aren’t likely to be household names today, if they even still exist.
Anyone who has been at a fintech conference in the last decade might have been given a business card and tote bag by a company with a clever name, stylish design, scads of VC money but with no obvious reason to exist. Such companies might not provide a new or better solution to an existing problem or have a real addressable market, and quite often no plan to become a profitable business.
This preference for growth over profit is key and is one of the defining aspects of the ZIRP era. Of course, there are example where it was been responsible for massively successful companies: Amazon dramatically cut prices of books to the point that physical bookstores were going out of business, eventually expanding its customer base so much that it cannot fail to turn a profit – it is selling so much that even the pennies it makes on a sale add up to hundreds of billions of dollars in gross profit each year.
However, its rate of growth is falling, despite a marked upturn during the pandemic, falling from an average of around 40 per cent YoY quarterly growth in the early 2010s to 30 per cent later in that decade and now a flat 20 per cent. It has now transitioned from a period of rapid growth to a profit-driven model, something that many other growth-oriented companies have failed to do.
Getting real about profit
As the faucet of cheap money shuts off, the VCs face a reckoning. The shotgun approach of spraying cash at hundreds of companies in the hope of striking gold won’t cut it anymore. The new imperative? Finding the needle in the haystack – those rare gems with genuine profit potential and genuine solutions to real problems.
It is important to say that fintech investment is still happening, albeit at a deteriorated rate. But some startups are choosing alternative paths, wary of the VC roller coaster. This could mark a welcome shift: a refocus on problem-solving first, growth second. The road ahead might be bumpy, but it could be the very dose of reality the industry needs. It’s time to build for value, not just valuation.
