Recent data shows that VC investment in fintech — historically Europe’s best-funded sector — has been eclipsed by climate and deeptech funding.
As tempting as it is to interpret this shift as a sign that VCs have discovered a new moral compass and turned their back on fintech in favour of the more noble endeavours of education, health and the planet, I find it hard to believe. This hinges heavily on a loss of attractiveness for Europe’s largest fintech market: the UK. Behaviour matches incentives, and incentives to invest in the UK fintech scene have waned since the glory days of 2017-21.
Investors are simply looking for their next cash cow. Here are a few reasons.
Fragmented markets and little room to scale
All countries have their own unique blend of regulation, market structures and consumer behaviour to navigate — but not all of them have the early-adopting consumers, pro-competitive regulation and digital economy that the UK does. This makes it incredibly hard to export fintech products designed for the UK to other markets, including those across Europe.
Fintechs on the continent are also still grappling with the challenges of market fragmentation as EU policymakers have not yet achieved single market integration — take N26's struggle to export a European product to the UK or the catalogue of failed attempts to pass coalition-based schemes, most recently the P27 plan to integrate payments between different currencies in the Nordics that withdrew its licence application last month.
The startups showing signs of potential global success are the ones solving cross-border payment issues — like Wise, Airwallex and GoCardless.
Most fintechs in the UK and Europe — with the notable exceptions of Adyen and Klarna, who have their own headwinds to contend with — haven’t been successful in breaking into the world’s largest market for finance: the US. When you remove the global audience from the sights of fintech ventures and are left with largely domestic European markets, it all starts to look a lot smaller and more saturated.
As the increased cost of capital weighs on VC activity and equity markets, the established playbook of "scale then IPO" is breaking down.
This is an issue because for fintech scaleups like Monzo and Starling their only option is IPO. Their costs are too high for profit-conscious acquirers and the integration efforts would be grim. Trade exit opportunities in fintech have always been much more limited than other technology industries.
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Incumbent banks in the UK and mainland Europe, while they're in a position to acquire, won’t
From my experience working with incumbent banks in the UK and mainland Europe, while they're in a position to acquire, they won’t. IP-based valuations or "perceived valuations" seen in venture rounds are less attractive, and while revenue multiples have come down, they're still high compared with publicly listed incumbents.
The trade exit options are therefore limited to "big fintech buys small fintech", but even those warchests are being eroded by declining valuations.
Lack of business model innovation
Perhaps the hardest reason to blame “the environment” is the lack of genuine business model innovation in fintech and the paucity of good ideas. Many of the best-backed and better-known fintechs have driven adoption by solving convenience needs, rather than doing anything truly original business model-wise. The retail banking model, for example, remains selling debt and collecting interchange on card spend.
This means winning is dependent on displacement, rather than serving a brand-new need. There are a handful of exceptions, like Nutmeg, Bank of London and ClearBank, but the vast majority of venture-backed fintechs are pushing on closed doors in the UK and Europe and will struggle to hit the heights as a result.
Global markets by nature
Conversely, climate tech, healthtech and edtech benefit from attributes that will likely make them much more valuable investment targets in coming years.
Markets like health, education and reducing emissions are global by nature. For example, diabetes, mental health or heart health are worldwide pandemics, with a clinically predictable impending growth and a compelling scientific base. The need is universal, physiological and ever-changing compared to financial needs, which are contextual and haven’t changed much since the invention of the card.
While healthcare systems may be different across the world, it’s not hard to see a global market for a healthtech like an early detection mental health platform or a consumerised heart health product that nails a common global problem with a well-designed solution, and there’s no reason why a UK-backed venture can’t provide that answer.
Relatively underserved and misunderstood
Equally, these markets are new. They are not replacing an analogue, sub-optimal status quo. In many cases they are solving new problems, like recycling EV batteries, or solving old problems with new tech.
This means, by definition, a solution or way of solving the problem hasn’t proliferated, so there is a genuine opportunity for the market to pick a winner of a global prize.
Opportunity to find ‘positive sum’ opportunities
There are massive socioeconomic, health, education and environmental problems for the world to solve, and entrepreneurship may be the best weapon in solving them. This presents a unique opportunity for ventures that create both successful entrepreneurs and happy investors, as well as positive human and societal impact.
Despite the (very) positive PR push for "impact investing", we can’t pretend the filter won’t always be the commercial return.
Now is a good time for VCs to pick a new hero. The rapid economic shift will help prune the vast number of unviable and unimaginative fintech ventures limping through the venture cycle.
It makes a lot of sense for investors to back entrepreneurs with ideas that have the potential to solve the world’s big problems, rather than putting a new digital front-end on another legacy industry.
As much as I'd love to think this shift was the pull of a higher mission, I suspect it's more likely to be the push of a sketchy returns horizon for their fintech endeavours.