Having this past week attended the first in-person, national payments technology conference – TRANSACT 2022 – since before the pandemic, I came away with the inescapable sense that even among the advent of today’s Promethean stew of disruptive and innovative financial technologies, financial technologies that are encroaching upon and competing with the historically ‘walled gardens’ of merchant acquiring and payments processing, the acquiring community continues to prove itself remarkably resilient, and soldiers-on with a dynamism consistent with, and well up to the task of keeping pace with today’s accelerated adoption of commercial digitalization and open banking. It was inspiring to see and speak with so many payments and fintech entrepreneurs whose collective ambition to thrive in this moment of accelerated adoption and application of financial technology and SaaS-based business management solutions has surpassed the mere expectation of just surviving in it. As optimism abounded at TRANSACT 2022, so too did questions of the availability of growth capital for investment, and the valuations at which the same was being deployed within the context of rising interest rates and negative sentiment creeping into the major equity markets. And these questions are apropos of a wide swath of payments companies and fintech in a materially changing market.
The short answers to the questions surrounding the number of funds being raised, the frequency of investment, and the valuations that invested capital are being deployed at, are less, less, and less respect. There’s been no shortage of analysis and commentary substantiating these trends, coming in weekly posts from Bloomberg, PitchBook, CrunchBase, BusinessInsider, and TechCrunch. But the nature of these trends is that they are slow-moving. And while that may provide temporary psychological relief to founders and operators, there are a couple of realities they should be prepared to understand and accept as the macro-environment continues to evolve.
Although funding volumes and frequencies are down, it needs to be understood that many financial sponsors, especially traditional buy-out and growth equity firms, are still sitting on capital raised for 2021 funds, and this capital needs to be deployed. Because of this, there is a positive market dynamic in place to drive continuing deal activity. So, despite less new capital being raised, there’s a back-log of ‘dry powder’ seeking investment opportunities in payments technology and fintech.
This beneficial dynamic, at least for now, is contravened by the more negative market force of decreasing valuations. In a rising interest rate regime, technology, across the board, stands to suffer from higher borrowing costs, inevitably slowing growth, impairing profitability, and forcing capital providers to seek higher returns to justify invested capital. This market dynamic is unavoidable and should be accepted by founders and operators as the ‘new normal. To think, as unfortunately, some do, that waiting for the market to change before pulling-down much-needed growth capital is wise, is in fact foolish, as market timing is not a rational strategy for companies that need capital now.
Investment banking take…
These two, ‘new normal’ realities regarding the availability of capital and the volatility of asset valuations ought not to be feared, but they should be understood. I’ve never been fond of traditional ‘gloom and doom’, fear-based arguments by investment bankers to goad clients, or prospective clients, into transacting for transacting’s sake. The only beneficiaries of that type of investment banking are the investment bankers themselves. If a founder needs capital, he or she should get it. Sure, it may be a little pricier now and in the near future, but if it’s used correctly, the underlying premise, that the return exceeds the costs, should prove out.
With this said, I’ll offer one last thought regarding the ‘new normal’ of the changing payments and fintech market.
Regardless of rising interest rates, and the direct influence, it has on capital markets, fundings, and asset valuations, there’s a behavioral component that needs to be accounted for by founders and operators. This involves how investors perceive risk. As is already being seen in the public markets, which I alluded to last week in ‘Fintech Wheat – Fintech Chaff’, there’s a ‘flight to quality’ dynamic governing investment capital allocations. Investors are turning away from speculative assets with murky pathways to profitability and questionable product/ service moats and turning to more fundamentally sound opportunities. This process whereby investors are applying much greater scrutiny to companies’ historical performance and seeking substantial projections of future growth, is taking hold and I don’t believe this will change any time soon.
As such, there’s still a tremendous amount of opportunity for raising capital for high-quality, fundamentally sound, and well-run companies in fintech and payments.