As we as a business reflected on the different trends we
felt were worth talking about for 2022, the fintech investment scene and
current tech stocks felt like something worth expanding on more widely.
Before we focus on the current climate let's talk very
briefly about the drivers of the dot com bubble:
Low interest rates, huge amounts of capital pumped into
fledgling businesses in the hope of turning a profit and a volatile tech stock
market - Sound familiar?
Whilst it could be a slightly lazy comparison there are
certainly parallels that make it a worthy mention. Let's consider them
individually:
1. Low interest
rates:
I suppose somewhat of a counter narrative, but I believe low
interest rates to be a positive when it comes to fintech investment. When
considering the general flow of capital into the fintech ecosystem, low
interest rates could mean less meaningful returns for LPs or funding partners -
giving the opportunity for VC/ PE to raise larger funds to deploy. Better
written by Gompers and Lerner; “the willingness of investors to commit money to
venture capital funds is dependent upon the expected rate of return from these
investments relative to the return they expect to receive from other
investments”. This can be seen in the report I have linked to below, but the
research suggests that a 1% interest rate increase leads to a reduction in VC
fundraising by $647mn the following year.
During the financial crisis we saw the Bank of England
forced into a huge reduction in the Bank Rate in order to stimulate growth in
the economy. As highlighted by the below, we have seen no real bounceback from
that. In fact, only two trigger events have seen any material alteration to
this rate. 1. Brexit (let's leave that for now) and Covid.
So whilst low interest rates are a stimulus for investment I
believe the correlation here with both the birth of fintech (in my view circa
2008) and 2021 is a preceding strife of a much wider macroeconomic disturbance.
Early Feb saw the first interest rate increase in some time. Whilst marginal,
if we defer back to that point around access to capital made earlier, (and much
more succinctly in the paper highlighted here) this could be a cause for
reduced deployment of capital.
2. Huge amounts
of capital:
According to an Innovate Finance article in the UK alone we
saw over $11.6bn representing 217% YoY growth in the amount of capital
available (see previous statement around low interest rates). But, of equal
interest within the article is what stage of funding that capital is being
allocated to. 61% of global capital is being invested in later stage funding -
this shows that people are taking less risks and are looking for existing
product: market fit - and dare we even say it a pathway to profitability.
3. Volatile
tech stock markets
Whilst I think things are slightly different this time,
investors are ready to back their businesses long term and the digital
transformation that consumers are going through all over the world indicates
that fintech is a great long-term bet. But we have to be careful.
I think this does pave the way for M&A. How many
warchests were built in 2021..? Let's think about it for a second:
● NYDIG raised
$1bn
● Klarna raised
another round $1bn
● FTX raised a
$1bn
I think you get the point but to put this into perspective.
There were 457 unicorns created last year. 151 of these sits in the fintech
space alone.
I predict that some of the biggest fintech players in the
market are in a prime position to start acquiring a variety of hugely valuable
businesses at a good market rate. Look at the tech stocks at the moment. It is
certainly not making my eToro account look very good at the moment.
And guess what, it has already started. We saw Plaid acquire
Cognito this year already (here) and our friends at FTX with their acquisition
of Liquid
Conclusion: how will this play out?
Everything that we see above makes for an interesting tale
of caution when it comes to capital markets and the potential for a burst
bubble. Yet every day we see more capital being allocated and more funds being
created. Some, in the case of Sequoia, that even now buck the trend of the
10-year cycle. For this reason, I think the conclusion is still to be written.
I hope there is continued support of what has become my home and certainly an
ecosystem that is doing so much good for this world. But I also hope that
valuations taper slightly and don't increase to a level of impossible return.
We need these funds to return a profit to those institutions making
investments, otherwise it is the pension fund and ultimately you or I that lose
out in the long term.
Click here for the
original article.