Fintech, the home of the fabled unicorn, is hot. There are now 36 fintech unicorns in the wild, which is up 25 from 11 over the last year. This staggering growth is a reflection of the hype around fintech, where a plethora of startups are using technology to compete against or collaborate with established financial players. The result is a dramatic increase in company valuations as investors look to get in on the ground floor of the next big thing.
However, there is an enormous difference between being valued at $1 billion-plus and realising that exit. Vast potential seems to be sacrificed too early. Young unicorns are culled. Why is that?
In Europe the fintech scene isn’t set to create a wave of financial technology giants hell bent on world domination. Too many are built to exit, rather than to compete.
Built To Exit, Not Compete
The most likely end-game for a successful startup in the fintech sector is being acquired by a major technology firm such as Apple and Google or a trade sale to a larger firm (this is particularly common with payment companies).
During the first three quarters of 2014 the value of fintech-related mergers and acquisitions hit $10 billion, nearly doubling from $5.3 billion in the previous three quarters. Importantly, the average revenue multiple increased from 2.3x to 3.2x, while the average EBITDA multiple rose from 12.0x to 16.2x.
With such impressive multiples, it’s not surprising that entrepreneurs and investors are being drawn to the sector. The danger of skyrocketing valuations in a fiercely acquisitive market is that fintech startups are founded with the express aim of an exit, rather than to establish the next fintech powerhouse.
An E&Y review of company exits from 2009 to 2013 revealed there were no IPOs of UK-registered, venture-backed tech companies in that period. This has since changed with the Just Eat and King IPOs but the implication remains the same. Despite the availability of funds, fintech startups aren’t growing into the mid market and beyond.
After the startup has left the incubator and run through its funding rounds, the options are to either deliver on the vision the market has bought into or sell to the highest bidder. It seems the latter is too attractive for the majority. Why is it that fintech startups are built to exit rather than compete?
The startup scene in Europe is in the midst of an identity crisis as it wrestles with U.S. influence.
When it comes to funding, Europe is awash with money from U.S. VC firms. According to CB Insights, more than 50 percent of the money raised by London-based startups last year was from U.S. VC groups looking to cash in on the city’s fledgling digital groups. And when European VCs get in on the act it seems they only have one thing on their mind – find the best European startups and sell their business to a U.S technology company ASAP.
In 2014, 332 European tech companies were acquired. Of these acquisitions, 122 were from U.S.-based firms. The next closest is Germany with 40, followed by the U.K. at 33. So, when European companies successfully exit, it is predominantly because of interest from across the pond.
The problem is that everyone thinks that only great companies come from Palo Alto, and that you can’t make it without help from the Valley. The average European fintech entrepreneur is likely to get funding from the U.S., work with U.S. companies for distribution (Apple, Facebook, Amazon and Google) and then exit to a U.S. firm.
Unlike U.S. startups, European players haven’t bought into Silicon Valley’s most striking mantra – “Fail fast, fail often.” Failure still carries a stigma in Europe. So rather than risk failure, it’s much safer to work with the U.S. ‘machine’ and exit for tidy profit than stand up against the might of Palo Alto.
This means that most European fintech companies aren’t growing into established global players. That there are only three technology companies in the FTSE 100 is a testament.
What needs to change?
Investment. European investors need to take a longer term view and look to build companies that are able to compete on the international stage, without help from the U.S.
A big part of this is increasing access to cash for mid-sized companies – if you’re a start-up, money is practically thrown at you. And as an established company, finding funding is pretty straightforward. However in the mid-market, no one wants to know.
Government. Governments need to see the value (employment, tax, etc.) in creating an environment where start-ups can become genuine challengers. This is about increasing access to skills, opening up private investment into the mid-market and investing in infrastructure. Steps are being taken – the U.K. government recently announced the ‘Help to Grow’ scheme, which assists businesses in making the transition from small to medium size.
Approach. The most important thing is for the mindset of entrepreneurs to change. It seems that in the rush to start businesses, the whole point of starting a business has been missed. If the fintech scene is to be sustainable, then it needs to produce businesses that are viable concerns, not just future additions to multinational conglomerates.
Rather than put up the for sale sign in the window from the outset, fintech startups need to outline a clear vision and strategic plan to truly compete that builds investor and market confidence.
Growing Up Gracefully
Startups, investors and the wider market needs to shift its approach to compete rather than exit. Only then will we stop the flow of startup value moving across the Atlantic from Europe to the U.S. Only then will fintech startups have a chance to become grown-ups. Only then will European unicorns become real.
Source: Daniel Lowther is head of fintech at CCgroup