The bursting of the fintech bubble presents a unique opportunity for banking organizations to acquire their erstwhile competitors, accelerate their innovation strategies, and position themselves to compete over the next decade.
Shares of high-growth, low-profit public fintech companies are 60% to 80% off their peaks, according to Pitchbook. That decline is far steeper than the overall market. The situation in the private markets, which has manifested more slowly, is similar. Silicon Valley Bank research indicates that 44% of fintech startups with less than $10 million in annual revenue will need to raise money before the end of 2023.
The years when customer growth, without a clear path to profitability, could support a high stock price or infinite infusions of venture capital are over. Many fintech businesses, products or features that have not reached scale or proven out a viable business model on their own could benefit from traditional banking institutions’ built-in distribution and ability to cross-sell.
Build vs. Buy Quandary … Suddenly Solved?
Historically, many financial institutions preferred building customer-facing technology solutions internally rather than buying them. But with shareholders balking at increased technology spending, M&A looks more attractive.
Traditional banks looking for attractive fintech targets should start by looking at nonbank lenders, neobanks with attractive customer bases, and vertical payments or other specialized software solutions.
Software aside, your optimization strategy could be losing you money. But, with the right goals as your strategic foundation, your ROI will trend upward.
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Start on the Credit Side of the Business
Fintech lenders have been squeezed by fragile funding structures (rising borrowing costs, jittery capital markets) as well as deteriorating credit conditions. But they could be valuable within a larger banking platform.
The fintech wave of the past decade bred hundreds of nonbank lenders. They now account for a large percentage of both unsecured consumer and mortgage lending. Fintechs have also made major inroads in small business lending, credit cards, auto credit and more.
If a banking institution can find proper customer and credit-appetite alignment with a technology-rich fintech lender, a deal could make both strategic and financial sense.
Neobanks Offer Opportunity — and Some Risk
Another opportunity is the number of neobanks created in recent years to serve niche markets. The future of many of these companies as independent players is questionable, as the interchange-driven neobank business model has not, to date, proven profitable — even at scale.
However, so long as a neobank’s niche customers fall within a buyer’s credit, financial and risk management ranges, there may be opportunities to provide greater value to — and generate more revenue from — those customers by offering them loans, insurance or investment advice.
Reaching an agreement on price will be challenging, as most of a neobank’s value (beyond replacement customer acquisition cost) would come from access to the bank’s platform.
The risk of customer attrition is also significant. Many neobank customers opened their accounts because they didn’t like traditional banks. Convincing them to stay with a new owner through an arduous conversion process will be challenging.
Caveat Emptor When Neobank Shopping:
Neobank buyers will need to look closely at the terms of the partner bank's contract as, absent clear prior agreement on the price to be paid to ensure a collaborative account transfer process, the partner bank has no incentive to cooperate.
Even more challenging is the question of who really “owns” neobank deposit accounts and relationships — the neobank or the incumbent banking-as-a-service “partner bank.”
In addition, what obligation does the partner bank have to support an account and deposit conversion after the deal closes? If the sale of a neobank means the partner bank loses critical funding necessary to support its own lending and investment activities and liquidity position, management and regulators may balk at the deal.
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Payments Providers Already an M&A Target for Banks
Similarly, vertically focused software and payments companies have grabbed toeholds in several niche markets. Banks looking to serve a particular sector, or with existing customers in that sector, may see opportunities in acquiring bespoke software providers serving that sector.
Accounting and other software solutions increasingly monetize by incorporating payments into the offering. Banks targeting the restaurant space could, for example, acquire a company like Toast (and compete with PNC Financial Services, which recently acquired Linga). Those who see opportunity in the wellness industry could acquire a firm like MindBody, which provides software and other business services for firms in that specialty.
A large bank could, in theory, roll up a number of vertically focused players, building presence and share simultaneously.
Some of the more technologically confident and competent banks have already gotten into the action. JPMorgan Chase has announced a string of fintech acquisitions and investments including payments company Renovite. PNC and Fifth Third have also been active buyers.
Some midsize banks have gotten in on the action too. Western Alliance acquired Digital Disbursements, a payments platform for class-action settlements, while Webster Bank recently announced the acquisition of deposit network interLINK. Many similar transactions will be seen in the next year.
Traditional Banks Are Positioned for Growth
Banks are in a unique position to reap many of the benefits of the deflating technology bubble. Banks have relatively healthy valuations and are generating strong returns with the rise in interest rates. Most remain well-capitalized and well-reserved heading into a potential recession.
Acquiring fintechs strategically will allow banks to capitalize on the last decade of innovation, rapidly accelerate their innovation strategies, and ready themselves for the next decade of competition.