Startups faced two brutal years for fintech investment. The heyday of 2021 may never return, but several venture capital firms are optimistic that 2024 will see a rebound.
Deal activity in the fintech industry shrunk in 2022-23 as jittery investors waited for a market correction that did not occur. Fears of a recession and a slowdown in the economy along with higher interest rates prompted venture capitalists to wait on the sidelines as valuations for some startups fell. The dearth of capital in 2023 fell to $43 billion globally, reaching the lowest level in six years, according to data from Crunchbase.
The levels of fundraising dipped by over 50% year over year. In 2022, $89.5 billion was invested in financial services in 2022, while a whopping amount of $143 billion flowed into the sector in 2021.
The areas that were the hardest hit were investments in early-stage financial services and fintech as funding fell to 12.4 billion, a level not seen since 2016.
While the first part of the year remains uncertain, “enough of the dust has settled” and venture capital firms are more enthused, said Bukie Adebo Umeano, an investor at Anthemis, which is focused on venture stage investments across Europe and North America and has $1.1 billion in assets under management.
Here are five reasons why some VCs think fintech investment will rebound this year.
Deal Activity Should Rise
Deal activity seems likely to increase this year, especially in embedded finance and pure play fintech.
In 2023, New York-based Anthemis invested in nine fintech companies by writing checks in the $1 to $3 million in early stage capital, she said. These include Agreena, Greenspark, Fifth Dimension and Flyby; Anthemis was the lead investor in Elevate and conducted a follow-on investment in Flock. Umeano believes the outlook is promising for 2024 and deal activity in pre-seed investing and seed investing stages will pick up.
“We are likely investing in more companies this year,” Umeano said. “We’re starting to see pretty good quality dealflow.”
Several companies appear to be “strong contenders” for investment, she said. “I am more enthusiastic about a handful of companies in January. This year has been a busy start. That is a positive sign since there has been good momentum.”
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Deals Could Get Cheaper
Insiders are still awash in capital even though it is a “slower trickle unless the market improves dramatically,” said Chuckie Reddy, a partner at QED Investors, an Alexandria, Virginia-based fintech venture capital platform focused on high-growth financial services companies with unicorn investments in its portfolio, including Credit Karma, Nubank, Avant, SoFi, Klarna, GreenSky and AvidXchange.
Deal activity will be more measured and companies will come to the market when they need growth capital, he added.
“Deal quality has improved and we are encouraged by that,” Reddy says. “The pace will result in “more measured investing than in 2021.”
QED plans to make more investments in 2024 compared to last year unless a major geopolitical event occurs, Reddy said.
Funding is less sensitive to interest rates since the Federal Reserve has indicated it is finished with rate hikes. One catch is that deal sizes have come down by half as valuations have also declined and funding rounds are likely to be smaller, he said. “Valuations have changed and startups now grow at a more measured pace since there is less competition and less pressure on labor,” Reddy said.
The shift will be beneficial to startups because it “allows us to build with founders much higher quality and stronger companies,” he says. “I am bullish that the investments we do over the next two to three years are durable and companies are built in a favorable, competitive environment.”
Some Fintech Sectors Are Still Attractive
Since most capital is heading towards AI-related tools, fintech is still “not a hot sector right now” and a rebound could occur slowly, Matt Wilson, co-founder and managing partner of BDev Ventures which has $150 million of assets under management.
But Wilson is bullish that Web3/DeFi will play a role in the monetization of AI.
“This means there is opportunity at the intersection of AI and Web3 for a new fintech ecosystem to emerge that could capture the imagination of investors,” Wilson said.
The Mountain View, California-based firm focuses on enterprise software companies and has invested in three fintech companies – Pinata for rent payments, Hownd for marketing payments and Worky for payment management. BDevVentures has 28 portfolio companies and typically invests $100,000 to $3 million with an average check size of $250,000.
“There is opportunity at the intersection of AI and Web3 for a new fintech ecosystem to emerge that could capture the imagination of investors.”
— Matt Wilson, BDev Ventures
In 2024, the firm expects that 20% to 25% of its investments will be in the fintech industry, he said.
“Maybe we strike about 40 deals, making fintech deals come to a total of eight to 10” deals with a goal to invest in about “two times more fintechs than last year,” Wilson said.
Embedded fintech, which is fintech bundled in a software offering, in the proptech space has picked up steam, Wilson said.
One example would be rent rewards platforms like Pinata Rent, which also adds a debit card or another other payment option.
“I’m looking at some things that are interesting in the identity space where it makes it easy to sign up where they already have pre-filled” data, he said. “It’s kind of like identity tech meets fintech. We’re also looking at stuff in the B2B landscape, tools for the CFO suite like payment tools and cross-border tools and a lot more embedded fintech solutions where maybe fintech isn’t the only thing, but it’s a component of it.”
Fintech companies who can “deliver the same outcomes” as the legacy financial services industry with a small fraction of the expense and headcount” by leveraging tech will attract capital, Wilson said.
But companies with business models that have to reacquire customers or are based on “expensive-to-reach markets with me-too products, such as neobanks, will not get a second look right now,” he said.
“The old rules of business come up,” Wilson said. “Do you have a defensible innovation in the form of a product or new business model? If yes, then you’ll find funding is available to you.”
QED, which has $3.6 billion assets under management with $662 million invested in 225 portfolio companies, is looking to invest in companies that have business models with organic growth. The firm invested in Wander, a company that provides short-term rental homes that are managed by the company, and Summer, which provides rental housing for vacations.
“There is an opening in the market to do the next level thing,” Reddy said. “This is the next iteration to Airbnb by creating a brand standard and bringing capital into vacation houses. Single-family rental is growing. We are interested in this asset class and we think it could be quite large.”
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M&A May Get Hot
A number of fintech companies will be acquired this year as M&A will rise when “big incumbents buy up cheap tech companies and products,” Wilson predicted.
But he doesn’t think investors who are waiting for fintech IPOs in 2024 will be rewarded.
“Valuations in the private sector were so high, that it will be hard for them to achieve the same in the public markets. I would expect some, but far fewer than in 2020 and 2021,” he said. “SPACs, which were a huge contributor in 2020 and 2021 are also pretty dead.”
Investors in the fintech industry will continue to reap rewards, Reddy said.
“The good thing about fintech is that it’s a massive market and there is a lot of space to continue to innovate, especially if you provide a good service or product like Stripe or Credit Karma,” he said. “We believe that fintech is incredibly interesting. Over time, while things have gotten better, there is still a lot of space to provide consumers and small businesses with solutions.”