A lack of financing opportunities and investor interest in capital markets FinTech at the Series A stage is contributing to a major gap in funding for the sector, according to Illuminate Financial founding partner Mark Whitcroft in a research interview with FinTech Global.
“With new solutions emerging at a rapid rate, thousands of startups are competing for a limited pool of finance at a critical stage in their development,” Mark Whitcroft said. The main locales for funding are corporate venture, industry angels, innovation departments, labs and VC funds. In what is often a complex and technical market, these investors will then typically follow a resource intensive three stage process to reach capital deployment: identify, filter and connect.
Investors will initially look to match the market challenges with viable solutions, before filtering down the choice of applicable tools and finally engaging with prospective companies with the best teams. Whitcroft explained.
While early stage companies are often successful in securing funding through angel investors, seed stages, or crowdfunding platforms, many struggle to navigate the gulf between seed investment and more advanced funding rounds, where the pool of capital is deeper.
Whitcroft said, “This [Series A] is where the funding gap really is. It exists because most of the exits are acquisition led rather than the $500m to $1bn+ IPOs. The majority of exits are acquisitions well before that in this sector. Hence a lot of the traditional venture funds don’t find capital markets FinTech particularly interesting because as a venture investor with a $500m fund, they have to look at every opportunity as a potential fund returner, which is challenging in this space.”
“These rounds are too big for angels but too small for corporate investors,” Whitcroft said. Investments from banks are strategic, so there needs to be a business alignment, and after all the due diligence spent through investigating solutions, most want to make big cheques. A minimum investment valuation will be $50m up to $1bn plus, so the absolute lowest cheque they would want to contribute to a company is around $5m, but most of the time its ideally a bigger sum.
Since 2014, Series A funding has represented only 10.1 per cent of total capital into the FinTech sector, amounting to just over $10.6bn of equity, according to data by FinTech Global. During this same period, the deals in this investment stage represents around 13 per cent of the total number of transactions, which is less than half of the companies that received seed stage commitments. There have been 2655 companies to have completed a seed round, while only 1049, have finalised a Series A.
Illuminate Financial’s £35m maiden fund was raised from 17 investors, including strategic LPs IHS Markit and Deutsche Börse. In 2017, the firm completed six late-seed/Series A investments with one second-round in data privacy FinTech specialists, Privitar.
The most recent transaction into FinTech TransFICC, will help fixed income traders aggregate market intelligence from multiple E-venues, while a joint $5m investment into RegTekSolutions will help the firm enable clients to meet multi-jurisdiction reporting requirements.
Whitcroft said, “We don’t see much direct competition in our space but if anything the competition are the super angels who can fund million-dollar cheques with tax incentives attached to their investments making them less sensitive to valuation. Also we don’t see the same pots of money going after B2B FinTech, or particularly capital markets FinTech in the same way as we have seen in the B2C space. This is because in consumer facing opportunities, such as robo-advisory, mobile payments or other business models, traditional venture firms can get their heads around those but can also see potential billion-dollar exit opportunities.”
Is blockchain the exception?
Within the capital markets sector, blockchain has led the way for funding and interest from investors. There has been a lot of interest over the past two years, but this is now moving towards AI and machine learning, he said. There are very specific areas of blockchain that can benefit banks, leading to a lot of interest, which in turn has helped it somewhat bypass the funding gap.
Whitcroft said, “Blockchain has had a lot of money pumped into it by banks at a very early stage. So, a lot of the blockchain teams that received money were very early in product development and benefitted from a lot of strategic money. Hence the valuations for many of those firms, which are pre-revenue and or even pre-product, have reached the tens if not hundreds of millions of dollars. This has been fuelled by strategic money that has come in at seed stage or Series A.”
While there has been a greater focus on these types of companies, it is not necessarily an advantage, as it increases valuations much higher than they should be at these early stages. The blockchain and cryptocurrency market is set to see another record year for funding, which will be its third consecutive annual rise. The first half of 2017 saw $412m deployed into the sector, which is only $160m less than the entire year in 2016, but there have been nearly 100 less deals, according to data by FinTech Global.
“Blockchain is well publicised as its been through the high point of the hype cycle. If we take machine learning and AI, they are probably at the same peak hype point. People overestimate the short-term potential, but probably underestimate the long-term potential.”
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