This article relates to Shearman & Sterling's upcoming inaugural Digital Finance Summit on November 15-16. Learn more about the Summit.
Transactions in the U.S. FinTech sector were very active in 2021, accounting for over $100 billion in value.[1]
But that was then and this is now.
Starting in the second quarter of 2022, FinTech M&A activity decreased significantly, with global funding down 33% on a quarter-to-quarter basis to its lowest levels since 2020 and a meaningful decline in deal volume as well.[2] Much like the rest of the M&A space, the FinTech sector has been impacted by general economic and investment uncertainty, fueled by rising inflation and interest rates, and growing angst over the U.S. economic and political environment.
Room for Opportunity?
Yet, in any challenging market, there are pockets of opportunity, and the FinTech space is no different.
Despite an uncertain macroeconomic and political environment, many key drivers of M&A activity still exist in the FinTech sector – a fast growing and evolving industry, a large amount of deployable capital, particularly private capital, and a return to reality for some of the remarkably high valuations for FinTech companies that were present in 2021. Taking each of these drivers in turn:
- FinTech has been one of the fastest growing industries, with rapid growth of industry participants and large numbers of new entrants each year. In order to remain competitive, companies will look to M&A to increase scale, obtain new capabilities and talent, and execute on their strategic objectives. As companies face a challenging market with little access to cheap capital, the need to make this pivot will become particularly important.
- Founders or venture capital firms looking to exit or to monetize part of their ownership stake need, in today's environment, to turn to M&A given the stasis existing in the equity capital markets.
- In spite of recent market challenges, the amount of deployable private capital has increased significantly in recent years, and a fast-growing industry like FinTech is likely to remain a popular focus for much of this capital.
- The deployment of capital in the FinTech space will also be driven by a decline in valuations for FinTech companies from the sky-high, and often unrealistic, valuations that were commonplace in 2021. As those valuations return to more reasonable levels, investors will likely find FinTech companies to be attractive investment targets.
- Given the large number of smaller valuation companies, M&A transactions can be consummated without debt financing, which is largely unavailable in the current market.
Furthermore, for those FinTech companies that are not able to keep pace with their competitors, or are unable to raise enough capital to continue operations, the best option may be to sell the company (or else cease operations).
Outlook for 2023
So, what does this all mean for FinTech M&A in 2023?
Much will depend on how the macroeconomic and political environment develops in the upcoming months. Sitting here today, it’s difficult to see that environment improving – inflation and interest rates remain at elevated levels, many foresee a significant risk for a global recession, and geopolitical tensions continue throughout the globe. Indeed, it seems safe to assume that much of the uncertainty present in today’s environment will continue, and perhaps even increase, as we enter 2023. This uncertainty will weigh on deal activity.
For FinTech M&A, however, it’s not all doom and gloom – the key drivers for M&A activity that were discussed above are likely to continue to exist in the FinTech space. As a result, though it’s unlikely that 2023 will be another record year like 2021, these key drivers should support a healthy M&A environment in FinTech. As for how that M&A environment might look, expect more robust activity in the middle market, as economic uncertainty is likely to have a greater impact on larger deals, particularly in relation to the costs of financing a large purchase price. Also expect the cadence of deals to slow down dramatically. Unlike last year, investors are no longer buying targets virtually sight unseen. Instead, they are taking their time to conduct diligence and kick the tires on proposed valuations. Capital is available to be deployed, but now more selectively for companies that can prove their value proposition.
[1] https://home.kpmg/xx/en/home/media/press-releases/2022/02/total-FinTech-investment-tops-us-210-billion.html
[2] https://www.cbinsights.com/research/report/FinTech-trends-q2-2022/
