By Yulia Chernova for WSJ Venture Capital
Financial technology startups, which are highly susceptible to broader economic turbulence, have hit a downdraft in venture capital funding.
Taking a nose dive, U.S. venture investment in the first quarter into fintech startups declined 29% from the previous quarter, to $826.3 million, according to Dow Jones VentureSource. That is also 37% below the totals from the year-ago period. The broader venture market, by contrast, was down 21% compared with the first quarter of 2015. VentureSource, like The Wall Street Journal, is owned by Dow Jones & Co.
Many fintech startups, for a while some of the most sought-after companies in the private market, several of them valued at $1 billion or more, will have to manage expectations down this year. And that is a notoriously difficult task, especially for companies that were previously funded at sky-high valuations.
“The fact that there hasn’t been a financial technology IPO this year has not gone unnoticed by later-stage venture capital investors,” said Raj Date, founder and managing partner of fintech venture firm Fenway Summer Ventures and former deputy director of the U.S. Consumer Financial Protection Bureau.
“That, plus the fact that strategic acquirers aren’t fools either, has naturally compressed what otherwise were soaring later-stage valuations,” Mr. Date said, adding that early-stage valuations also came down a notch.
Lending and payments startups saw declines. Insurance tech also dipped compared with the last quarter, but it was up significantly over the first three months of 2015. That subsector appears to be the new darling of fintech, where some prelaunch startups garnered seed rounds in two-digit millions of dollars.
Lending, meanwhile, the biggest subsector of fintech, marked a drop of 64% in venture investment, attracting $298.16 million. That represents a 44% decline over the first quarter of 2015.
This quick change of heart in the lending market is challenging startups. Many invested heavily last year into pumping up their customer acquisition departments, counting on investor demand for loans. Prosper Marketplace, for example, one of the largest venture-backed consumer lenders, hired some 100 people in sales and marketing last year, as WSJ Pro Venture Capital recently reported. But it is now tamping down marketing reach, along with others, such as Avant Inc., as The Wall Street Journal reported.
A dangerous outcome of today’s market forces may be that some lenders would loosen credit requirements to generate more revenue to justify valuations, said Ali Hamed, managing partner of venture firm CoVenture.
Even though debt has gotten harder to obtain, there is still too much of it lining up behind loans issued by startup businesses that may well go under, Mr. Hamed warned. Some of these companies may want to originate as much as possible to generate fees now, while the going is still good, he said.
At the same time, more early-stage startups are creating niche lending businesses, which tend to generate plausibly high yields on loans that debt investors like. But these types of companies also tend to be too small in scope to really be venture capital candidates, said Ali Hamed, managing partner at venture firm CoVenture.
It isn’t just the lack of exits that is spooking investors. Fintech is more sensitive to changes in the broader economy than many other tech sectors. Publicly traded online lenders Lending Club Inc. and On Deck Capital have seen big drops in share prices since going public in late 2014, as investors started to question their ability to grow rapidly as the broader economy starts to cool.
Debt markets, a crucial component of any lender’s business model, tempered their enthusiasm for alternative lenders, too, raising costs and limiting access to debt for alternative lenders. That, in turn, limited their ability to originate more loans.
“All that said, the major secular forces remain just as strong now as they have been,” Mr. Date, of Fenway Summer, said. Consumers are looking for alternatives to traditional financial services, even as the bigger corporations have to deal with heavy regulatory burdens. “What we are seeing here is a pretty remarkable level of activity and entrepreneurialism within a sector that has not necessarily been at the top of the list of such dynamism.”
Indeed, the second quarter of the year opened with a high-profile deal. Affirm Inc., a fintech startup co-founded by Max Levchin, raised a $100 million Series D round led by Founders Fund, at a valuation of about $800 million, representing an increase in valuation over its previous round, according to PitchBook Data Inc.
First appeared at WSJ Pro