UK FinTech: the 2016 landscape
February 2016 | EXPERT BRIEFING | SECTOR ANALYSIS
As 2015 has become 2016, we have found the success story of FinTech – that is technology and its application in financial services – still high on the agenda for the year ahead. This is undeniably good news for the UK given reports that the UK technology sector as a whole raised $3.6bn from venture capitalists in 2015.
At a time when the chancellor of the exchequer has issued a verbal reprimand to the UK’s economy for becoming complacent and reminding us that we are still facing numerous economic headwinds, the media is again awash with comments about just what it is that the UK is are good at and, more critically, that other people want to actually buy our products and services. Despite its intangibility, the continued feeling is that FinTech is a very real asset to the UK.
KPMG and Australia’s H2 Ventures reported in their collaborative FinTech 100 publication that an estimated $20bn of investment had been made in FinTech firms in 2015, contrasted with $12bn in 2014. The breakdown of these selected 100 companies offers some indication as to possible FinTech trends. It should be noted that 18 of the listed 100 companies are UK entities; however, there is substantial competition with the US continuing to dominate with 40 companies and Asian entities accounting for 22 of the entries. Indeed, it was reported that $35.7bn was invested in technology groups in the US in 2014. However, the UK does offer the advantage that the regulatory picture is simpler than those jurisdictions with regulations at state and federal level. Furthermore, the Financial Conduct Authority’s launch of Project Innovate in October 2014 was a progressive and encouraging development for FinTech, particularly given that its stated aims include supporting new and established innovator businesses.
There are, of course, the usual and quite sensible cautionary words around FinTech valuations. Start-ups and valuations are constant bedfellows, and 2015 was in-part characterised by the infamous ‘unicorns’ with a valuation of more than $1bn and subsequent questions as to how private companies can attract such valuations. Putting aside the billion dollar valuations, the point remains that whilst investors are interested in the sector, they will be exercising care in identifying genuine prospects. It is difficult to disagree with these sentiments. For example, much has been made of one company whose share valuation on its initial public offering in late 2015 was 30 percent lower than its valuation in the pre-IPO funding round. It remains to be seen what impact this will have on the other highly-valued private companies, but perhaps such companies will shun a public pricing for fear of suffering the same fate. Closing one of two traditional exit avenues may lead some investors to further question the wisdom of investing in ‘unicorns’ and perhaps focus on less-grandly valued entities.
One of the trends running through the FinTech 100 is the prevalence of companies focusing on the payments, currencies and transactions sector. This is an already crowded area and a fiercely competitive section of the FinTech spectrum, as demonstrated by the lower share value referenced above. Nevertheless, the travails of one company does not necessarily sound a death knell for the sub-sector. The exploration of technology in payments, currencies, transactions and the use of the distributed ledger has far more distance to run and there is a sense that we have only begun to explore the possibilities and applications.
Twenty-five of the companies listed in the FinTech 100 are service providers to financial institutions, the so-called ‘enablers’. Financial businesses are faced with mounting regulatory compliance obligations as regulators seek to progress multiple objectives, ranging from transparency for clients through to greater clarity and accountability to the regulators. Products which simplify the back-office burden and reduce the costs of compliance will always gain the attention of financial institutions. At the front end, the use of blockchain technology in smart contracting to enable trade execution is one example of how FinTech can be taken into the complex, and lucrative, financial sector.
Where the technology focuses on individual consumers, potential investors must look for functioning products, which are gaining traction and display the potential for viral growth. Without the attention of the mass market the opportunity for monetising the technology is greatly reduced. Start-ups will not succeed if their idea, no matter how clever, is not developed with a clear idea of who will buy the offering. Central to the success of technologies targeted at consumers will be their seamless delivery and ease of use, particularly around products which solve a previously undescribed problem or simplify the customer’s life. This may not require complex intellectual property and armfuls of patents, and so less emphasis could be placed on intellectual property, particularly at the earlier stages. Of far greater importance is the choice of platform. It is essential for consumer-facing products to focus on mobile platforms and internet-only offerings will be at an inherent disadvantage.
For enablers, the challenges are somewhat different. The intellectual property will be far more important, with an example being the need for complex algorithms in big data applications. In contrast to consumer technology requiring mass market appeal, in this case a small number of institutional customers can be transformative. However, getting to the point of signing up customers presents its own difficulties. Gaining the necessary traction can be obtained through business partnerships with financial institutions to help develop the product and with providers of complementary technology necessary to help realise the potential of the product being developed. Companies with those strong partnerships, or at least the willingness to forge them, will be at an advantage.
Finally, investors need a return. If the investee company’s management are content to sit on high theoretical valuations, and use funding rounds to provide them with the all the capital they need, there seems little appeal for investors. With interest rates beginning to shift upwards the appeal of the risky start-up may diminish for some investors who prefer the more stable returns offered elsewhere. Technology companies will need to work harder to raise capital and financiers should bear this in mind when driving the deal.
In short, the message is that there is great appetite and appreciation for FinTech but greater emphasis will be placed on identifying genuine value and prospects for realisation of that value. In identifying likely success stories there is much to be said for sticking to the old principles of looking at companies which satisfy three characteristics – the product needs to have appeal, the timing needs to be right and the management team needs to be balanced and strong. Given the statistics, now would appear to be the time for FinTech.
Sam Pearse is a partner at Pillsbury Law. He can be contacted on +44 (0)20 7847 9597 or by email: email@example.com.
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