Fintech companies will be pleased to hear that, despite uncertainties over Brexit and the current lack of confidence in the UK market, private equity (PE) appetite for investing in the blossoming fintech industry remains strong. The UK’s fintech industry is growing from strength to strength; according to recent figures from KPMG, the UK accounted for over half of the total European fintech investment. As is a common theme across technology investments, artificial intelligence and machine learning are the hot technologies attracting most attention.
A cautious approach
PE houses have demonstrated caution when investing in fintech start-ups, for a variety of reasons. Most notably, PE houses may harbour concerns as to how profitable fintech companies are in reality. There have been many examples of fintech investments failing to return profitability – and even global, well-known companies, such as Uber, which have benefited from PE investment in the past, are yet to prove profitable.
Coupled with this, the future profitability of fintech start-ups can be hard to assess. PE houses use a company’s past performance to measure likely future performance and to determine what changes need to be made to run the company more efficiently. The problem with this is that fintech start-ups are often in their initial stages when seeking PE investment and, in such cases, there will be little or no indication of how to increase or attain profits. There is also uncertainty as to how much overall investment a fintech company will need, which is typically obtained through multiple rounds of dilutive investment.
PE investors are also conscious of the risks involved in trying to pick the winner in areas where there are multiple, well-capitalised fintech start-ups operating.
How to attract PE investment
Have a realistic valuation and financials. Fintech companies should make sure that they know their figures and can demonstrate the likelihood of significant (and immediate) financial return. A PE house will want to see a comprehensive business plan detailing how its investment will be spent and cash flow. In addition, companies should obtain a realistic valuation for their business; an over-inflated valuation is likely to discourage investment from PE houses.
Protect IP. This is particularly key for those fintech companies for which IP (such as software, programmes, etc) is the most valuable part of their business. Companies should ensure that all IP rights are properly registered and protected and owned in the name of the company (rather than by any individuals).
Focus on market strengths. PE houses will want to see evidence that the business can grow and become more profitable. Fintech companies should be prepared to show that they have a strong customer base with many repeat or long-term customers, that competitive threats are low and that there is a strong pipeline of both customer and product development. Having plans to target a different customer base, expand market reach or diversify by entering into new segments of the market can also help a fintech company to show its potential for growth to a PE house.
Have the correct management team in place. As part of their due diligence process, PE houses will check that the right management team is in place to take the business forward. On a management buy-out, a PE house will expect the owners of the business to take a back seat and the management team to run the company on a day-to-day basis.
Prepare the company for change. To achieve maximum profitability, a PE house is likely to seek to make changes to the business to drive efficiencies and to ensure that formal and professional processes are in place (such as corporate governance and more stringent key performance indicators). The management team should be prepared to embrace this change and ensure that it is implemented throughout the business.
Make a clear exit plan. Given the relatively short-term nature of PE investments, it is important to have an exit strategy in place from day one to ensure the business’s long-term sustainability. Exits may happen by way of a secondary sale to another PE house, a merger or an IPO or a sale to a trade buyer; whatever it is, all parties should be clear on the exit plan from day one, as PE investors will always want to prioritise how and when their investment will be realised.
Do your research. Any company seeking PE investment needs to do its research to ensure that it chooses the right partner. Fintech companies should look for a PE house with industry experience or those who have previously invested in fintech companies. Such PE houses will be best placed to support fintech companies and help drive growth and profitability. It is also helpful to understand where a PE house is in its investment cycle as that can drive their desired timetable as to when they exit an investment.
With these points in mind, fintech businesses should be able to more confidently seek PE financing – and, in turn, PE investors can more confidently invest in these sometimes high-risk propositions.