By Martyn Holman, Partner at Augmentum Fintech
The effects of the COVID-19 pandemic are being felt across all industries and all areas of day-to-day life. In some cases, the impact will be short-lived; in others there will be permanent change. The only certainty for the moment is uncertainty. This article looks at the reaction to-date of venture capital investments, in particular those in the fintech industry, and looks at what the evidence is suggesting about the longer-term future for the space.
Show me the money…
VC investment in general followed an observable (and perhaps superficially surprising) pattern during the early stages of the COVID-19 pandemic. Global volumes were in fact only slightly down in the early part of the year (Jan – Apr), at $82bn vs $93bn in the same period in 2019. The two biggest casualties were funds raised in China (understandably down 30% year-on-year) and early stage (Seed/Series A), also down 30%, with remaining volumes at later stage being flat in comparison to 2019. Later data, specifically for fintech in Europe, corroborated this picture, with investment volumes flat year-on-year for the whole of H1 at $2.9bn – down in the first quarter, and slightly up in Q2.
All of these patterns are understandable in the context of VC behaviour during the first half of 2020 as the COVID crunch was unfolding. As countries locked down across the world in March of this year, most VC funds turned inward and focused on ensuring adequate liquidity amongst their own existing portfolio investments. This activity was further reinforced by a proliferation of state aid programmes quickly ushered in by governments around the world, encouraging yet further matched capital from private investors. As in most asset classes there may have also been something of a ‘flight to quality’ – many later-stage rounds in high quality prospects were continually fulfilled during H1 2020, for example Robinhood ($350m), N26 ($450m), Trade Republic ($60m), Marqueta ($120m) and in our own portfolio, Onfido ($100m) to name some of the largest.
Those already invested in by VCs (i.e. generally later stage investments) therefore received a significant influx of new capital, whilst earlier stage prospects were generally ignored. The net result being that overall investment volumes were therefore maintained, but with significantly less being deployed at earlier stages.
Many observers expect to see the real impact of COVID-19 on venture capital volumes – both general and fintech – in H2 2020, citing the 3- to 6-month lag in investment timelines, and the general drop off in portfolio activity now that liquidity has generally been secured. There are however multiple factors which suggest this may not be the case.
In pure logistical terms, venture capital investors have been quick to adapt to new ways of working. Remote pitches and management interviews via Zoom are proving more efficient than prior working practices for many. Remote investigation with cloud-based data rooms was already the norm prior to the lockdown. Essential support services such as legal, financial and technical investigative resources have been fully available throughout the full period of lockdown restrictions. The reality of a venture capital investor’s role has, in reality, always been independent of the availability of a centralised office environment.
So, the investors are ready, but what about their capital? Given the rapid growth in venture capital fundraising and deployment in the last decade, particularly in Europe, funds are sitting on significant levels of ‘dry powder’, variously cited to be in excess of $0.5trn globally. Indeed, European VCs raised a record €7.6bn in H1 2020, representing +50% year-on-year growth, despite the global pandemic. The structure of a traditional GP/LP fund generally provides for the deployment of these commitments over a four-year investment cycle (with a further four years for follow on investments and portfolio management). Funds are generally neither rewarded nor incentivised for slowing their rates of investment and not fully deploying within their investment window. In other words, supply of capital is still very much in place.
The demand side of this equation is also equally robust. Discontinuities in the economic cycle have repeatedly driven innovation in recent times – witness the likes of WhatsApp, Uber, Slack and Square all rising from the ashes of the 2008 global financial crisis. Discontinuities starkly reveal new market opportunities and existing market gaps, and release the talent necessary to address them as larger corporates retrench their own workforces. Early stage funds will likely already be awake to the opportunities that are now beginning to swell their investment pipelines.
In addition to the supply/demand equation, many of the trends that have reinforced fintech’s rapid growth in particular have been accelerated and reinforced by COVID and the lockdown period. For example, over the seven years to January 2020, online penetration of UK retail sales increased from 10% to 20% and at the start of the lockdown in Europe, £1 in every £5 collected by UK retailers was online. According to ONS data in June, online retail sales were at 33% – £1 in every £3, representing 60% of total transactions (by number), up from 20-30% pre crisis. Simply put, COVID lockdown concentrated seven years of progress into less than six months. Other examples include ATM withdrawals (-40% in the UK) indicating the acceleration of a cashless society, and retail trading volumes (+30%) ushering the move to increasing self-directed investment and personal wealth management.
Fintech was already equipping the market with advantages that are now increasingly in demand as we transition to a “new normal” – enhancing access to capital, scaling distribution, digitising physical processes and reducing costs through automation of previously inefficient or labour-intensive processes. Public markets have perhaps been the first to recognise the opportunities that this “new normal” is bringing to fintech.
Unprecedented levels of fiscal stimulus have been undertaken with central banks around the world hoovering up vast swatches of government debt, thereby funding the support of both supply (corporate programmes) and demand (public tax breaks and grants). In the UK, nominal debt levels at over 100% of GDP are higher than they’ve been since the 1950s, albeit the cost of servicing that debt is at an all-time low. In response markets have stabilised, regaining much of the ground lost in the early days of generalised economic panic in late Q1/early Q2 2020.
An index of fintech leaders on Nasdaq, down 40% from its pre-COVID peak at the height of the market disruption, was trading at +5% by the end of June 2020 versus the Nasdaq index down 30% and recovering to flat over the same period. Similarly, a basket of UK listed fintech funds had regained its pre-COVID market peak valuation by the start of July versus a generalised public market still down by over 10-15%.
In short, COVID-19 will not define fintech. Rather, the economic disruption it has caused has accelerated digital disruption in the space, and investors have been quick to recognise that. With the opportunity still in its nascency (incumbent players still control >90% of the global market for financial services), it’s all very much still to play for.
Martyn is a Partner at Augmentum Fintech [AUGM], the UK’s only publicly listed investment company focusing on the fintech sector in the UK and wider Europe, giving businesses access to patient capital and support, unrestricted by conventional fund timelines and giving public markets investors access to a largely privately held investment sector during its main period of growth. Learn more: www.augmentum.vc/investors
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