2015, with respect to FinTech investments, came in like a lion with big funding rounds and unicorn designations flying around at warp speed.
It may be going out on a somewhat less ebullient note.
The summer brought uncertainty in international markets, which was followed this fall by a hiccuping stock market and some very public haircuts from a few, as well as very big names that jumped from being darlings of the private market to being the designated whipping boys in the public markets. (Here’s looking at you, Square.)
The valuation party, it seems, may be coming to an end — or at least moving past the point where the top shelf alcohol is being handed out with reckless abandon. Which has led to some trepidation about “what’s next” when it comes to innovation and the dollars invested in it in 2016.
So what are the best minds hypothesizing as the shape of things to come?
Interest Rates Up = Investment Enthusiasm Down?
While there is broad agreement that the Federal Reserve’s quarter-point rate increase won’t have much of an immediate effect on the startup investment marketplace, the shape and pace of future raises could tell another (and possibly more alarming) story.
If Chairwoman’s gradual tightening amounts to a series of rate hikes, the consensus of the panel of VC The Wall Street Journal spoke to was that such an action could very well signal a change of tide in Silicon Valley investing.
“Venture doesn’t exist in a vacuum and the “risk-on” mentality that caused many growth-starved institutions to flood startups with capital may reverse itself rapidly. If that happens, VCs could feel a crunch and entrepreneurs may find themselves short of cash and forced to refocus on monetization and profitability efforts in short order,” Chris Douvos, managing director, Venture Investment Associates, told The Journal.
Imagine that! A focus on monetization – and profitability. What IS the world coming to!
“A quarter point rise, especially one that’s widely anticipated, shouldn’t make much of a difference. However, it’s like Mike Tyson used to say about boxing: ‘Everybody has a strategy until they get hit,’” he further noted.
Rory O’Driscoll, partner at Scale Venture Partners, noted that there is a slowdown coming in VC investment in startups, but that change is not so much a function of a small rate change, and instead just the result of the marketplace inevitably sobering up after a few years of being drunk on the majesty of growth.
Growth at all costs, in other words.
“We have reached the end of “sloppy growth.” Years of high valuations and cheap capital have put pressure on companies to keep growth going at all costs. Otherwise, that valuation might come down. … In some vast macro sense, cheap capital from the Fed for 10-plus years may have driven all these speculative investments, but the tide is not turning because of the 0.25% rate increase, but because it is becoming obvious – even before any rate change – that the prices are wrong,” O’Driscoll noted.
And some VCs were upbeat and optimistic about the situation, noting that high interest rates might not necessarily mean the wells running dry for startup funding that others have predicted.
“To be fair, we haven’t seen rising interest rates in almost 10 years. Probably a majority of VCs/entrepreneurs were not in the business back then,” noted Neeraj Agrawal, general partner, Battery Ventures.
“If we assume we are entering a rising rate environment such as we saw in 1994 to 2000, or 2004 to 2007, we should remember that startup companies did great back then.”
Clearly the birth of the commercial Internet helped a ton. Will the massive diffusion of smartphones do the same for this wave of startups as we head into 2016?
The Unicorn Herd Predicted To Thin
For much of 2015, a “unicorn” designation was an unqualified good — a signifier that the investing community has branded a firm with the success seal of approval and that an entrepreneur had “finally” made it over the billion dollar finish line.
But by the end of 2015 the shine was off and the predictions about “unicorpses” began to emerge, as well as increasingly vocal founders who swore up and down that they’d been more or less dragooned into raising more funding than they’d been seeking — since, why not? Money was there and why not take it.
That, like going up a fourth time to the all-you-can-eat-buffet, isn’t likely to be as accepted moving forward. It’s unlikely that VCs will be forcing funds on anyone. Which will mean one of two things.
“We believe some on this year’s IPO pipeline will be forced to go public because they won’t be able to raise money from private investors like they did in 2015,” CB Insights CEO Anand Sanwal noted.
Or they actually work on making money and being profitable and operating like real businesses. There are other viable options for companies than having to continually raise boatloads of money from VCs or go public.
So what to look for in 2016? Startups will still get funding – the good ones will anyway. And how unicorns get born and how many aging ones survive or get put out to pasture, remains to be seen.
In the Year Past, Myths and FinTech Reigned
We promised ourselves we would not start out our Year in Review discussion of our Investment Tracker with reference to a mythical beast that proved to dominate discussions all year round, from water coolers around the globe to these very halls at PYMNTS.
You know, the one that carries mystery and allure and riches to those who can capture it.
Just kidding! Everyone knows Yetis are real.
OK, unicorns. The horses with wings that in many cases flew too close to the sun, to mix mythologies, and got melted down a bit once private valuations met public scorn. Not just Square, of course.
But we may be a little ahead of ourselves, so let us back up a second and present the bird’s eye view as of Dec. 25, the last full week of 2015.
We have $72 billion in total investment activity. Headed into the waning days of 2015, and that seems a strong tally that actually, on closer examination, shows deceleration, with the strongest months on a global basis coming in at the beginning of the year. Contrast the February and March tallies of more than $9 billion and $10 billion, respectively, and then, say December, which lurched to a close at sub $1 billion. Caution began to rule the day against, of course, signs of slowing growth globally, and dare we say it, valuations? Banking and trade finance grabbed the lion’s share of funding, at $18 billion and $12 billion, respectively; together, they represented nearly half of all movement in the IT tracker for the year. The trends? Speed, and payments disruption – in a positive way, of course – for trade finance. And for banking, the name of the game was consolidation, especially cross-border, with an eye on movement into new territories to bring in size and scope beyond, traditional U.S. or European home bases – but then again, community banks got rolled up, too. Think, for example, BB&T’s buy of Susquehanna Bank over the summer. Low interest rates had made it hard for smaller players to bring much to the net income line, while bigger players had the dry powder on hand to make deals. And debt, even with the looming specter of rising rates via the Fed, remained (and still remains) relatively cheap. In fact, the biggest deals in our investment universe came from the banking sector – and we’re talking billions with a capital b. Think General Electric’s fleet deal for just under $7 billion, sold to Element over the summer. Or HSBC’s multibillion-dollar sale of its Brazilian unit. FinTech also held sway over investors’ imaginations, as firms like Adyen got to unicorn status and VC firms geared up new investment vehicles in the hundreds of millions of dollars and even some banks started to get in on the act, putting (at least, and at last) some financial muscle behind upstarts playing in blockchain and bitcoin arenas. What about the last week? Anything in the tea leaves here, amid a workday-shortened week via holidays? Not much tell here. The week saw only $169 million in deals in the week. The bulk, as seen below, was in FinTech, at nearly $154 million, with 91 percent of the tally.
The crawl toward the 2015 finish line was led by Yirendai, China’s P2P lending player which came to market in the United States in the last IPO of the industry this year and promptly fizzled, ending the day down 9 percent. The tiny deal size may not really be enough to act as a tell on IPO sentiment headed into the new year, especially given the profile of the P2P lending sector overall, but the drop seems to hint that firms looking to make the move from foreign domiciles to U.S. markets may have a tough road to hoe. Likewise, the next runner-up in this week’s investment activity grabbed just under $74 million, and this was for RBL Bank, based in India, which also looks to go public (locally, in India), but secured the financing under the wire from a consortium of lenders such as the Asia Development Bank and the U.K. government.
Oh, and as for the fabled unicorns at $1 billion implied/real market caps and above– taking a page from Goldman Sachs by way of The Wall Street Journal, the following chart shows that they may have been on everyone’s lips the past year – but they’ve been around for a while – just not as plentiful. Take a gander at the chart below:
The question that this chart begs is perhaps an obvious one: Are unicorns born or made? Clearly, good companies are and will always be good companies, but when just about everyone is a unicorn, it suggests that perhaps more may be forced into fitting a Silicon Valley definition than perhaps deserve to be.
And only time will tell if we are at a peak.
We haven’t even begun the new year, but any look back must beget a look forward. The Fed has just raised rates, with an eye toward an economy that is healthy enough to be self-sustaining (i.e. artificially low rates need not act as a form of stimulus). The worries that debt may be hard to come by – at least for now – because it would be prohibitively expense, would not bear fruit, not coming off such a low base. Against that backdrop rates are low enough so that even nascent companies should be able to get the money they need.
But on the other side of the coin, that is, on the equity side, we could see more onerous terms start to jell as would-be investors demand more in the way of equity stakes – and more from ventures to get potentially smaller investments. Or perhaps VC and private equity firms may find some succor in a deal like the one that bedeviled Square, where some investors had been guaranteed a 20 percent return, with the promise of newly issued shares in the event that was not hurdled. That’s known as an IPO ratchet. Look for more of those ratchets if IPOs face a hatchet.
And, unicorn-mania notwithstanding, 2016 could become the year in which the reality check of the markets and investors delivers a more realistic picture of venture success and sustainability. A year in which only the fittest of unicorns will thrive and survive.