Lately, it seems that every meeting I go to, somebody announces that the end of the ‘fintech bubble’ is upon us. This declaration often comes from ecommerce, VC or IT veterans that experienced the 2000 Dotcom Bubble in person. I’m one of these people, but I’m not sure about their predictions. Even though some of the most recent business valuations in the sector may be a bit overoptimistic, 2016 is very different from 2000.
An ‘irrational exuberance’ (quoting ex-Fed chairman Alan Greenspan), partly fueled by the media at the beginning of the century, led to internet businesses being seen as unrealistically big-growth opportunities by investors. This resulted in an unjustified rise in valuations of digital businesses (called dotcoms at the time) followed by a huge fall and subsequent collapse in trust in the whole internet sector.
The consequences of this collapse were quite profound. VC investment almost dried up overnight, leaving many startups stranded and underfunded. In the next few years, many companies (including some high profile ones: see Pets.com, Boo.com, and Webvan) went bust because they couldn’t fund their own growth. Businesses set up to help create and ‘accelerate’ the growth of internet companies were also badly hit and were either wiped out or dramatically downsized. These included Viant, Idealab, and Antfactory, to name just a few. The demand for talent became less frenetic, with anecdotes of programmers going back to school to study accounting circulating widely.
The press, that had in previous years had a great time in creating unrealistically high expectations from the sector, started fueling a continuous flow of negative stories on the risks of the internet. This spooked some customers, but also led to certain complacency in the businesses target by the dotcoms, leading them to underestimate the threat they were under – a mistake some paid for dearly.
After the initial turmoil, the effect on customers was less marked. Some initially became suspicious of the internet, but most just continued using dotcom businesses, albeit at a slower rate than that forecast by startups and their investors.
It is undeniable that there are some similarities between 2000 and 2016, but after a closer look, I would suggest that today’s situation is very different from the dotcom bubble. Let’s take a look at some of these similarities and differences.
- Businesses are getting valuations that some say are not realistic reflections of their long-term value generation potential (I won’t name any one business here).
- Large numbers of young, talented professionals are leaving traditional careers to launch fintech startups.
- VC money is pouring into the sector at breakneck speed – Accenture says up from $4bn in 2013 to $12bn in 2014.
- A number of high-profile business incubators are being set up to help accelerate the growth of startups. The Moneywiki blog lists over 30 worldwide.
- The size of the ‘fintech bubble’ is still a fraction of the dotcom bubble, even at $12bn.
- Today, we have a much bigger target market. Internet Live Stats estimates that we have 3.3 billion people with internet access compared to 500 million in 2000.
- Financial services are an inherently digital product that can be easily sold remotely – differently than the complexities of selling physical goods.
- The quality of the businesses we’re seeing today is substantially superior to those in 2000.
- Investors are mainly VCs, corporates or angels, all of which are more experienced investors than the general public in 2000.
These points would suggest that the growing interest in fintech is probably not a bubble, but just a sector reaching maturity. That said, there’s still a strong probability that in the next few months, we’ll see a leveling (or even a contraction in) the volume of funding targeting the sector. This could be triggered by many factors: a failed IPO, the collapse of one of the fintech poster children, or even another recession. I thought it would be interesting to explore what the impact of this would be for the different stakeholders.
Fintech is attracting many different types of investors. With few exceptions (luckily), unlike the dotcom bubble, the general public is the major one of these. Let’s take a closer look:
Angels: These are a major source of investment for fintech startups. The effect of a contraction in the sector’s valuations could be profound on angels. A few will see the value of their shares diluted, while many will see their investments disappear. This will probably lead many angels to exit the sector in a big way, making it hard for entrepreneurs to get their business off the ground.
Venture capital: VCs will have a similar behavior, only with a few more zeros added to their losses. They will also become more conservative in their investment strategies. Some more courageous firms will wait for the market to settle and then get back into the sector with the aim of getting a few good assets on the cheap.
Corporate investors: These will also be affected. A downward push on the value of the sector, and possibly in businesses they have invested in already, will trigger uncomfortable conversations with the leadership of the organizations they are part of. Some may see this as an opportunity to invest more, but most will probably become more cautious.
Incubators and accelerators: These could be hit hard, with substantially reduced exit options for their startups. I think we may see a reassessment of this industry as a whole.
Private equity: These will be largely unaffected, as most haven’t entered the sector too aggressively (with the exception of two sub-sectors of fintech: payments and challenger banks). A fintech valuation realignment will be substantial in both areas.
It will become harder for early-stage firms to raise funds. Some businesses, that just a few months earlier had seen many interested suitors, will struggle to fund subsequent rounds. Some will have to accept down rounds and some may even fail.
New businesses will also find it harder to find investors. Only those with the most decisive leaders, strongest business models and clear paths to profitability will find backers. Valuations will be much lower that those of a few months earlier.
The only upside will be that the average quality of the businesses post-shakeup will be much better than before.
These will have a mixed response. Some will see the downsizing of the fintech bubble as validation that they’re safe with their business-as-usual approach, and will probably slow down their investment in digital change. Money will flow to maintenance and management of legacy systems, and investment in innovation will contract. They will eventually see that this was a mistake.
Other incumbents will see this as an opportunity to accelerate innovation. They will be able to acquire startups that are proven and complementary to their business at a fraction of the cost of a few months earlier – a great way to renew the business for less.
Most regulators will become more cautious about supporting fintech. I don’t think we’ll see any real reversals of past regulatory decisions, but I would expect most regulators will become more skeptical of the potential of new fintech firms becoming real challengers to the big players.
The end-user will largely be unaffected provided that the possible collapse of some fintech firms doesn’t leave them out of pocket. I believe that customers will react differently with different businesses. Fintechs that provide loans, payments, forex or information will be largely unaffected. Those that provide investment or savings propositions will feel the impact, as customers may expect more reassurance that fintech startups are secure places for their money.
A sector that may need to tweak its business model will be P2P lending. They will increasingly explore going from a crowdsourced model to a ‘financial marketplace’ approach, enabling institutional investors to take positions on their platforms. Some customers will opt to go back to the incumbents, yet these returning customers will be different than before because they will have new expectations of service, pricing and UX. Incumbents will have to work hard to keep these returning customers happy.
Some good talent will suddenly be back on the market, because either their business has gone bust or the down rounds made their share of the business so diluted that it’s no longer worth it for them. These people will most likely seek roles with more established players with deeper pockets than their previous employer. It will become a lot easier for incumbents, well-capitalized startups, consultants and agencies to attract talent.
The excesses seen during the dotcom bubble in 2000 are not present in the same scale today, but we’re certainly seeing very early-stage businesses being valued too richly, so a downturn (or at least a cooling of period) is probably ahead.
As with any financial downturn, a downward push of fintech valuations will benefit some and damage others. I believe that, at least in the long-term, the bursting of the fintech bubble will be a beneficial thing for the industry as a whole.