The fintech landscape in 2023 looks vastly different from the previous year, as the industry grapples with global economic uncertainty, rising interest rates, significant layoffs in the tech sector, and the visibility of cryptocurrency bankruptcy.
The continuing rise of interest rates has put pressure on prices as the Federal Reserve aims to control inflation. Interest rates have increased from 0.08% in January 2022 to 4.57% in January 2023, with further increases expected in the near future. This has led to decreased demand for services, resulting in corporations and consumers scaling back. Mass layoffs have also been observed across the board, affecting both big tech companies and startups. However, similar to the 2008-2009 financial crisis, some individuals who lost their jobs could see opportunities in the disruption market.
Less demand for riskier assets has resulted in the bankruptcy of many cryptocurrencies. Over 4,000 cryptocurrencies failed to make it to their two-year mark, according to CoinGecko. Despite the challenges, venture capitalists invested $57.6 billion globally into enterprise and consumer fintechs in 2022.
Although this represents a reduction in fintech deal activity from the high of $100 billion, both VC deal value and deal count remained above pre-pandemic levels, suggesting investors continue to see long-term opportunities in the sector.
An alternative financing method gaining popularity among fintech transactions is the formation of a consortium-structured fintech company. This could be funded by a group of banks or other financial service firms or assembled by one or more firms based on the identification of a specific need. These companies, structured either as a corporation or an LLC, offer economic and governance flexibility.
However, there are challenges, including misalignment of prioritization, pricing, product fit and roadmap, and commercial and growth interests of core customers and non-customer stockholders in investor syndicates. Other challenges include differences in exit/sale/liquidity strategy, complexities around designing non-cash equity incentives for recruiting and retaining management, and varying strategies around subsequent investment rounds, such as identifying syndicate partners, trade-off between valuation and commercial considerations, and governance structures and policies.
Enforcement and the importance of regulatory diligence are critical considerations when working on a transaction, as parties must consider not only the transfer of value but also the transfer of regulatory and enforcement risk. Over the past two years, there has been a marked increase in regulatory scrutiny, particularly by the CFPB and FTC, and attorneys general and banking regulators at the state level.
Diligence is crucial as it can determine associated risks and whether there are ways to mitigate or eliminate those risks. Regulatory considerations are essential in this environment, as traditional incumbents may see opportunities to strategically invest in companies at more favorable valuations, allowing them to invest in a new business line without having to build it from scratch. Diligence can help determine potential risks and associated costs, allowing investors to seek specific representations in their agreement to mitigate those risks.
Some questions to consider include whether the target entity is registered with any US regulatory agency, whether it has been subject to regulatory examinations, and what business activities it is considering for the future. It is crucial to determine who is responsible for regulatory compliance after the transaction’s completion.
