Understanding the 2020 Fintech M&A Landscape

A look at the largest sector in the growth company space

By Henry Woram, Vice President at Palm Drive Capital

Visa’s acquisition of Plaid was shut down, but we still want to talk about some of the other major players and trends in the space during 2020…

2019 was a banner year for fintech investments, because the sector saw $20.6B in venture funding. 2020’s pandemic accelerated adoption of fintech technologies — for example, there was a 42% increase in fintech usage from March to April 2020. Despite this increased adoption, however, fintech funding and deal activity declined slightly in 2020, falling by 2% and 13% YoY, respectively. Highlighted in a study by CB insights, deals in every fintech vertical fell except for SMB, which grew by 13% YoY.

A note on the SMB fintech sector: small and medium sized companies endured financial hardships during the pandemic, and struggled to compete for access to capital like PPP loans while reeling from myriad operational challenges: supply chain disruptions due to factory shutdowns, loss of customers due to widespread economic uncertainty, shifting to remote work, etc. As CEOs tightened their budgets, some turned to fintech startups like Pipe for alternative financing or lending tech startups like Kabbage to get loans quickly.

Investing momentum returned at the end of the year. 2020’s Q4 saw 522 deals, an 11% quarter-over-quarter increase of deal activity. 90% of these deal increases were through Series A, B and C rounds, which explains why mega-rounds’ funding fell from 59% to 55% in the quarter, making up only 5% of fintech deal activity.

Nonetheless, fintech is still heralded as one of the fastest growing sectors in tech, with a predicted annual growth rate of 10.2% until 2025. By comparison, the single fastest growing tech sector in 2021 was the e-commerce industry, which grew 44% in 2020 due to record participation in online shopping as consumers adapted to the restrictions of the global pandemic. Fintech and e-commerce are naturally linked, because digital payments facilitate online transactions. Therefore we believe the rise of fintech is linked to the rise of e-commerce.

The rapid growth of fintech companies also resulted in a healthy mergers & acquisitions market in 2020. Legacy corporations like MasterCard and American Express have gone on spending sprees, while newer financial service powerhouses like Intuit made waves with acquisitions of their own.

Two types of fintech are especially prominent in 2020 acquisitions: companies that automate banking operations for businesses, and companies that accelerate consumer financial decisions.

Why are banking operations being automated? Some companies have been ahead of the technology adoption curve long before the pandemic, for example JP Morgan, which used AI to process over 360,000 hours of loan applications in 2017. But in 2020 we saw the rest of the financial industry forced along the technology adoption curve by an overwhelming demand for PPP loans and other financial services within the context of a remote work environment. No longer able to conduct business at branch offices, bankers consistently turned to B2B fintech companies like Ncino, Kabbage, Finicity and Plaid to streamline their banking operations. Plaid founder Zachary Peret estimated that banks spend an average of $300 to service customers manually, underscoring the opportunities to increase profits by automating old banking processes like data collection and loan application reviews.

Fintech companies themselves, likewise, experienced the need to accelerate their product offerings during the pandemic. While fintech companies are adept at building and deploying technology rapidly, they often struggle to navigate regulatory and compliance hurdles in a streamlined manner. Financial institutions, with their massive scale, have huge departments handling back office operations like compliance.

B2B Fintech Companies Automating Banking Operations

The explosion in consumer fintech products and services goes hand-in-hand with the emergence of infrastructure providers. Digital banks need modern software, payment apps need rails to traditional banks, and everyone needs data aggregation. Consumer bank data is highly valuable, thus the fintech startups that can serve as conduits to that data are highly valuable.

What we have seen in 2020 is the maturation of a number of banking infrastructure startups, either through IPO or acquisition by an incumbent.

Here are some great examples of startups that achieved massive exit valuations:

Galileo (Acquired by SoFi for $1.2B)

Galileo powers North America’s leading fintechs-including Chime, KOHO, Robinhood, SoFi, Varo and many others-as well as the U.S.-based business of international powerhouses, such as Monzo, Paysafe, Revolut and TransferWise.

• Galileo’s technology enables fintechs to easily create bank accounts and issue physical and virtual credit cards. Galileo takes on the regulatory burden that fintech companies face, and enables fintechs to offer better products, thereby increasing consumer participation in the new fintech economy.
• Globally, it processed an annualized $45 billion in transaction volume last month, up from $26 billion in October 2019 — nearly doubling in just six months.
• Galileo has been in business for about 20 years, and its growth has mirrored that of the fintech industry.
• Mexico City still has 80% cash transactions. Galileo has recently opened offices there, indicating the promising future of the Latin American fintech sector.
• Galileo is starting to see the need to support real-time payments faster than bank transfers and ACH, and expects this may be one of the next big fintech trends.

Data APIs and workflow automation boosting multiples

In particular, companies building data APIs or automating workflows have seen their multiples boosted significantly. This is a reflection of the way in which the incumbents value data and process optimization. Finicity, for example, enables better financial decision making because it has the infrastructure to aggregate vast amounts of data from diverse sources. MasterCard paid a premium not only for the data, but for the infrastructure as well.

On the workflow automation front, Plaid, Galileo and nCino are streamlining traditionally sluggish financial processes. These cost savings are ultimately transmitted to the customer, meaning faster service at lower prices. This phenomenon is speeding up adoption and resulting in increased valuations.

The Importance of Scale in Consumer Fintech

Despite having the world’s 5th largest nominal GDP per capita ($63,501), citizens in the United States have an average checking account balance of $2,900. To generate value as a digital bank or consumer fintech in the United States, you therefore need to achieve tremendous scale with users. This means go-to-market strategies like viral distribution, referral marketing, and content marketing are just as important as building sound backend technology.

Companies like Credit Karma and Honey Science have achieved tremendous scale, growing to 37 million monthly active users in 13 years and 17,000,000 monthly active users in 8 years, respectively.

These companies have exited at soaring valuation multiples:

Honey Science (Acquired by PayPal for $4B)

Founded in 2012 in Los Angeles, Honey Science began when co-founder Ryan Hudson was struggling to support his family. After calling utilities companies to save $200, and scouring the web for coupons to save $1 on pizza, Ryan decided to build a browser extension to scout discounts automatically. Using cookies, pixel tags, web beacons, and other makers, Honey engages consumers by tailoring its deals to each person’s preferences.

Honey struggled to raise venture capital initially because it did not have a mobile app. They didn’t need capital to grow, however, because Honey grew organically due to word-of-mouth referrals. With the consumer shift to e-commerce merchants, hyper-personalization and a customer-centric strategy, Honey’s user base grew. Eight years later he sold his business for $4bn to PayPal. By the beginning of 2020, Honey had 17 million monthly active users and 300 million active accounts.

Every time a user redeems a Honey coupon on an e-commerce site, that e-commerce merchant pays Honey a commission. Similarly, when users receive cash back from a merchant through Honey’s cash-back program, Honey takes a piece of those savings.

Honey / PayPal Synergies:

• Honey’s customer base matches up with Venmo users and fits the demographics of PayPal’s core platform (67% of Honey’s users were Millennials as of 2017, though the company has a more diverse customer base now)
• By acquiring Honey, PayPal has positioned itself even earlier in the point of sale process for the online shopping journeys of 17M Americans every month.
• PayPal has played a big role in cross promoting Honey to its huge network of consumer accounts
• This will launch Honey’s mobile shopping assistant and strengthen its position in mobile commerce

Our conclusions

In the past two decades, most fintech innovation has focused on either the direct-to-consumer sector or front-end banking technology. Incumbent financial institutions have focused largely on using digital innovation to find new, sleek channels for selling existing products, while neglecting to modernize their core banking infrastructure. This is evident from the fact that Fiserv, a fintech company founded in 1984, has 37% market share of the “core processing” vertical.

We think there is tremendous potential to invest in the next Unicorn that will disrupt the Fiserv / First Data monopoly, and are actively seeking meetings with ambitious startups to tackle this market.

Overall, the demand for digital payments, contactless payments and e-commerce platforms has only increased with COVID-19, thus fintech investment is expected to remain a priority. 2020 forced the rest of the financial industry to adopt new technologies and was a catalyst for new fintech business models and consumer products and services. It highlighted the weaknesses of the current banking infrastructure, and the opportunity for scale in consumer fintech brands.

There is ample opportunity in the fintech space for innovation, new developments and for funding new channels, making it one of the most highly anticipated and largest sectors in the fast growing technology industry. We will be closely monitoring the fintech sector for new startups with disruptive technologies.

Originally published at https://palmdrive.vc on March 18, 2021.