All the SPAC activity around fintechs is kind of normal. If you have not followed this new craze, here is a good recap from CB Insights. The huge amount of money going into fintechs needed an exit of some sort. When VCs give you some cash to build a business, they expect a return. As big as it can be. All of these investments into fintech over the past 10 years were meant to eventually return something. These exits can be an IPO or being acquired by another company. Like all this chatter about Lloyds Banking Group buying the neobank Starling Bank. Sometimes it’s good for the investors, but bad for the startup. Like the Simple fiasco with BBVA. A few big fintech public listings are rumoured for this year. And there has been obviously the Ant Group IPO that could have happened. So what’s going on with fintech startup exits?
The state of play
Firstly, what we mean by an exit is an event that gives liquidity to early shareholders. Venture capitalists, business angels, and founders for instance.
The thing is, an initial public offering (IPO) is not the likely scenario for fintech startup exits. That is even taking into account this great SPAC wave that is engulfing the private capital market. It might or might not increase public listings. The SPACs could well just merge with companies that would have done an IPO instead. Which is what seems to be the case at the moment. Since the 1980s, it has been increasingly unlikely that a venture capitalist would see an exit through a public listing. So you might read a lot about these super hot IPOs, like Airbnb or DoorDash, but in reality it does not concern many startups. Actually for U.S. Venture Capital, it is less than 10% of startup exits. The numbers are roughly similar for other VC markets in Europe and elsewhere.
So what happens when VCs are trying to get out after a few years? Say 5 or 10 years? Well, they are likely to push for M&A. Or without actually pushing for it, that might just be what the founders want. Someone calls you and say “hey, here is a big fat cheque for your business, do you want it?” and you decide that you would be better off sipping margaritas by the beach. Why not. This is obviously good news for banks and established financial institutions. Given their track record integrating fintech startups, that’s not particularly great for innovation in the industry as a whole. It’s like building something awesome and throwing it against a wall to see if it bounces off. Most of the time, it does not. And break.
To be fair to banks, most M&A transactions are a fiasco for many reasons. It’s not just an issue in financial services. According to Harvard Business Review, between 70% and 90% of acquisitions fail.
How do you fix this?
There needs to be a revamp of the IPO process. It is not particularly efficient at the moment. It’s the reason why many fintech startup exits do not end up in public listings. Or decide to go for SPACs. They are very popular these days because from an investor’s perspective, it is not too bad. For the startup, you do not get to ring the bell at the stock exchange. But it is a much quicker and gives you certainty over pricing. As an investor, you are even given the choice to exit before the acquisition of the target. For the sponsors, it is a pretty sweet deal, as they end up with a lot of equity in the target. That’s why every man and his dog have a SPAC now. Yes, even Shaquille O’Neal has one. You don’t have a SPAC? What is wrong with you!
David Erickson from Wharton looked in details at what his wrong with the current process and how it could be fixed. From streamlining the whole process to collapsing the time disconnect between the fillings and when the stock trades. And including an improvement of the transparency with the overall demand.
Some things can be done. For instance in the UK, the Kalifa Review recently suggested a few changes to the listing process there. In order to have more British startups listing on the London stock exchange. Instead of looking to get acquired or listing in the USA. The new stock exchange in the US – The Long-Term Stock Exchange – is also looking to change the way companies are listing. And encourage more companies to trade publicly. All of these activities could lead to public listings being a stronger option for fintech startup exits.
More generally, there is also the trade-off between being a public company or staying private. The level of scrutiny from investors, the Q1 trading updates and all that good jazz. That might be harder to change because that is a fundamental business choice.
Bottom line: why fintech startup exits matter
Beyond the fact that M&A is probably more destructive for innovation than a public listing route, fixing the way investors can exit has more ramifications. Fintech startups staying private for longer is in the end pretty bad for equality. So if you care about ESG, you should care about fintech startup exits. And they stay private much longer now. The average age of US technology companies going public went from 4 years on average in 1999 to 11 years in 2015.
The private capital industry has adapted with huge funds capable of supporting the growth of companies for longer. But ultimately early stage investors need a way out. So unless they sell to a private equity investor or a strategic partner, they are stuck.
And the problem remains access.
Access to private investments is notably harder than the public market. These days you do not need much to go and buy some stocks. You download Robinhood and go on a meme-fuelled rampage on GameStop shares. For private investments like venture capital or private equity, it’s harder. You can get some sort of exposure through equity crowdfunding for venture capital. Through ETFs invested in private equity or by buying shares of listed PE managers like KKR. But that’s not the real thing. And to invest into a fund directly, you might be lucky if the minimum investment is only $5,000. That’s a lot and not a lot of money: the rule of thumb is that you should have 5% to 10% in private capital. That implies that you have much more than $5,000 in investable assets.
Fintech startup exits is not only a challenge for Silicon Valley VCs. It is a much broader issue.