Drying investments, falling valuations, increasing layoffs: Is the ‘fintech bubble’ bursting?

2021 saw VCs funnel an unprecedented amount of funds into early and late-stage fintech startups. VCs invested a record $121.6 billion in 2021 – up 153% YoY, and made a total of 4,987 investments in the space – up 54% YoY, according to PitchBook data. However, since the start of 2022, things have taken a gloomy turn.

Rising interest rates and fears over a looming recession have become roadblocks for the economy, forcing the fintech industry to take survival measures. Giants like Robinhood are coming crashing down after a strong 2021. Earlier this month, the firm announced a 44% drop in its revenue, and a decision to lay off another 23% of its employees, having already laid off 9% of its workforce earlier this year.

This trend is consistent across the board. Stripe recently revised its internal valuation, lowering it by 28%, from $95 billion to $74 billion. A couple of months ago, high-flying BNPL operator Klarna saw its value slashed by 85%, from $45.6 billion to $6.7 billion within just a year. Fintechs have accounted for 10.1% of the total layoffs among tech startups so far this year, according to tracker Layoff.fyi.

There may be more dark days ahead for the industry, as experts say the bear market could last another two years. Funds are continuing to dry up, and companies are taking measures to stay above water and not accumulate too much debt and losses.

CB insights' new report shows just how drastic the fall in fintech investment has been.

In Q2 2022, fintech investments from VCs clocked in at around $20.4 billion, which is not only a 33% drop from the previous quarter, but also the lowest it has been since Q4 2020. Additionally, mega rounds of $100 million+ funding fell by 45% since the last quarter, to $9.7 billion across 55 deals. Fintech mega rounds also made up a smaller portion of total investment deals done than each quarter last year, at just 4%. The top 3 funding rounds went to Singapore-based Coda Payments, and US-based Velocity Global and Circle.

In Q2 2022, only 20 fintech unicorns were born. That is down from 30+ each quarter for the previous five quarters. Even M&A in the industry is down by 30% QoQ.

The 'fintech bubble' began around the fourth quarter of 2020, when the industry saw significant increases in hiring as companies reaped the benefits from an abundance of investment from venture capitalists, according to Jay Metzger, a financial analyst for retail investment platform Jika. He argues that since a company's valuation is positively correlated with the number of employees hired, firms continued hiring to achieve goals set by their investors and raise their valuations.

“However, investors are becoming more wary about their investments in these small companies as the market wades into risky waters. This has led to a decline in cash flows from investors and now founders are looking for ways to save money, so they’ve begun with layoffs and hiring freezes. This is, in fact, a sign that the fintech bubble could be bursting,” he told Tearsheet.

As investors show greater reluctance in completing deals, fintechs are focusing on cutting costs, reevaluating expansion plans, and putting together roadmaps to profitability. Otherwise, they may run the risk of going under or being forced into raising down rounds.

A developing opinion in the industry is that the boom of the last 18+ months was not necessarily correlated with strong business fundamentals or performance data. Fintech has often been focused on sourcing and brokering assets and customers online back to incumbents instead of reinventing the core functionality of finance. Robinhood is built on top of Citadel, LendingClub on top of WebBank, and Brex on top of the existing payment network and acquiring banks. This architecture adds extra cost by adding an intermediary. At the same time, it is rare to find a fintech company with network effects.

“When fund capital is flowing into ventures at a rapid pace – $643 billion globally for 2021 – firms which are growing without a path toward profitability can attract capital. When capital retreats, however, this momentum reverses,” Blair Silverberg, CEO at alternative financing platform, Hum Capital, told Tearsheet.

So, this steep decline was not unexpected after the record-setting highs of 2021. Some view this downtime as a repricing phase within the industry. As opposed to the bursting of a bubble, the situation could be viewed as a necessary but painful evolution.

“Every asset class and vertical is down substantially in 2022,” said Ruth Foxe Blader, partner at Anthemis Group. “In the public markets, this definitely feels like the bursting of an asset bubble, accompanied by substantial repricing. In the private markets, the bursting bubble is balanced by the unprecedented amount of committed capital searching for great venture deals.”

Interestingly, the same conditions that are contributing to banks looking like attractive investment opportunities, such as rising interest rates, are creating stress for fintechs. On the finance side, fintechs thrive when they are getting credit for tech innovation. However, publicly traded tech companies, including fintechs, have lost their sheen as investors fear broader economic contraction and its impact.

“Many entrepreneurs will experience this market downturn as their first bear market or winter. Painful periods are required to flush out winners and losers. We expect to see this natural process happen over a period of years, with numerous opportunities for consolidation,” Blader said.