The venture capital landscape is demonstrating a trend toward investments occurring at later stages, with increasing deal sizes and higher costs. Consequently, the fintech industry – a particularly active and well-funded segment – is mirroring this development.

This progression is advantageous for established fintech companies. However, it raises questions about whether this shift toward larger, more advanced funding rounds is hindering the ability of smaller, emerging companies to secure investment and achieve substantial growth.

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Our previous analyses of venture capital activity in Q3 2020 revealed a pattern of investments becoming both later in stage and larger in size. Specifically, when reviewing results for the United States, we observed that “54% of all venture capital funds invested in the U.S. during the third quarter were allocated to rounds of $100 million or more,” with a record number of 88 such rounds totaling $19.8 billion.

The remaining capital was distributed among the other 1,373 investment rounds completed during the quarter. Furthermore, the proportion of late-stage rounds, along with their average value, is increasing, reinforcing this overall trend.

The fintech sector appears to be following a comparable trajectory.

We have previously investigated the venture capital market within fintech, concentrating on the areas of payments, insurtech, wealth management, and banking.

Today, utilizing a report from PitchBook concerning fintech’s performance in the third quarter, I will emphasize how this sector is also experiencing a shift toward later-stage funding – a development that is important to consider as we monitor both which startups are preparing for initial public offerings and which ones are likely to obtain the necessary funding to reach the expansion phase.

Increasing Investment Sizes and Later Funding Stages

According to PitchBook’s analysis of North American and European venture capital activity in the fintech sector during the third quarter, a total of $8.9 billion in capital was secured, representing a $1.3 billion, or 17%, increase compared to the $7.6 billion raised in Q2 2020.

However, PitchBook also points out that “only 414 deals were completed in the quarter—the fewest since Q3 2017.” This indicates a trend of greater capital being allocated to a smaller number of funding rounds. This pattern is noteworthy.

Initially, our review of the data suggested that consumer fintech companies were experiencing a strong year, while certain business-to-business (B2B) fintech categories appeared to be slowing down. In fact, consumer-facing fintech businesses in North America and Europe have already raised $5.9 billion in 2020, having secured $3.7 billion in 2019.

However, this growth was overshadowed by the information presented in the following chart:

This data focuses on North America and Europe, but it reveals significant shifts in angel/seed and early-stage venture capital activity in 2020. Despite being on track for a record year overall for fintech venture capital investment across the two continents, the rate at which startups in the pre-late-stage phases attracted funding actually decreased.

This trend began in 2019, when combined angel/seed and early-stage VC totals declined from 2018 levels, a decrease that was offset by a surge in late-stage investment within the sector. The same dynamic is occurring in 2020, but to a greater extent.

Deal statistics regarding North American and European fintech investment in the quarter provide further insight into these changes:

• PitchBook data indicates that the median pre-money valuation for late-stage VC-backed fintech startups in Q3 was $95.0 million, an increase from $73.8 million in 2020.
• The median pre-money valuation for early-stage VC-backed fintech startups in Q3 was $20.0 million, also higher than the $15.6 million recorded in 2019.

PitchBook also reports a rise in valuation multiples, although they did not reach new all-time highs in Q3.

Regarding fintech sectors, our initial assessment of this data led us to consider a comparison between business-to-consumer (B2C) and B2B companies. While this comparison is valid, we believe it obscures the central narrative. The following chart illustrates North American and European consumer fintech VC activity over the past several years, with data current through September 30, 2020:

What implications does this have for founders of younger fintech startups? The expansion of larger fintech companies into new product areas may be reducing the available market for smaller businesses. Consequently, the substantial late-stage funding we are observing could potentially hinder the launch and growth of new fintech ventures.

Similar to the challenges faced by entrepreneurs attempting to establish a new food-delivery service given the established capital bases of companies like GoPuff, Uber, and DoorDash, it is possible that many areas within fintech have already been addressed and funded. Furthermore, a decline in VC investment in the space could occur once several of the larger players undergo exit events. It is worth considering how these numbers would appear without the inclusion of companies like Robinhood and Chime. Would the overall figures remain as impressive?

We intend to consult with fintech-focused venture capitalists to gather their perspectives on the current state of the early-stage market. We are eager to learn more. (Please contact me if you are a relevant VC.)