2023 UK Fintech report reveals cautious funding trend

In the 8th Annual State of UK Fintech Report 2023 by Finch Capital, a resurgence of funding discipline has been revealed, prompting a fierce battle for profitability within the British financial technology ecosystem. 

The UK’s fintech sector is experiencing tighter funding conditions, prompting companies to prioritise profitability as they navigate these challenges. This shift reflects a more cautious approach to investment and a greater emphasis on financial sustainability within the industry.

2023 UK Fintech report highlights

Finch Capital provides a comprehensive analysis of the UK’s financial technology landscape in their 8th report, focusing on three main areas: 

1) Impact of investment environment on the UK fintech landscape: a shift in investment discipline has led to a decline in funding, with the UK’s share increasing and mega funding rounds on the decline.

2) The state of fintech in the UK: The UK fintech sector has felt the impact of the changing funding environment, with total capital raised in the first half of 2023 dropping 70% (from £15.3 billion) in 2022. The top 20 funding rounds in the UK represented over 60% of total deal volume in 2021-22, though their sizes decreased. Corporate investors have retreated amid economic uncertainties, affecting Series A to C stage companies the most. Payments, traditionally resilient, saw a surge in capital deployment in 2022, with crypto benefiting from early-stage investments.

3) Thematic trends in UK fintech: The report highlights the decline in funding value across major markets in the UK, along with reduced activity from US-based investors. US-based investors have also scaled back their presence, with no US firms among the top 5 investors in the UK in 2023, compared to three in 2021. Valuations in both public and private markets have regressed to 2019 levels, particularly in later-stage funding rounds. However, there is hope as valuations stabilise in 2023.

The 2023 trends

Structural changes in funding landscape

The UK’s fintech sector has undergone significant transformations due to evolving funding dynamics. In the first half of 2023, the total capital raised amounted to £4.6 billion, representing a stark 70% decrease from the £15.3 billion raised during the same period in 2022. 

Notably, the top 20 funding rounds, which accounted for 50% of the market in 2021 and 2022, now command over 60% of the total deal volume, despite their reduced sizes. Consequently, smaller deals outside the top 20 have faced challenges in raising capital, particularly in Series A to C stages.

In terms of sectors, the payments category, historically resilient, witnessed a surprising downturn. Meanwhile, the crypto sector experienced an upsurge as investors gravitated toward early-stage businesses.

While the report highlights a 70% decrease in funding value across the UK, emphasising the shift in funding discipline, the UK’s share of the total European funding increased from 45% to 50%, bucking the trend of declining investment. 

From a valuation perspective, public technology markets have retraced to 2019 levels after robust growth in 2020-2021. The private markets are experiencing a slower transition to 2019 valuation levels. Later-stage valuations have seen significant drops, sometimes up to 50%. In contrast, earlier-stage fintech companies have demonstrated greater resilience, with valuations remaining relatively stable.

Exit market resilience with exceptions

Mergers and acquisitions (M&A) activity has experienced a modest 5% decline, signalling a willingness to engage in deals at favourable prices. However, M&A transaction sizes have plummeted by 84%. Public markets have remained largely closed due to bottomed-out valuations, but the decline in inflation could create new exit opportunities for the UK’s highest-valued fintech companies in 2024.

The M&A landscape has seen a considerable decrease in large outcomes, with less than 19% of all deals valued over USD 500 million.

Venture funding in ‘megarounds’ has also regressed to 2019 levels.

Profitability focus leads to layoffs

The pursuit of profitability has become a central theme in the past year, resulting in over 3,000 announced layoffs in the UK fintech industry. Despite this backdrop, the sector continues to hire, with the 10 fastest-growing fintech companies adding more than 1,050 employees in the past year, constituting 50% of their employee base. 

To adapt to the current market conditions, some companies have opted for hiring cheaper junior positions while parting ways with senior sales personnel.

UK maintains resilience

Amid the funding challenges, the UK has demonstrated greater resilience compared to other European countries, accounting for over 50% of total European funding. While regions like the Nordics, Poland, and France have maintained momentum through substantial crypto funding rounds, they continue to rely heavily on local early-stage investors.

Shift to B2B fintech continues

The transition from consumer-oriented fintech to business-focused fintech, particularly B2B fintech, has continued and solidified in 2023. Lending and balance sheet businesses have faced challenges due to increased funding costs and deteriorating loan portfolios. 

The rise in interest rates has offered some relief to B2C fintech companies, contributing to healthy interest income revenue.

Furthermore, regulatory technology is gaining traction in the B2B fintech sector, driven by increasing complexity in Know Your Customer (KYC) and Anti-Money Laundering (AML) processes. 

Generative AI is poised to reshape retail banking and insurance, making the Chief Financial Officer (CFO) an even more pivotal figure within organisations.

What this means for small UK startups

The current trends in the UK fintech scene have significant implications for startups in the industry. 

Here’s a summary of what these trends might mean for startups and how they can navigate the situation to their advantage:

Challenges:

• Funding discipline: the resurgence of funding discipline means that securing capital has become more challenging. Startups may find it harder to secure large investments, especially in the absence of profitability.
• Larger exits delayed: the delay in larger exits until 2024 means that startups may need to prepare for a more extended period of growth before achieving significant returns for investors.
• Reduced investor activity: investors from the US, Asia, and other strategic sectors are less active. This could limit access to international capital and partnerships for UK startups.
• Business valuation pressures: valuations in later-stage funding rounds have dropped, putting pressure on startups’ perceived worth.

Opportunities:

• Focus on profitability: startups should prioritise building profitable business models. The emphasis on profitability is a response to changing investor sentiment and economic uncertainties. Demonstrating a clear path to profitability can make them more attractive to investors and sustainable in the long run. 
• Try to diversify your funding options: given the decline in funding for early-stage companies, startups must be more resourceful in securing capital. They should explore a mix of funding sources, including niche venture capital (for women specifically, for example), or government grants including the UK’s SEIS and EIS schemes. Leveraging relationships with existing investors and showcasing a clear path to profitability can make them more attractive to potential funders. London was recently ranked best city in the world for networking.
• Efficiency and cost control: startups can optimise their operations, reduce costs, and consider more efficient hiring practices to weather the funding challenges.
• Thematic trends: consider aligning with emerging thematic trends in the fintech sector, such as B2B solutions, regulation technology, or generative AI, to tap into growing market segments.
• M&A and partnerships: although larger M&A deals are challenging, startups should remain open to strategic acquisitions. Smaller and more targeted acquisitions could be a viable growth strategy. Building strong networks and strategic joint ventures can increase the likelihood of such opportunities. Collaborate with other startups or established financial institutions through mergers, acquisitions, or partnerships to strengthen market positions.
• Focus on the UK market: given the UK’s resilience in the fintech sector, startups should prioritise their home market and build strong relationships with local investors.

Conclusion

In conclusion, the UK fintech sector is navigating a period of funding discipline and increased focus on profitability. 

While the merger and acquisition (M&A) market continues to show activity, larger deals face challenges, impacting the UK’s unicorns.

It is evident that the resurgence of funding discipline has compelled the UK’s fintech ecosystem to prioritise “survival mode“.  

2023 might be a challenging year for significant exits, but 2024 holds more promise. The next 12 months are expected to bring about a healthier environment for the surviving players in the UK fintech scene.

While challenges persist, the industry’s adaptability and resilience suggest a path toward a more sustainable and competitive ecosystem in the future. The UK remains a standout player in the European fintech market, and the shift toward B2B fintech continues to shape the trajectory of this industry.