When interest rates rose at the tail end of 2022, London-based savings platforms Flagstone found themselves in demand.
The company, which provides savings products for consumers and fintechs like Revolut on a white label basis, quickly became profitable. In the process, it attracted a new kind of investor that had long shied away from VC-backed fintechs: private equity.
Simon Merchant, Flagstone’s cofounder and CEO, says the shift gave Flagstone more options for raising fresh capital to finance its growth. “The fact that we became profitable really opened up the opportunity to do a more sizable round with a private equity fund.”
Flagstone closed out 2022 with a pre-tax loss of £6.5m according to Companies House filings. But Merchant says the fintech’s been profitable for the last six quarters, telling Sifted the company made £37m in sales last year.
In March this year Flagstone closed a £108m funding round from American private equity firm Estancia.
And it’s not the only fintech to take private equity capital this year. Data from Dealroom shows that 14 European fintechs raised funding rounds with private equity firms as the sole backer in the first quarter of 2024 — the highest since Q3 2022 when 23 such deals were closed.
In July, Morgan Stanley Expansion Capital, the American banking giant’s private equity platform, led a $31m investment into international payments fintech Sokin, which saw them take a “significant” stake into the company.
While Flagstone and Sokin both say that there are currently no immediate plans to be acquired by their new PE investors, PE buyouts of VC-backed fintechs are also on the up. So far this year, PE firms have bought up VC-backed European fintech worth a combined €40m, the highest year by deal value since 2020, according to data provided to Sifted by Pitchbook.
Blurring the lines
Private equity’s encroachment onto fintech comes as the lines between VC and private equity blur. Much like VC firms, private equity investors are under pressure to deploy the vast sums of capital they have raised while, at the same time, repatriating funds to their LPs through exits.
This trend has recently led venture firms to push portfolio fintechs to seek profitability — inadvertently, that’s piqued PE’s interest in the sector.
“VC-backed startups have shifted their focus on profitability since the venture capital bubble burst in 2022/2023, which caught the attention of PE investors,” explains Frank Henkel, a partner at law firm Norton Rose Fulbright, who oversees deals in the fintech space.
The move to prioritise profitability left many smaller players — which are revenue-making but not dominant players in their respective verticals — unable to fundraise, says Barbod Namini, partner at VC firm HV Capital, forcing them to consider buyouts.
“During the frothier period, the same [business] model was being funded everywhere — in Portugal, Spain, Italy, Germany and France,” he says. “Now we’re back to professional investors saying let’s focus on the big winners.”
The dissolving divisions between fintech VC and PE can also be seen in the acquisitions and hires in the industry. 2022 saw PE firm Motive Partners buy embedded/capital, a Berlin-based VC focused on fintech. And, just last month, former SoftBank’s EMEA fintech lead Neil Cunha-Gomes cofounded Feria, a PE firm focused on taking majority stakes in digital asset companies.
Private equity is the new VC
But private equity is a whole different beast from VC. For starters, they have a reputation for engaging in the process of asset stripping, where a firm will buy an undervalued company to sell off its assets to make a profit.
PE firms also typically take controlling stakes and seek to steer the direction of a company — compared to VCs who generally don’t take majority stakes and are more hands off. Even with Flagstone’s minority investment from Estancia, two of its principals took board positions in the company.
And while some founders might not like this more meddlesome approach from their investors, there are upsides to accessing capital from PE Firms. They typically have access to larger pools of funding and their hands-on approach can be beneficial to fledgling fintechs.
“They’ve played a really supportive role,” says Flagstone’s Merchant. “One of the things they’ve given us particular input on is financial reporting and managing information systems — this is something they’ve done for a lot of portfolio companies in the past.”
For Sokin founder Vroon Modgill, the Morgan Stanley investment was an opportunity for the company to wean off relying on VC money — especially at a time when investors are more preoccupied with climate tech over fintech. According to data collected by Sifted, H1 2024 saw fintech startups land €8.8bn in funding across equity and debt while €21.3bn went to climate tech startups in Europe.
“We didn’t want to be just another fintech player, raising money from VCs for the sake of raising money year-on-year,” says Sokin founder and CEO Vroon Modgill. “We actually wanted a partner that can be long lasting and have a credible name attached to it.”
PE firms tend to target more mature, and therefore less risky, businesses than VCs, which invest at an earlier stage in hope for a larger return on exit.
This means that PE firms naturally deploy larger amounts of capital, and aren’t expecting hypergrowth from portfolio companies to deliver a 10x exit outcome.
Flagstone’s Merchant says this enabled the company to raise a sizeable round, without the urgency of growing unnaturally quickly that can come with VC money. “For fintechs that have outgrown the startup phase and are looking to scale or stabilise their operations, a PE firm might be a more suitable partner than a VC firm,” says Norton Rose Fulbright’s Henkel.
Leftover fintechs
Not every fintech, however, can rely on PE firms plugging the hole left by the venture funding slowdown.
Norton Rose Fulbright’s Henkel expects PE buyouts will emerge as a popular exit route for VC-backed fintechs over the next few years, but thinks these deals will be focused on fintechs serving niche markets particularly in the B2B vertical that are close to profitability.
“It is unlikely that PE firms’ deal teams will screen VC’s portfolios looking for potential new targets,” he says. “Most of them are based on high valuations and are yet to become profitable.”
Still, HV Capital’s Namini says having a PE firm on a fintech’s cap table can be a win-win for everyone involved. The PE firms he has come into contact with are running similar market strategies — eying up either an IPO or an exit to another PE firm — and for many loss-making fintechs, they may have no choice.
“If they come on the cap table of a big asset, it’s a great way to not have to constantly raise but have a strong partner to build towards an IPO,” he says. “And even for the assets selling at conservative valuations, it’s still a win because let’s face it, what’s the alternative?”
Read the orginal article: https://sifted.eu/articles/private-equity-fintech/
