Dan is the Founding Partner of Commerce Ventures, a venture firm focused on digital innovations in the FinTech, Payments, and Commerce eco-systems. Commerce Ventures represents a highly strategic set of individual and corporate investors and, thus far, the firm has invested in over 100 portfolio companies since its launch, including Bill.com (IPO), BillGO, Bloom Credit, ClickSwitch (Acq’d by Q2), Forter, Grow Credit, InAuth (Acq’d by Amex), Kin, Marqeta (IPO), Moov, MX, SessionM (Acq’d by Mastercard), Socure and VestWell.
Prior to creating Commerce Ventures, Dan was a Principal at Highland Capital Partners where he invested in mobile and FinTech companies, such as PerkStreet, Quattro Wireless (acquired by Apple), Triad, and WePay (acquired by JPMC). He has also worked at HarbourVest Partners, where he invested in growth-stage technology and communications businesses; in Corporate Strategy at RSA Security; and was implementing lending systems as a consultant at American Management Systems before the term ‘FinTech’ existed.
Happy New Year, FinTech! Welcome to 2023, the year that FinTech really gets messy.
Who Made This (FinTech) Mess?
Over the past 5 years, starting and funding FinTech companies became easier than ever before. With tremendous inflows of capital to venture (and especially to FinTech as a venture category), insatiable investing appetites overruled the laws of venture physics. Startups with limited traction were able to raise funds undeterred, while those with rapid revenue growth were offered seemingly unending access to capital at increasingly unjustifiable valuation multiples. At the height of this frenzy, it was not uncommon for prospective founders to receive term sheets for their new startups…before they had even left their existing jobs!
Think about it this way, FinTech venture investment grew over the past 10 years from roughly $2B in 2013 (the year Commerce Ventures launched) to $56B in 2021 (Source: NVCA Venture Monitor Report 2022). Despite secular growth in venture as an asset class, FinTech venture tripled its dominance (% of all venture dollars invested) to become a top sector for the VC industry. Along the way, it became a staple coverage area for storied franchise VCs as well as a launching vector for newer, ambitious, emerging managers.
With so much capital entering the FinTech ecosystem and the market opportunity expanding so rapidly, it was easy to confuse overdue innovation demand for entrepreneurial exuberance. For venture investors, it would have been easy for newcomers and veterans alike to feel like we were winning (and pretty good at our jobs). In reality, the surge of institutional capital had its way with our industry. Now, as that capital influx is receding, we are recognizing both the absurdity of too many of our decisions and the false signals of demand that persuaded us to throw caution to the wind.
Without question, company formation exploded in response to this newfound investor demand for FinTech startups to fund. According to Dealroom, early-stage FinTech funding rounds (pre-seed through Series A) grew from 500 in 2013 to over 1,400 in 2021 (<3x growth), the peak of the market. Given that investment volumes grew 25x+ in that time period, it stands to reason that round sizes grew substantially and valuations rose rapidly as investors scrambled to get their new funds to work in the sector. Relatively nascent categories (e.g. neobanks, banking-as-a-service, BNPL, etc..) suddenly had countless new entrants vying for market share, leaving many investors scrambling to place a bet for fear of missing out.
The magnitude of market abnormality struck me last year when an investor friend I respect a lot mentioned that his (highly rated VC firm) hadn’t had a writedown in 5 years. After 23 years in venture, investing across several cycles and at all stages, I can promise you this is just not how venture works. People start companies with a hypothesis, and sometimes that hypothesis just doesn’t prove to be correct. If those people are highly skilled and motivated, they might pivot to another idea and find success before they run out of money, but that was exceptional. These past few years of capital flooding the industry provided an unending series of at-bats, and that’s just not natural.
The Only Way Out is Through
Round sizes are going to shrink, the terms will be tougher and the ‘bar’ will be higher. This means we should expect down rounds, recaps, fire sales and, unfortunately, plenty of wind-downs. During heady times, challenged businesses (including some in our own portfolio) were able to find meaningful liquidity, even in spite of not having reasonable prospects of remaining independent. Those times are gone. The tone of acquirers has shifted from aggressively pursuing innovators to narrowing focus on only the most strategic opportunities for M&A and a very strict eye for value in those areas. In this new reality (where so few acquirers really need to be aggressive, and several are struggling with their own access to capital and valuation), we should expect to see those most heavily funded FinTech segments feel the most pain - think of it as too many folks trying to get through a narrow fire exit at the same time.
Let’s also stop pretending that the challenging market we’re faced with today is a discrete shift away from one category of companies like “consumer fintech” or “neobanks” and recognize what is really happening. These businesses were never supposed to be easy to build, and investing successfully in them has historically required patience and skill that these past few years have not. Now we find ourselves not in a temporary pause of investment pace, nor an equivalent shift from one investment theme to another, but a return to what startups and venture have always been…challenging.
Embracing the Challenge
This all sounds bleak, right? It isn’t. Those of us who have been doing this for a while recognize this challenge and are prepared to roll up our sleeves and work closely with founders and co-investors alike to ensure we can make it through. While times will be especially tough for some this year, we very much believe in the enormous market opportunity for FinTech innovation that lies on the other side of these challenges. A founder friend and mentor of mine taught me that one of the keys to his success was recognizing that building a successful startup is rarely neat…and that recognizing and embracing the messiness is how you win.
I struggle to think of many companies of enduring value that were built very quickly. In fact, if you’re a FinTech that IPO’d <5 years after launch, I’d bet you're not enjoying being public right now. In our own portfolio, I can remember a time when each of now-public Bill.com and Marqeta struggled to raise capital and scale product-market fit. That’s just part of the journey.
So, as we look to the year ahead, let’s pause on the predictions for which recently public FinTech companies will get delisted, or when we think investment velocity will ‘return to normal’ (spoiler: this is the new normal). Instead, let’s focus on what we each need to do next.
For early-stage founders, keep calm, focus on ensuring you have enough cash runway to accomplish that critical next milestone that you think can unlock additional capital under market-reasonable assumptions. Growth-stage startup leaders should be focused on a path to breakeven, even if they end up deciding to raise more capital. You want to raise from a position of strength, and nothing shows strength to funders more than not NEEDING the capital to survive. If either of these paths doesn’t seem possible, figure that out as soon as possible and work with your existing investors to either add the needed capital “around the table”, make critical operational changes to extend runway, or find an M&A outcome that avoids a total wind down.
For investors, keep calm and focus on solutions rather than getting hung up on the problems that got us here. Work closely with founders, colleagues, and co-investors to identify constructive, fair and empathetic solutions. It’s rare that one investor will ‘save’ a company, but several working together often have a good chance to make an important difference. I assure you that founders will remember who stuck around and helped when times were tough, and those who disappeared or became combative. Remember that the mess isn't really a passing challenge we’re trying to overcome, but a permanent part of the startup investing business. Try to see the opportunity for personal growth, improving relationships, and the learnings that arise from overcoming adversity, so we all get better and better at what we do.
All opinions expressed by the writers are solely their current opinions and do not reflect the views of FinancialColumnist.com, TET Events.