Were There Signs Of A Slowdown In The FinTech Market Back In December 2019?

On Dec 2^nd, I wrote a column on Forbes.com asking the question, “What if the FinTech Market Slowed Down in 2020?” 

 I didn’t know the COVID-19 situation would happen and hold the economy and our freedom to move, at ransom.  All I knew was that the private market had followed the public equity market down a path of a 10-year bull run, and there were telltale signs of an overheated situation: record fund-raising, VCs falling over each bidding up valuations, and a gradual lowering of investment standards. So, I wrote a column asking two questions:

Are we prepared for a slowdown in the private market?

What would our game plan be, as investors or FinTech founders?

My goal was to urge all the players in the FinTech ecosystem: management teams, employees, investors, LPs in VCs, to start thinking and planning if the wheels came off the FinTech train. That’s all. A lot of us have the 2008 crisis seared in our memories. I was an analyst covering Capital Markets and Asset Management for TowerGroup at the time, and promised myself that the next time I would be vigilant for early signs of a market top and raise the alarm for clients and colleagues early, rather than late. The time to talk about a crisis was late 2007, not 2009. That’s why – this time around - I raised the question about a potential slowdown in the private market back in December 2019, when things were still going great. 

Let me share a few observations from that column that have become incredibly relevant for us today, as we consider the consequences of the current economic situation on the private FinTech market…

The Crucial Correlation Between Private and Public Markets

Points #1 and #3 in the above excerpt from my December column are especially important. Pay attention to them. #1 says that the Private Investment market is cyclical – ebullient periods are inevitably followed by contraction. It happened in 2000, and again in 2008. This time won’t be different. #3 says the private market responds to the public market with a lag, usually 4-6 months, according to the research of Professor Josh Lerner at Harvard Business School, a scholar, and authority on the PE and VC businesses. While we can see markets price the securities of public companies every day, we can’t see the current valuation of private companies. Is Stripe still valued at $33 Billion (Pitchbook, as of Sep 2019) when prospects for growth were strong? Or has its valuation contracted amidst the current economic environment? We simply don’t know…. It will take a few months for clarity about how valuations of private companies have changed, FinTechs included. The same goes for fundraising by VCs from their LPs, or the amount of investing in FinTechs. It will only become evident in a few months. Furthermore, the adjustment process is not linear, and happens in fits and starts which makes predicting key private market metrics very difficult. This exposes all participants in the private FinTech market to risk and opportunities which means all participants must be extra vigilant about shifting market conditions in the private market. There is no consumer sentiment monitor, no Bloomberg consensus earnings projection, that indicates conditions in the private FinTech market. 

Who switched the lights on (or is it off) during the party? 

 Chris’s quote from Ahoy Capital is tremendous! It captures the sentiment of all of us, how suddenly business conditions, the economy, the equity markets, have gone from record highs and low volatility, to incredible uncertainty and downright fear! All in four weeks. It’s almost as if someone snapped the lights on and we woke up with a jolt, wondering if the last four years of fundraising, investing, valuations, was all a dream. I’ve been in the business for 25 years and have been through multiple corrections and recessions in the market, but the swiftness of the shock has shaken me out of my saddle. 

How the Dominoes May Fall

How could the dominoes fall in the private market? What would be the sequence of events? Here’s what could happen if we study the lessons from 2000, and especially 2008. 

What’s happening already is that VCs and other investors have put on-hold almost all new investments for the next 30-45 days. Next, they are stress-testing their portfolios and considering what would happen if the virus-related shutdown continues for another 60 days with severe consequences for the economy. After that, they are quickly studying the income statement and balance sheets of individual companies they have invested in, to try and answer two important things: 1) how will the economic conditions impact the business performance of a company (sales, expenses, profits), and 2) how will the firm’s funding requirements change due to the new economic reality? 

Over the next 60 days, if we are still in a bear market, then institutional investors (e.g. LPs invested in Venture Capital companies) will look at their public/private portfolio allocations and be forced to address the over-allocation to private markets, as the public market portion of their portfolio would have shrunk while the private market portfolio will be held at book value. If enough investors try to liquidate their positions, it may drive down valuations for not just marginal players but force the sale of good assets as well. So, winners may experience collateral damage and be sold along with the losers.

Implications of a Downturn: Things to Consider

The last section of my column was a section of open-ended questions for investors (both LPs and GPs) and entrepreneurs, that I suggested they should be preparing themselves as if there was going to be a downturn. And those are exactly the questions the private market is facing today: 

·      How robust is an entrepreneur’s business model to withstand weaker business conditions? To what extent are your costs variable so you can ratchet them down as your sales decline? How long will your investors have the patience to support you? 

·      For investors, how well do you understand your LPs and their unique needs and circumstances? Will your LPs start liquidating private positions to get their private/public market allocations in line with their investment charter? 

And finally, here’s how the column closed….