Among the many “prediction” pieces written over the last few weeks the suggestion that there will be an increase in mergers and acquisitions (M&A) in the fintech industry in 2023 has been prevalent.
Techcrunch pointed to the likelihood of consolidation among smaller neobanks, Sifted’s roundup of industry experts’ opinions featured two foretelling more mergers and acquisitions, and Verdict’s piece contained no fewer than four perspectives agreeing with the sentiment.
The general consensus appears to be that the macroeconomic environment, i.e. higher interest rates, more cautious VC activity and widespread deceleration in growth or full-blown recession, will result in fintechs looking for a speedy exit. In turn, that will result in companies’ increased willingness to merge with, or be acquired by, larger peers — as opposed to the more popular options over the last few years which were raising funds to fuel growth, or a public exit.
In which segments is M&A activity most likely?
The obvious candidates are: Banking-as-a-Service (BaaS), Buy-Now-Pay-Later (BNPL) and Neobanking, and here’s why.
Many have bought into the idea that “every company will be a fintech company”, a concept facilitated by BaaS which, in short, enables banking license holders to white-label their core products and have them distributed by third parties. A classic example of this is Apple’s
On top of the basic premise of BaaS, a whole industry has sprung up with companies offering ever more specific parts of the value chain, from individual products e.g. lending, credit cards and payments, to key operations such as user interface and compliance specialists.
This has resulted in a very, very, very, crowded BaaS market, with potential buyers left struggling to understand what each supplier is offering, where they overlap, and to a certain extent, what BaaS actually means. We’re already seeing companies react to that, as more established providers expand across the value chain in order to offer holistic services and make them a more obvious choice for confused potential customers — Marqeta has expanded from card issuing and processing into broader banking services, for example.
Marqeta built the additional functionality itself, but there will be others of a similar scale, and larger, that want to boost their offerings quickly and for them, acquisition of smaller, more niche players is an obvious choice.
Other companies, which don’t have the capacity to expand, will find themselves struggling to stand out in a crowded market and with funding to expand runway increasingly hard to come by, will provide the supply side of the equation. One example of this has already come to light, as European Railsr — an early market entrant — is reportedly up for sale amid financial woes.
There is also the fact that regulation for the BaaS space is coming soon in the US, and there will be some companies which just can’t cope with the compliance burden — making them more willing to look for an exit.
The BNPL market is similarly crowded, and to be fair a certain amount of consolidation has already happened — Australian incumbent AfterPay was acquired by Square, while smaller providers are increasingly seeking to join forces or pulling out of international markets, notably the UK.
The next phase of the segment’s evolution will likely see these trends accelerated as banks either build their own solutions, increasing competition in the market, or look to buy a solution in order to launch an offering at speed.
At the same time, BNPL providers’ business models will be tested as recession bites and more customers, with less ability to pay, turn to instalment payments as a way of trying to make their funds go further. This consumer behaviour has already been noted in the UK, with data from fintech Snoop showing the use of BNPL is up across all age groups while the number of people finding themselves unable to pay bills is also rising.
Further pressure on BNPL companies is coming from regulators, especially in the UK, as warnings about the need for customer protection, clearer terms and conditions, and reporting to credit bureaus solidify into legislation. That’s a double edged sword, with providers having to find the resources to ensure compliance, while also being restricted in the ways in which they can make up repayment shortfall because of the frowning upon of late fees by authorities.
The result will be a fintech segment that looks very different in 2024, with fewer fintech players and a wider variety of instalment payment options.
It’s a truth universally acknowledged that there are too many digital-only banks, especially across Europe and the US, and yet new ones keep appearing. This is interesting in a market where numerous earlier entrants — Dozens (UK), Xinja (Australia), Volt (Australia), Glorifi (US) to name just a few — have already folded, and even Goldman Sachs’ digital-only retail offering, Marcus, hasn’t turned out to be the digital pioneer the bank had hoped.
As we enter the new year, and the changed economic environment, it’s likely we will see more of the closures and fewer of the newcomers. That’s because running a bank is expensive, far more expensive than most other types of fintech — especially if you have a banking license and are subject to capital requirements. Even if you don’t, unless you are a lender, making money is difficult.
In Europe, consumers aren’t used to paying for banking services, and the startups that have tried to change that behaviour have struggled. Interchange is also capped in the region, reducing companies’ ability to make money from transaction fees, and while this is not the case in the US, making interchange a valid source of revenue there, too many startups have relied too heavily upon it.
Even for those that do lend, difficult times are coming — as noted above, underwriting models from new market entrants are going to be tested, while those that don’t have access to cheap capital (i.e. deposits), will struggle to find funds to distribute to customers.
The result will be more closures certainly, but also increased M&A, particularly from incumbent banks looking to leverage brands that have successfully acquired customers, as well as for modern technology stacks that can support stand alone offerings. Acquihires are also likely — banks are on the lookout for talent, and as the fintech industry wobbles, there will be people who seek the relative safety of working for a large bank amid cost of living crises.
M&A across the board
These are the largest, and most obvious, segments where increased M&A will occur over the next 12 months but it will touch on companies in all areas. Large banks should start preparing a shopping list, if they haven’t already, but also think long and hard about how they are going to support a fintech partnership or acquisition in order to make a success of it — there are many examples of failure.
Larger fintechs and technology providers, meanwhile, are likely to have a better idea of how to incorporate a peer or competitor into their organisation, but again, should be wary of trying to force square pegs into round holes.