Signals Q2’23: Every fintech will be an AI company

Hey Fintech Friends,

What better way to ring in Q3 than with a recap of what fintechs have been up to over the past quarter?

For new readers, Signals is the premium subscriber edition of TWIF designed to get you away from the headlines and to explore the larger trendlines. Each quarter, we break down four key questions on fintech activity:

If you haven’t already, subscribe to future editions here!

Fintechs raised a total of $4.925 billion in Q2, a 59% decrease from the prior quarter. The number of rounds raised was down 11%, and rounds shrank 54% in average size* compared to Q1.

Public markets, meanwhile, signaled that weakening appetite for fintech investments may be at its trough. Valuation multiples in F-Prime’s Fintech Index have normalized to around 4x EV/revenue– a steep drop from highs of 21.7x in 2020, but this hasn’t stopped public fintechs’ market caps from surging by 104% (beating the NASDAQ nearly five-fold):

Even as valuation multiples stay down, fintechs' revenues are still healthy; revenues in the Fintech Index are on average growing 35% YoY.

Let’s dive into fintech activity in Q2. 

Venture funds struggling to raise fresh funding has left VCs with the lowest levels of capital seen since 2017, which... doesn't paint a great outlook for fintech funding in the near future. 

This didn’t stop capital from flowing across all fintech concepts in Q2. Areas that received the most funding were:

A few concepts received notable funding, including:

Employee benefits led acquisition activity, with FinFit and Salary Finance US’s merger and Origin’s acquisition of Finny​​ consolidating financial wellness offerings; Employee Navigator acquiring fellow employee benefits platform Ease; Nordic bank Nordea acquiring Swedish pension broker Advinans; OneDigital Investment Advisors taking over Huntington National Bank's 401k unit, and Netchex’s sale to PE fund GrowthCurve Capital.

In consumer digital banking, Greenwood acquired Kinly, a neobank similarly focused on serving Black and Latinx communities; Robinhood nabbed credit card platform X1 (as it laid off another 7% of its workforce), and Acorns’ purchase of personal finance app GoHenry paves the way for its expansion into the UK & Europe.

Nasdaq’s purchase of investment infrastructure platform Adenza from Thoma Bravo for $10.5B (!) marks their biggest acquisition to date.

Venture funds are feeling the squeeze amid shrinking deal sizes, a lull in successful exits, and higher interest rates luring LPs away from venture allocations. Luckily, fintech investors prevail:

It’s worth noting that scarce funding environments tend to have an outsize impact on minority entrepreneurs as we saw in 2022, when venture investments declined by 36% overall but dropped 45% for Black founders.

Aggregated risk data solutions abounded: Taktile released a Data Marketplace to power lending decisions, while Plaid Beacon and SardineX’s industry data consortiums emerged to power real-time fraud insights across fintechs and financial institutions.

In B2C payments, virtually every smartphone is now a POS terminal as Apple and Android gradually open their phones’ NFC readers to more payment processors– most recently, PayPal, Venmo, Square, Clover, CaixaBank, and Mollie’s new (!!) POS suite.

Expense management is more automated than ever, as underscored by the launch of Brex Empower, Navan’s expense management cards, Payable’s automated reconciliation, Modern Treasury’s expanded Reconciliation Engine, and Vault’s launch in Canada.

Stripe is bringing B2B payments to online meetings via merchant payment acceptance in Google Calendar and Microsoft Teams.

One segment that’s raised more funding QoQ despite the headwinds: Business financial management.

In Q2, business financial management platforms (e.g. accounting, expense management, tax automation…) on average closed 149% more funding than in the prior quarter. If venture dollars are drying up for most other startups, how did business financial management platforms (BFMs) manage to play the Uno Reverse Card?

BFMs are benefitting from two big drivers right now. For one, recurring revenues from B2B SaaS contracts appeal more to investors in times of economic uncertainty. B2B SaaS fintechs can also expand horizontally (redeploy in new industries) and vertically (add new financial services) fairly easily, so there’s lots of room to diversify revenues here. 

The second (more topical) driver for business financial management platforms is their unique position to deploy AI ahead of most other fintech segments. Implementing AI presents regulatory risks for any company, but these risks are generally lower for B2B SaaS platforms than for, say, consumer lenders. This gives BFMs room to capitalize on the spike in AI funding and pitch investors on their own AI upside. In fact, every business financial management platform in our dataset that raised last quarter and mentioned using “AI” closed an equal or greater amount of funding than they did the round prior. On average, these companies raised 116% more funding in these most recent rounds– a major feat in this economy.

A lot of BFMs didn’t necessarily need to be actively using AI to reap the potential benefits here. Certain BFMs with no track record in AI mentioned in their press releases that they plan to explore adding AI down the road, so it seems like for fundraising purposes, being Excited to Explore Using AI in the Future™ can be pretty much on par with actually doing AI.

This isn’t to say that BFMs are raising more funding than they should; rather, there’s a lot of potential upside in giving leading platforms a first-mover advantage in technologies that scale this quickly. AI can be a powerful tool for ingesting data from different sources, contextualizing its meaning, surfacing insights in real-time, engaging with customers, and other processes that will be critical for any platform to differentiate itself on.

It will take a while for fintechs to realize AI’s potential in offering services like banking or tax accounting given how much fine-tuning new models will need to be compliant in these industries. For the time being, those of us outside of business financial management may want to keep an eye on this cohort of fintech canaries as they foray into the proverbial AI coal mine.