The Alchemy of FinTech Valuations
By Ansaf Kareem
INTRODUCTION
It’s been no secret that FinTech has been one of the hottest sectors over the past few years, and one of the greatest beneficiaries of the capital that fled into the tech ecosystem over the last cycle.
FinTech venture investments in the sector aggregated to over $350B in the last 5 years alone. In addition to dollars flowing to the sector, we’ve also witnessed companies reaching meaningful scale with over 312 FinTech companies reaching Unicorn status.
However, with the downturn in the public and private tech sectors, FinTech has not been immune. Number of investments made in 2022 were nearly half of the number made in 2021, with Q4 2022 marking the slowest quarter in fintech funding since 2018.
Despite the increased attention and maturation of FinTech private companies, there has been little conversation on exits. Where did the market go wrong in valuing these assets? Can FinTech companies trade like software assets? Or do they trade like legacy financial institutions? Do they have as many strategic buyers as traditional SaaS companies or do they attract a different kind of buyer?
With the Stripe IPO on the horizon as a potential vanguard for breaking the IPO window, FinTech performance will likely be back under the magnifying glass. The top 10 FinTech unicorns also have over $270B of combined private value, which will likely need an exit valve in the near future. This backlog of companies will start to get pressure to assess IPO/M&A opportunities or will have to consider raising financings at new/suppressed valuations. Additionally, given the glut of investment over the last few years in the sectors, many early and growth stage companies will be raising capital in the next 12–24 months in an environment that looks very different than 2020 and 2021. Both founders and investors will have to assess how to value these companies in a new normal. Below are a few key ways I’ve thought about understanding how to value FinTech companies.
YOUR SUBSECTOR IS ALSO YOUR STRATEGY
Some of the most common mistakes I’ve witnessed have been in the mischaracterization of business models. That may have worked in 2020 and 2021 — but there is a much harsher lens placed on fintech in the public markets today.
For example, in the last few years, I often heard both founders and investors describe transactional revenue to be like subscription revenue because their “customer behavior is highly predictable”. Interchange or transaction-based businesses are highly exposed to consumer behavior shifts, especially in downtowns compared to annual subscription plans which have a laggard effect in downturns. But more importantly, the public markets will certainly not treat the two the same.
Similarly, I’ve seen many banking companies describe their companies as software companies either because of the business model (subscription elements) or because they sit on top of a partner financial institution and thus “only provide software”. However, public markets will not value these companies like software. Chase does not argue that its products are also subscription via their monthly maintenance fee. If you pay $12/month to access a bank account primarily digitally, can you call yourself a SaaS company? I’m pretty sure Jamie Dimon would argue that isn’t the case.
THE BIG BANK IS NOT YOUR COMP
Another complexity that arises in fintech investing is the lack of easy comps — in some cases, it may be easier to compare a startup with an incumbent for easy comps (e.g., Ramp to American Express, Robinhood to E-Trade) given the similarities in models, but in reality, incumbent financial services companies do not provide great 1:1 comparable to many newer startup models. If we go back to the Chase example, Chase drives significant revenue from areas like trading, commercial lending, and wealth management — very different from a Chime or a Nubank.
Fintech was too easily categorized as a monolith in preceding years, primarily by venture investors, despite subsectors trading on a variety of different valuation metrics in the public markets.
FINTECH IS NOT A MONOLITH
A lot of what has driven complexity in FinTech valuations is that private markets often treated revenue across multiple sectors as a monolith, frequently placing an EV/Revenue multiple on the business. This was simply an extension of what they were used to doing for their enterprise software assets. For software businesses, given the similarity of most SaaS models, revenue multiples tend to crowd around an average (these days, 6x NTM — but at its peak upwards of 20x+ NTM). If you look at the BVP Cloud Index (as of 2/14/23), the Top-Quartile and Median NTM revenue multiple is ~8x and ~6x respectively — a reasonably narrow band. But FinTech cannot be assessed the same way. Within Fintech, there is a massive difference between software assets, payments, banking and infrastructure business models.
Further exasperating the problem of valuations in FinTech is the comparative dearth of public exits in the space. If you look at the last 10 FinTech companies to go public in the US, there is a highly varied list of business models: from Nubank (NYSE: NU, neobanking) and Nerdwallet (NASDAQ: NRDS, affiliate marketing) to Avid Exchange (NASDAQ: AVDX, SaaS) and Remitly (NASDAQ: RELY, payments). All “FinTechs”, but completely different businesses. You have companies trading at ~1.4x NTM like Nerdwallet (NASDAQ: NRDS) and Stronghold Digital Mining (NASDAQ: SDIG) to 8.5x EV /NTM Rev and 10.2x EV / NTM Rev respectively for companies like EngageSmart (NYSE: ESMT) and Clearwater Analytics (NYSE: CWAN) that offer a SaaS model for their products.
So what does this mean for entrepreneurs? As you build your company or are nearing a potential exit, make sure you are clearly defining which subsector you fall into within fintech and understand your closest public comp set. How do your company’s metrics trade compared to that public comp? For instance, if you are a neobank, using Avid Exchange or Bill.com as a comp set will not be effective long term.
Below you will find a broad summary of fintech sectors, the closest public comps, the key metrics to pay attention to, and where multiples are today. My hope is that it gives entrepreneurs a better benchmark to work off of when scaling their businesses.
- Banking: Banks at maturity are generally traded off of Price to Book Value versus a revenue multiple. If we look at Nubank as a best in class neobank example, we see its P/BV multiple at 4.8x. Compare this to MoneyLion at 0.8x P/BV. As a reference, most traditional banks trade at 1–2x P/BV (JPM — 2.0x; BofA — 1.6x; Citi — 0.6x).
So why does Nubank derive a substantially higher P/BV ratio?
The easy answer is because it’s growing faster — and that is part of the equation. In this case, a company like Nubank derives a higher P/BV ratio also because it is more efficient in generating value off its asset base, driven by its focus on credit card/lending versus pure deposit/interchange focused neobanks. Furthermore, neobanks with limited balance sheets due to partner bank agreements may see discounts on P/BV in the future since their net assets may not include their partner bank agreements. Strategically for founders, this may inform how they consider expanding their business model over time and consider how to manage their balance sheet.
But how do you price a private asset that can’t yet calculate P / BV? For startups who are not yet able to calculate P / BV, another way to consider valuing the company is off of Gross Profit / Customer relative to the overall Deposit base. Gross Profit / Customer provides insight into the strength of the customer and how efficiently the neobank can get a return on this customer. For Nubank, its GP / Active Customer is 31.4x with a deposit base of $15.8B (based on FY 2022). For MoneyLion, its GP / Total Customer is 31.5x (for FY 2021 due to lack of Q4 2022 reporting). Interestingly, both companies demonstrate a similar GP / Customer multiple, but Nubank witnesses a much larger overall valuation due to 1) its immense customer base and scale — ~$1.5B+ of GP on ~50M+ customers; 2) the fast growth rate of these over time versus MoneyLion (whose growth has decreased and revenue has also diversified away to B2B revenue streams that are different than a traditional bank, e.g., affiliate marketing).
Many other factors may also contribute to the strength of a neobank’s valuation including overall TPV and non-interest income, non-performing loans for lending focused companies, and overall growth rates of deposit accounts, but the above multiples can provide a generalized insight into the valuation potential of a neobank. If you are a private neobank — your key driver should be how to derive gross profit from a fast growing and active customer base (GP / Active Customer).
2. B2B SaaS: SaaS Multiples are the easiest to understand in this environment. FinTech software companies are generally traded as an EV / NTM Rev multiple, similar to other SaaS companies, and thus a revenue multiple is warranted. Bill.com is a good example of a strong performing FinTech software company receiving an 8.2x EV / NTM rev multiple. Top tier SaaS multiples are driven by high revenue growth (e.g. ~40%+) while showcasing profitability (e.g., exceeding Rule of 40). As a private company, you can look to target a ~6x EV / NTM Rev multiple in this market at maturity by focusing primarily on your growth rate and profitability/efficiency.
3. InsurTech: Similar to banking companies, Insurtech companies are valued off Price / Book Value. Lemonade as an example is trading at ~1.3x P / BV while Root Insurance is trading at ~0.3x P / BV. For reference, most insurance companies trade between 1–2x P / BV.
InsurTech companies, similar to Neobanks, can be tough to value due to their frequent MGA status where they will acquire and underwrite on behalf of an insurance carrier. In this case, much of the premium will actually be passed on to the partner insurance carrier while InsurTech receives a commission for these services (e.g., Lemonade’s agreement passes along ~75% to their partner carrier).
In this case, to help provide credit for the value driver of the business (premiums), one way to examine InsurTechs would be through the lens of EV / Gross Earned Premium. In the case of Lemonade and Root, this would lead to a 1.98x multiple and 0.18x multiple respectively (annualizing gross earned premium for Q322 (last reported) and using market cap instead of enterprise value in this example). In this case, Lemonade’s stronger growth rate versus Root’s decreasing growth rate in earned premiums also drives a differential in their multiples. Other key metrics to watch out for in InsurTech include loss ratios (ideally 40–60%) over time and acquisition costs given the heavy distribution angle. If you’re a private InsurTech business, growing earned premiums consistently while managing your loss ratios are key to driving strong valuations in the public market (EV / Gross Earned Premium).
4. PropTech: PropTech is perhaps one of the most disparate subsectors within fintech given the various models within the space, from iBuying like OpenDoor to Zillow which combines multiple revenue streams from advertising, lead generation, and even iBuying and SaaS tooling. Given the variance in business model, the easiest way to compare apples to apples would likely be an EV / Sales or EV / EBITDA multiple where available (5.1x EV / NTM Rev for Zillow; 0.7x EV / NTM Rev for OpenDoor).
For private proptech businesses, understanding your EV / Sales multiple will be helpful but you will likely need to also identify more company specific variables (e.g., gross profit / home) in attempting to unpack an appropriate multiple.
5. Payments: Payment companies are frequently valued at EV / NTM EBITDA. Observing Adyen and PayPal, you can see Adyen obtain a ~41x multiple vs PayPal at a ~12x multiple. The market likely gives Adyen credit for its continued fast growth rate and B2B model (i.e. less sensitive to consumer demand like PayPal). However, to take into account relevant reach, a multiple of Total Processing Value / Enterprise Value could help take into account the scale of a business given payments businesses are ultimately driven by volume. In this case, we see some more grouping with Adyen at 18.2 TPV / EV and PayPal at 11.1 TPV / EV, with Adyen getting a higher multiple due to its larger growth rate. For private companies, consistently demonstrating the scale and reach of TPV will help drive value in your business (Total Processing Volume / EV).
6. WealthTech: Wealthtech companies can be looked at through the lens of AUM. If you take Robinhood and Charles Schwab, we can see that AUM / EV gets us 7x and 5x respectively, despite Charles Schwab having a much larger scale likely due to Robinhood’s growth potential. However, if we look at the companies through the lens of AUM / Active User, a much clearer picture emerges as we see that Charles Schwab maintains $22K / Active User vs $5.4K / Active User at Robinhood. In this case, we see that Charles Schwab’s ability to monetize its client base is much higher, likely giving it a higher valuation advantage. As a private company, focus on how much you are driving from each active user as a good barometer of how you will do in the public markets (AUM / Active User).
7. Infrastructure: Given the maturity of infrastructure companies, such as Jack Henry and Fiserv, and their lower margin profile (versus traditional software offerings), examining these companies through the lens of EV / EBITDA (or EV / GP for startups) is likely the right multiple. In the two examples, Jack Henry and Fiserv trade at a healthy 18.5x and 12.2x multiple respectively, with the market rewarding efficiency and limited competition. If you’re a private business and don’t have gross profit, focusing on a EV / Sales multiple can be directionally informative if coupled with a focus on gross margin profile.
8. LeadGen: Majority of companies who fall into this category, such as NerdWallet and LendingTree, primarily base their revenue off of revenue based on affiliate leads. Thus, EV / EBITDA or EV / GP is an apt measure for these types of companies given the lack of variation and focus on take-rates and volume as a driver of value. If you’re a private business and don’t yet have gross profit, you can examine other core metrics that drive revenue in LeadGen businesses: conversation rates, take rates, and price / lead.
STILL VALUE ACCRETIVE
Despite the valuation complexities, there is no bigger sector in the United States than fintech and much of the sector is still dominated by extreme legacy incumbents. We are also starting to get an impressive glimpse at the type of scale mature FinTechs can operate at given their market opportunity. For example, NuBank which went public in 2021 is continuing to grow steadily and nearing the scale of America’s biggest bank with over 57M active customers, or Stripe has likely exceeded over $400B of annual processing volume.
We are still in the early days of the innovation cycle in financial services with lots of newer tailwinds, such as federally regulated digital money as well as advances at the intersection of AI and financial services, that will continue to create new opportunities in the space. Understanding and clearly defining the subsector within fintech in which you’re operating in will help inform the strategic investments and product decisions you may need to make as you look to maximize the health and long-term value of your company.
