- From lending to payment solutions to wealth management, applications of fintech have spread across sectors.
- As the business of fintech companies grows, funds are required to facilitate operational and geographical expansion programs.
- As budding fintechs are similar in nature as start-ups, companies have very less tangible assets and less operating history, thus securing debt financing without collateral becomes difficult.
- Share purchase plans or institutional financing or convertible loans become the most preferred sources of funding for the fintechs.
Fintech is nothing but the amalgamation of technology in the financial sector. The word and the companies classified as fintech have been creating a lot of buzz recently. However, the concept dates back to the mid of 19th century when the first cable was laid, connecting New York and London. Then came Fedwire, the first electronic fund transfer in 1918.
Since then, the world has travelled long with financial technological advancements continuing to ease our life with novel services. From lending to payment solutions to wealth management, applications of fintech have spread across sectors including non-profit sector where players such as Pushpay Holdings Limited (ASX:PPH) are facilitating electronic donations amid the pandemic scenario.
Why Fintech requires funding?
The initial days of fintech companies start with giving a technological shape to the service they want to offer. This process takes considerable time, as it requires proper designing, coding, and building the platform and then testing the same in phases till it reaches a stage where mass adoption of the platform can be initiated with a market launch.
This process requires physical infrastructure, maintaining people who have technical skills to build the platform, supporting staff, execution tools and workable environment to operate efficiently. The financial industry is also extremely regulated, adding complexity to the process.
The process is time consuming and may go up to 2 to 3 years before the product is set for a mass market launch. The company is also required to spend on sales and marketing to create awareness and secure clients.
To facilitate such undertakings, the business requires funding, which can be derived through debt, bank facilities, institutional funding, equity raising, etc., depending upon the stage of the company and who are willing to fund a fintech.
Types of Funding
Equity funding refers to capital raising by a firm via issuing shares to investors and thus providing the investor an ownership of a stake in the business. The company has relatively less liability when it comes to equity funding, however the cost of fund is very high. If a company goes bankrupt, shareholders are the last to be paid after all creditors including company staff and suppliers are fully paid back.
Debt comprises every type of borrowings by a company. The lender has no stake in the business and charges an interest for lending the money. Debt is most of the time given against a collateral including assets as they are more secured in nature for the lender. Unsecured debt funding is also considered.
Lending institutions such as banks prefer not to risk their funds in companies with less operating history and/or little tangible assets without any form of security from entity or directors. However, debt funding is preferred by companies as ownership does not get diluted.
Convertible loan note is a midway borrowing involving equity and debt, which is usually unsecured in nature. While the amount borrowed will stay as outstanding as a loan, it is a debt that gets converted into shares in future.
Institutional Funding Wins the Race
It has been observed that the primary source of funding for fintech sector players remains private funding or institutional funding. Individuals, venture capital bodies or lending institutions primarily comprise of private or institutional funding. Listed fintech companies raise funds through share purchase plans or institutional financing or through convertible loans. As the companies have very less tangible assets and have less trading history, securing debt financing becomes little difficult.
Investment and Lifecycle of the Company
At the initial stages, fintechs generally put their own capital or borrow capital from family and friends. The companies also secure funding from high net worth individuals known as angel investors to support the growth of the company at the initial phase. These early investments through angel funding are known as "seed investments". At initial stages, the investors may offer convertible loan notes, which get converted to loan notes as business progresses.
Venture Capital Funds
An initial investment from venture capital firm is known as "series A investment" where the VC fund receives a minority stake in the company and receives preferred shares.
PE and IPO
As the company grows, funds are required to facilitate operational and geographical expansion programs. With hefty amount required, a fintech firm at this level generally receives money from private equity firms and eventually prefer raising money through an IPO. Post IPO, fintechs generally, raise funds through share purchase plans or institutional financing.
Several fintech sector players are listed on ASX including Sezzle, Zip and investors’ darling Afterpay that have experienced strong growth in the last few months. The sector players have benefitted massively through a shift towards online shopping amid the pandemic. To support further growth, several sector players have also recently raised capital.
There is no investor left unperturbed with the ongoing trade conflicts between US-China and the devastating bushfire in Australia.
Are you wondering if the year 2020 might not have taken the right start? Dividend stocks could be the answer to that question.
As interest rates in Australia are already at record low levels, find out which dividend stocks are viewed as the most attractive investment opportunity in the current scenario in our report.