2024 is likely to be a make-or-break year for venture-backed payments companies, with a more levelheaded funding climate potentially forcing some startups to make tough decisions.
During the frothy COVID-19 era, “unabated enthusiasm” for the sector resulted in inexperienced venture investors throwing gobs of money at payments firms built on little more than an idea, said Jordan McKee, research director at data and intelligence firm S&P Global Market Intelligence.
“We’re starting to see some of the consequences of that now,” McKee said.
Those fintechs, built for an era of fast growth and cheap capital, have faced the harsh realization that funding is in shorter supply, and they’ve scrambled to solidify a sustainable business model and product market fit, he said. Some have cut staffers, or shuttered operations in some markets.
Now, companies that put off fundraising over the past few years may find themselves at the end of the runway.
“There’s going to be a backlog of deals,” said Jeremy Jonker, co-founder and managing partner at San Francisco-based Infinity Ventures. “There may be not enough capital at the growth equity levels to be able to actually fund all these different startups.”
Investors are optimistic about what the year holds for earlier-stage companies and payments startups serving businesses. But consumer-focused payments companies and those further along in startup life cycles are more likely to struggle in the next year, they said.
Furthermore, oversaturated areas of payments, such as embedded finance or buy now, pay later, are ripe for consolidation, analysts have said.
Rasha Katabi, CEO of Canadian fintech Brim Financial, said she’s been approached by fellow startups seeking a buyer, wondering if her company could be in the market to make an acquisition.
Many struggling companies could be facing hard decisions, investors said. “There's going to be a lot of casualties of war,” Jonker said. “I don't think companies will be able to get funded and they’ll have to shut down.”
Last year’s slump
Last year was a dismal one for venture capital activity: In the U.S., payments companies raised $10.4 billion across 196 funding rounds, with Stripe’s $6.5 billion round in March of last year heavily influencing the funding total, according to a spokesperson for research firm CB Insights.
Globally, the payments industry tallied $14.1 billion in funding and 537 rounds, according to CB Insights’ 2023 State of Fintech report. Both counts dropped notably from 2022, and even that year was down from 2021’s peak.
Underscoring the notion that funding was more readily available to younger startups than later-stage companies, 2023 had the biggest share of early-stage funding rounds in the past five years, at 72%, CB Insights said.
Venture activity is likely to pick up this year compared to last, although it won’t look anything like 2020 and 2021, investors and CEOs said.
Previously, companies landed funding based on “me-too propositions,” which McKee described as “basically just copying the playbook of an existing company, and investors were so excited by the potential in the market that they didn't care.”
“They just wanted to place a bet and see where it would land,” he added.
Since then, multiple investors said the “fintech tourists” have fled, and founders and investors alike have taken a more pragmatic approach to funding. The industry has developed a better appreciation for what’s required to compete, and what realistic valuations look like, investors said.
Changes in 2024
“Business fundamentals are in,” McKee said. Operating efficiently, demonstrating product market fit and controlling burn rate are key. So is differentiation, he said. More than ever, investors are “really looking for that story around, what makes this business stand out from this very crowded pack?” McKee said.
As startups seek infusions of capital, investors are asking harder questions earlier, digging into the quality of leadership teams and zeroing in on problems startups are trying to solve. Profitable growth plans, too, are crucial.
Payments-as-a-service startup Rainforest, which raised $8.5 million in seed funding last year, was asked repeatedly about its core technology as investors sought to determine whether the company was “just a wrapper around another payment processor,” noted Joshua Silver, founder and CEO of the Atlanta-based company.
“Good quality companies will continue to be able to raise capital unimpeded, and some of those companies that were just wrappers or didn't have maybe as much in the way of core intellectual property, or not as big of a market, or not as solid a team, may continue to struggle,” Silver said.
Downturns tend to produce strong companies, so startups that make it through this time period are well-positioned, investors said. “This market right now is going to be one of the best vintages that we’ll see for the next couple decades,” said Drew Glover, general partner at venture capital firm Fiat Ventures. “There’s a different doggedness in the DNA of a lot of these founders.”
Payabli, a payment platform for software companies, raised $8 million in December 2022. Co-CEO Joseph Elias Phillips said the startup was able to do that because it had developed products, tapping limited capital, and because it had paying customers.
At the moment, companies are trying to get to market as quickly as possible and start generating revenue, said Phillips, also a co-founder of the startup.
Despite the more challenging fundraising environment, investors are keenly interested in business-to-business focused payments plays, given so much of the B2B market remains ripe for digitization.
Cross-border payment plays also continue to be appealing to investors, as plenty of friction remains in those payments. Startups with real-time or account-to-account payments propositions; those focused on addressing fraud or compliance; or those building bespoke payment solutions for specific industries not necessarily served by major payments companies remain top areas of interest for investors.
Funding activity expectations
Investors and analysts generally expect funding activity to pick up as 2024 continues. That’s because so many startups are starved for capital and investment firms have raised large amounts of money.
The industry can continue to expect more normal-sized funding rounds, and a focus on fundamental investing rather than momentum investing, investors said.
“People are generally acting more rational around their cash needs,” raising what they need to “instead of what everyone's willing to throw at them,” said Eric Kaplan, a fintech investor at Bessemer Venture Partners.
Until the fundraising picture becomes clearer, payments startups may continue to pursue alternative paths to fundraising, including relying on venture debt or returning to past investors for a flat funding round. For example, earned wage access company DailyPay this month raised $75 million in equity funding from existing and new investors, supplemented by $100 million in debt financing from Citibank.
Merger and acquisition activity in the payments industry is also projected to rev up, and may influence venture round activity this year.
“When you see M&A activity start to ramp up, that gives investors greater confidence that exit opportunities are increasing, and perhaps it increases their appetite to place larger bets or more bets on fintech companies,” McKee said.
Failed acquisitions can have implications, too. The collapse of the Adobe-Figma deal, scuttled in December, was not only negative for the overall venture sentiment, but it also meant $20 billion in capital wasn’t returned to investors to direct at new investments, Jonker noted.
On a related note, initial public offerings in payments may not pick up until the second half of the year.
Marketing automation company Klaviyo was “the shining star” of software services companies, “and the public market response has been kind of middling” since its September IPO, Kaplan said.
Digital payments company Stripe or Swedish buy now, pay later provider Klarna could be first movers. Glover expects companies such as Stripe and fintech Plaid are looking for “at least one to two quarters of good trends” in the public markets before they will go public. Plaid is said to be considering a possible IPO following a scuttled agreement to be acquired by Visa.
A successful IPO could spark a wave of activity because investors have more confidence that they’re going to see an exit, McKee said. “Nobody wants to test the waters,” but once a company does, “everybody is going to be looking at the market’s reception,” McKee said.