EXCLUSIVE: “Looking for the…” – Freddie Lower, Cazenove Capital in ‘The Fintech Magazine’
Freddie Lower from Cazenove Capital holds founders’ hands as they head to the door. So, what’s the role of the wealth manager in an exit and how do you say goodbye?
Following poor market conditions, confidence in IPOs as a meaningful exit strategy is lower than ever. Many startup founders, including those in the fintech ecosystem, are looking elsewhere for a deal – but it might not be the one they’d hoped for. Funding deals for fintech during the first quarter of 2023 dropped by 42 per cent when compared with May 2022. And whilst activity surpassed 2020 levels, the slowdown during the latter half of 2022 appears to be continuing.
A Q1 report from Dealroom says Unicorn creation dropped from an average of 40 per quarter, to just three in 2023. Investment in UK fintech from private equity and venture capital firms also fell by 56 per cent in 2022 to $17.4billion compared with $39billion the previous year, according to KPMG.
That’s not to say there isn’t money in those firms but rather the fintech sector is perhaps not the darling it once was and has fallen behind the deeptech and climatetech sectors, which have both seen more of that cash this year. This lack of funding has exposed some fintech startups to a starker reality, with the future uncertain and insolvency becoming more common.
This has mainly been the plight of consumer fintechs, although the fire sale of B2B banking-as-a-service platform Railsr in March 2023 showed that even a market leader in embedded finance can be taken down by a lack of profitability. Ultimately, all startups face this threat in an uncertain economy and where once they may have looked to funding to achieve rapid growth, there are now less options available.
Meanwhile, founders wanting to sell and make a clean getaway may have to be patient. Freddie Lower, portfolio director at the UK’s Cazenove Capital has some unique insights into the situation, from the perspective of someone managing the wealth of current and former founders, typically, those who are planning for, or have been the beneficiaries of, a midmarket private equity buyout.
Cazenove Capital often starts working with founders a year or two before they sell, helping them to plan for the exit and what comes next. But Lower contends that the choice of departure routes is gradually narrowing.
“There are three routes to exiting your business,” he says. “Firstly, IPO; secondly, selling to a private equity via a buyout; or thirdly, selling to a strategic buyer – another larger business in that sector. IPOs have really been eliminated as an exit strategy because it’s a terrible market in which to take a company public.”
Indeed, EY reported that the global IPO market had fallen by eight per cent in the first quarter of 2023, with proceeds down by 61 per cent, year on year.
“It all started at the beginning of 2022, when inflation started to get out of hand,” says Lower. “Central banks started to raise interest rates to try to cool down the economy. The problem with that scenario, for fintech startups that are not as yet profitable, is their entire valuation is predicated on the present value of future profits.
“When you work out what a company is worth, you look at their earnings and their future profits, and then apply a discount factor of what that’s worth today,” says Lower. “In an environment where interest rates have gone up, a future pound of profit is worth less today, as you can get more money, risk-free, on cash in the bank.”
Lower says that most startup founders by now will have been put off by the idea of going public if they want a valuation anywhere close to what they’d hoped. The market uncertainty has affected ’growth businesses’ – startups and early-stage businesses – but we have als seen it affect larger banks such as SVB and Credit Suisse, which is a worrying sign of the times.
“Both of these organisations invested in long-term assets, the value of which changed quite dramatically,” says Lower. “Ultimately, they both experienced a sort of old-fashioned bank-run scenario.”
MERGING, ACQUIRING AND STEADYING THE SHIP
This is all resulting in VCs’ increased reluctance to invest in potential and focus instead on certainty, with an increase in mergers and acquisitions taking place. A recent White & Case paper pointed out some key drivers of this, including the struggle to achieve growth and investors taking advantage of lower valuations.
The paper also outlined six sub-sectors that it tipped will be in particular demand and therefore command greater attention from investors, namely open banking, neobanks, regtech, greentech, paytechs and digital currencies.Lower’s own experience over the past year has been ‘seeing larger businesses looking to bolt on new capabilities or buy an existing book of businesses, and private equity houses looking for a larger number of smaller deals instead of acquiring big platform companies’.
That has resulted in a higher volume of transactions. So, there is still plenty of money in the market and deals are being made, but it’s harder to persuade investors to part with their cash.
For a founder that means the deal they seek may not be quite as lucrative as they had hoped and so it’s unlikely to be the overnight solution for those who want out.
“IPOs have really been eliminated as an exit strategy, because it’s a terrible market in which to take a company public”
“A lot of dry powder has been raised by these private equity businesses, so there’s still going to be a competitive group of buyers, but mainly they’ll be looking at smaller companies,” says Lower. “If I were a late-stage venture capital fund, or a growth fund, I’d be excited about the current market opportunity, because valuations have undoubtedly come down, and there are going to be some really good opportunities out there.”
For those founders that themselves have money to deploy, merger and acquisition presents an enticing opportunity that may not previously have been a part of a startup’s strategy, but which could help fast-track growth and bring that exit forward.
“There are companies out there that have cash on their balance sheet, either because they’re high quality, or because they raised a round in 2020/2021, and have money to deploy, or they might be backed by a private equity sponsor who’s giving them rein to go and acquire businesses,” says Lower.
“We’re certainly seeing some companies where M&A wasn’t necessarily part of their strategy, now thinking about how they can go out and either acquire a strategic capability, or technical expertise, or a book of business, to help them grow their company.”
The acquisition of UK fintech GoHenry by US-based unicorn Acorns demonstrated how two younger companies, both not yet profitable, could consolidate their lead by one acquiring its peer and providing both companies with access to new territories. A challenger might, on the other hand, be picked off by a larger incumbent, although that’s not always a clean break for the founder. Aviva swooped to buy a majority stake in Wealthify in 2018, but it was two years before it was fully acquired at which point its founder left.
NatWest announced it was to acquire an 85 per cent stake in workplace pension and savings startup Cushon for £144million this year – with 15 per cent retained by Cushon management, including co-founder Ben Pollard who continues as Cushon’s CEO. Lower acknowledges there are fintechs in a good place, either achieving or approaching profitability, making them ripe for investment. But for a lot of other companies, there may be a longer road ahead – smaller fintech companies who will need to raise yet another funding round before any meaningful exit.
“And that’s a challenge in this environment,” says Lower. “If you do manage to achieve that – well done. But if you don’t, there is a risk that your cash burn becomes too much to deal with, or that you end up raising a highly structured round, with lots of preference shares. “So, ultimately, failing to raise a round may lead to an exit, but it’s perhaps not the exit you would’ve wanted.” In which case, his advice is ‘sit tight’.
“Focussing on profitability and making the business sustainable and durable in a difficult environment is going to help, either for when it comes to raising a round, or simply for sustaining the business through this difficult period,“ says Lower.An exit will come at some point in the future. And, if the business is able to sell, or is heading that way, it’s important to have the right advice and support in place. Wealth managers don’t usually step in until personal equity has been released from a business for them to manage. But, in Cazenove Capital’s case, the relationship starts much earlier than that.
“We’re trying to build relationships with founders and management teams 18 months to two years before the actual liquidity event, to help them plan and make introductions to corporate finance advisors, legal advisors, accountants, etc,” says Lower. “We help assemble these people around the founder and management team, so that we ensure they’re getting the best possible advice.”
He goes on to explain why this is good news for a regulated sector like fintech. “It’s a challenging environment in which to undertake transactions. If you’re negotiating with a potential buyer, you need to know they’re a credible counterparty, acceptable to the regulator, and that they’re going to have approval for that deal. In those scenarios, having the right corporate finance advisors, and the right legal advisors, can really help.
“Similarly, if you’ve taken on some venture capital funding, then the VC can provide expert advice around selling a business in a highly regulated environment, using companies like Molten Ventures, who have experience with Revolut or Transferwise, or, more recently, Crowdcube or Freetrade.”
As part of FTSE 100 business Schroders plc – which, incidentally, backed UK challenger bank Revolut, from its early fundraising rounds to its most recent Series E – Cazenove Capital has opened just such doors to an enormous network of useful contacts for many founders.
“Forty per cent of our clients are entrepreneurs or business owners, who are at the point of sale, preparing for sale, or post sale. So it’s very much people who’ve made their money through founding, growing, and, ultimately, exiting businesses that they started,” says Lower.
Its presence as an ‘informed friend’ of the founder can help fintech companies maximise their valuation at sale. Ideally, the companies it’s interested in are in a position ‘whereby their existence isn’t dependent on a sale; that they’ve got enough cash runway, that they’ve got enough time on their hands, that if a deal doesn’t happen immediately, or falls over, the company’s very existence isn’t under threat’, says Lower.
“Fundamentally, we’re looking at private sales. In which case, the main thing to try to do is to build that competitive tension that can drive higher valuations, i.e. more than one buyer looking to acquire the company.”
As to Cazenove Capital’s role, Lower says it wouldn’t advise a founder on selling their company, ‘but we would advise them what to do around that’.
“Founders don’t necessarily want to engage too heavily in thinking about what comes next, because they don’t want to jinx it; there’s an element of superstition around not wanting to count their chickens”
“Our role is to sit on their side of the table, as their personal advisor, and help them get the best outcome for them as individuals. It could be succession planning, passing money on to their children, establishing a structure that means they’ve got enough income, so they never need to work again.
Or indeed setting things up so they’ve got a corporate investment that then allows them to go off and invest in other things, and carry on growing their wealth, and have seed capital ready for their next venture.”Right now, though, the goal for most founders, he says, should be ‘bringing forward profitability, and trying to make the business as high quality as it can’.
“Because the current market environment has very much switched focus to companies that are profitable, and that are growing at a reasonable rate. Whereas going back a couple of years, it was about growth at all costs, now the focus is on buying robust, sustainable businesses.”
THE FOUNDER’S DILEMMA
And once you’re out, what then? Many founders are surprisingly unprepared for their success, says Lower.
“Founders don’t necessarily want to engage too heavily in thinking about what comes next because they don’t want to jinx it; there’s an element of superstition around not wanting to count their chickens. As a consequence, sometimes they leave planning opportunities on the table.
“The process of preparing for and leading up to a sale is incredibly stressful and fraught with difficulty. At any moment, it feels like it could fall apart.
“That stressful exit environment isn’t necessarily the time to be thinking about the questions we’re asking, and the advice we’re trying to give around their long-term future: what they want their legacy to be, what they want their wealth to do for them and their family.
“Often our advice is predicated on a flexible solution. It gives them time to think, after that exit, once the dust has settled, and they’ve a clearer picture around what they want to achieve. It’s a very big shift in mindset, from being incredibly busy all the time, worrying about cashflow, how are you going to pay your people, how are you going to get the deal done, to that ‘what next?’ moment.
“Tallest peak syndrome is something that we see a fair bit from our clients – when you achieve incredibly great things, everything else can seem quite mundane, and quite uninspiring, compared to the fantastic achievement you’ve just had.”On the day of sale, one recently-exited fintech founder set off to row the Atlantic. Another phoned Lower the day the deal went through to say ‘what now?’.
“Finding meaning in the world, when you’ve got a lot of time on your hands, is a challenge that a lot of founders come up against if they’ve come through a clean exit,” says Lower. “With that client, I said, ‘spend some time with your family. Enjoy having a bit of freedom. You’ll find another project, another thing to get excited about. Don’t worry about having anything immediately to occupy your attention.
“‘You’ve worked really hard. Enjoy just having a moment to yourself.‘”
BIG UK DEALS IN H1 OF 2023
FINTECH FUNDING IS DOWN BUT THERE ARE STILL DEALS TAKING PLACE. HERE’S THE BIGGEST SO FAR THIS YEAR.
A personal lending fintech that uses AI and open banking to provide more accurate and affordable loans, Abound raised more than £500million in funding to bolster its current 30 per cent month-on-month growth. It’s on track to have £1billion on the balance sheet by 2025.
The sole unicorn to be minted in Q1 2023, Quantexa, an AI-based regtech company, secured just over £80million for its Series E funding round, which brought its valuation to around £1.4billion. The round was headed by GIC with participation from a consortium of partners.
TerraPay, a global payments infrastructure business, secured in excess of £79million for its Series B, although the exact figure is not clear. The funding round was led by IFC and will help it expand globally to 150 countries by 2024.
This digital bank secured the fourth-biggest funding round of 2023 by raising £75million from existing investors. Zopa Bank, formerly a peer-to-peer lending platform, plans to use funding to make further mergers and acquisitions this year after already acquiring point-of-sale finance technology and lending platform, DivideBuy.
A recent addition to the list of big UK deals is paytech Volt. It raised just over £46million in a series B round led by IVP. Currently operating in the UK, Europe and Brazil, it plans to take its technology to the Asia Pacific region and beyond.
TOP TIPS! THE BEST WAY TO PREPARE FOR AN EXIT IN 2023…
- Focus on profitability Delay capital expenditure, bring forward profitability, and try to make the business look as high-quality as it can because the focus is now on buying robust, sustainable businesses.
- Build competitive tension In the current environment, try to build competitive tension to drive higher valuations, i.e. more than one buyer looking to acquire the company.
- Know what you want If you are thinking about an exit, be clear in your mind about why you want to exit.
- Get the right advice Fintech is a challenging, regulated environment in which to undertake transactions, so it’s important to have the right advice. Your equity investors can often introduce you to corporate finance and legal advisors.
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