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Fintech Valuation: Highs and Lows

Startups in India have garnered praise from around the world for being tech-savvy, faster Go-to-market strategies and innovative solutions. But what it has garnered more from the world is investments.

India's startup scene has grown to become the world's 3rd largest, featuring over 99,000 startups spanning 56 sectors, including IT services, healthcare, education, agriculture, and F&B. Startup funding has surged 15x, investors grew 9x, and incubators expanded 7x from 2015-2022. The nation has 108 unicorns valued at $340.80 billion, marking 66% YoY growth since FY 2017-18. Bengaluru is a leading unicorn hub with strong FinTech, EdTech, and E-commerce performance. By May 2023, four startups have reached $10 billion valuations, marking India's trajectory towards decacorns.

Fintech Was the Darling of Investor

Investment in Indian Fintech has surged, addressing critical gaps in the finance industry. India ranks 2nd in innovation quality, with startups across 56 diverse sectors.

The Growth of Fintech

The Fintech revolution is marked by a thriving digital payments ecosystem, a large smartphone user base, and digital-first business models. These innovations bridge gaps in accessibility, convenience, and efficiency, transforming traditional finance models and meeting the evolving needs of a digital-savvy population. Hence resulting in exponential growth and lots of love from investors as depicted in the below image.

Funding distribution in Fintech

  • Payments and Digital Wallets: Platforms like Paytm, PhonePe, and Razorpay have received funding due to increased digital transactions and cashless economy efforts
  • Lending and P2P Platforms: Online lending for individuals and small businesses, seen in companies like Lendingkart and Capital Float, has attracted investment
  • InsurTech: Innovative insurance solutions from startups like PolicyBazaar and Digit Insurance have secured funding
  • Personal Finance Tools: Services like Scripbox and ETMONEY, aiding better financial decisions, have garnered investment
  • Neo-Banks: Digital-only banking platforms providing services without branches have entered and gained funding
  • Investment Management: Platforms offering investment and wealth management solutions have also attracted investment
  • RegTech: Companies providing technology solutions for regulations and compliance have drawn investor interest

Most Active Investors of Fintech in India

Ever wondered how these investors value a startup? With limited anecdotes available in the market to compare, investors use different techniques to reach the potential valuation of a startup. Let’s look into the factors affecting and methods of valuations.

How Do Valuations Happen for a Startup?

Valuation of startups involved different moving parts and can be a complex process. Some of the factors influencing the valuations are:

  • Stage of development
  • Market opportunities
  • Revenue and Growth
  • Competitive landscape
  • Funding and Investment
  • Scalability

Startups are new business ventures initiated by entrepreneurs. Their value can be assessed using methods like the Berkus approach, cost-to-duplicate approach, future valuation method, market multiple approach, risk factor summation approach, and discounted cash flow (DCF) method.

  • The Berkus method is a startup valuation method that uses five key factors to determine a company's worth: business idea, product prototype, management team, market relationships, and existing sales. Each factor can contribute up to $500,000 to the company's valuation. The goal of the Berkus method is to help investors identify startups with a high potential for success
  • The cost-to-duplicate approach values a startup by considering all its expenses, like developing its product and buying assets. This helps determine its market value. 
  • The future Valuation Multiple Approach looks at how much money investors might make from a startup in the next five to ten years. People predict how much the startup will sell and how much it will cost during this time. Then, they use a special number to decide how much the startup is worth
  • In the Market Multiple Approach, to determine how much a startup is worth, people compare it to similar startups recently bought or sold. They use the prices from these similar deals to set a value for the startup they're looking at
  • The risk Factor Summation Approach way adds up everything that could go wrong with a startup. People use numbers to show how much each risk could change the startup's value. They start with a basic value for the startup, then add or take away value based on how risky the business seems
  • Discounted Cash Flow (DCF) Method focuses on guessing how much money a startup will make in the future. It also guesses how much an investor should make for taking a big risk on a new startup. They use a higher number because startups are risky. The future money is changed to today's money

Check the link to read more about startup valuation techniques.

Challenges Along the Investment Journey

Recent developments in India's fintech landscape have highlighted a trend of valuations being marked down by investors, reflecting the broader challenges faced by technology companies both within the country and globally. Neuberger Berman, a US-based investment firm, has notably lowered the fair values of two prominent Indian unicorns, API Holdings (parent company of PharmEasy) and Pine Labs, by 21.6 percent and 39 percent respectively. This markdown has led to revised valuations of $4.39 billion for API Holdings and $3.14 billion for Pine Labs per filings with the Securities and Exchange Commission.

Reasons Behind Valuation Markdowns for Indian Startups

  • Rising Interest Rates, Profit Focus: High-interest rates emphasize current profits over future projections, causing startups with high cash burn to lose favor
  • Unrealistic Valuations: 2021's capital influx inflated valuations, but post-pandemic reality revealed many lacked profits
  • Geopolitical & Macroeconomic Pressure: Scarcer funding and a profitability focus in 2022 triggered markdowns
  • Discrepancy in Revenue Projections: Overambitious revenue forecasts don't align with actual performance
  • Valuation-to-Revenue Disparity: High valuation-to-revenue ratios compared to US peers raised concerns
  • Lack of Fundraisers, External Validation: Absence of profits and validation through funding led to markdowns
  • Market Uncertainty: Negative sentiment and market sway contributed to markdowns
  • Regulatory Hurdles: Regulatory challenges eroded investor confidence and led to markdowns

But the above reasons are just the tip of the iceberg. The innate problem lies in the frequent regulatory inventions and changes in policies. Let’s have a look into this in detail.

Below the Surface

Fintechs used to make money through lending, charging hefty fees for customer acquisition, KYC, lead filtering, and collection. However, the Reserve Bank of India (RBI) abolished the First loss-given default (FLDG) model in 2020, which shifted the risk of default to lenders. This led lenders to reduce fees, forcing fintech to pivot and increase operational costs to comply with RBI guidelines.

The RBI's data privacy guidelines are also hurting the fintech sector. The guidelines, particularly those related to restricted data storage and repeated permission requests, could hinder innovation and make it more difficult for Fintech to provide a seamless user experience.

This led to a race among lending fintech companies to become a regulated entity or in a straight manner NBFC. Also, investors have become more cautious than ever to invest in fintech startups and, most recently, after the failure of ZestMoney.

Race to NBFC

Fintechs like Cred and Jupiter are becoming NBFCs to enjoy the benefits of being a regulated entity, such as the ability to retain personal information with a single consent and the automatic compliance with the DLG guideline. NBFCs also earn higher margins as they don't have to share the fees with lenders.

But becoming an NBFC is not easy. There are various hurdles to cross before becoming NBFC:

  • Regulators are cautious about opening up NBFC space to fintech, scrutinizing license applications after IL&FS and DHFL fiasco
  • The number of new NBFC licenses has declined, with only 44 granted in 2021-22, signaling regulator concerns about market saturation and demand not increasing as much as the increase in license application

Despite the hurdles, the number of fintechs becoming NBFCs is expected to grow in the coming years. This is because the benefits of being an NBFC outweigh the challenges. The long-term prospects for fintech becoming NBFCs are positive

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Fintech Valuation: Highs and Lows

Purvai Soni
,
Ankit Abhishek
,
Yatharth Chaudhary
Yatharth Chaudhary
  • January 23, 2024
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