Investment Challenges in UK FinTech: Economic and Policy Factors at Play

The FinTech sector once dominated the UK’s innovation economy, consistently drawing substantial investment. However, the landscape has shifted in recent years. FinTech start-ups have faced increasing challenges, while the climate crisis has emerged as the paramount global concern, redirecting investment focus towards the energy sector, which has now surpassed FinTech in attracting the highest funding levels.

Moreover, economists and investors have warned that ongoing macroeconomic issues — such as persistent inflation, stringent monetary policies, supply chain disruptions, and the threat of a recession—are likely to continue suppressing discretionary spending and hindering dealmaking activities.

To gain insights into the current state of FinTech investment in the UK, we spoke with Evgeny Mishchenko, co-founder of the British FinTech company Payrow. Our discussion covered the measures being implemented to improve the investment climate and the government’s role in attracting investments to the UK’s FinTech sector.

FinTech Investment Decline and Rising Selectivity

In 2023, global investment in FinTech amounted to $51.2 billion across 3,973 deals, significantly lower than the $99 billion recorded in 2022. The number of deals also fell by 38%. As a major player in the global arena, the UK has witnessed investment fluctuations that fall in line with macroeconomic conditions. The UK attracted $5.1 billion across 409 deals in 2023, a significant drop from $14.6 billion in 2022.

Venture capitalists are becoming increasingly selective when it comes to investing in start-ups or emerging FinTech firms. This shift in investment trends was discussed during a webinar on FinTech trends and expectations for 2024, organised by a British CPA advisory firm.

Overall, market trends have shifted from stability to volatility. In 2020 and 2021, raising capital for FinTech was relatively straightforward; a good idea was often enough to secure funding. However, venture capitalists now require thorough business plans and regular meetings. There is also increased scrutiny of FinTech business teams, their backgrounds, and compliance records. This change is attributed to rising interest rates, higher capital costs, geopolitical uncertainty, a turbulent public market, and inflation concerns.

In many cases, venture capital is being distributed in tranches, with FinTech firms needing to meet specific goals to receive portions of the funding. This indicates a deeper involvement of venture capitalists in the business strategies of FinTech firms. Additionally, down rounds — where a company’s valuation decreases in subsequent funding rounds — are becoming more common due to funding shortages.

Evgeny Mishchenko explained, “In these circumstances, a steadfast shareholder base can bolster and fortify the business, which is essential for both the company’s partners and clients. Therefore, the Payrow team has concentrated its development strategy on shareholder equity rather than venture funding.”

UK Government and FinTech Industry Collaboration

The current investment environment in the UK for FinTech start-ups is active but challenging. Low start-up valuations compared to the US and a conservative approach by venture investors do not stimulate rapid growth in the FinTech sector. There is a noticeable lack of funding during the growth stages of start-ups in the UK.

However, the UK offers unique advantages for FinTech start-ups, such as the Talent Visa and early-stage tax incentives like EIS/SEIS. These measures significantly benefit FinTech companies, founders, and employees at the early stages.

Also, the UK government has stated its commitment to supporting the FinTech industry and has backed the launch of the Centre for Finance, Innovation, and Technology to help remove barriers to sector growth and promote job creation.

In July 2023, the UK Chancellor of the Exchequer, Jeremy Hunt, introduced the Mansion House Compact, tasking the British Business Bank with creating a vehicle to facilitate pension fund investments. This initiative aims to leverage the Bank’s expertise and access to promising high-growth companies, thereby stimulating the economy and providing better returns for pension fund members. However, the Chancellor has clarified that the UK will not force pension funds to invest in high-growth companies, and greater transparency is needed regarding where pension funds plan to invest.

The Mansion House Compact seeks to encourage defined contribution (DC) pension schemes to allocate at least 5% of their default funds to private equity by 2030, significantly higher than the current investment level of under 1%.

Since the initiative’s launch, the British Business Bank has engaged with over 20 pension funds, representing more than £450 billion in assets, to discuss viable investment strategies. Pension funds face challenges such as due diligence and the capacity to make substantial investments in venture opportunities. The Bank is currently developing the vehicle, ensuring it operates independently of government influence and serves the fiduciary interests of investors. This vehicle is expected to be operational within 18 months.

The First Unicorn Council for UK FinTech

The global FinTech sector has experienced significant fluctuations in investment levels. In response, Innovate Finance, the independent industry body for UK FinTech, has launched the first Unicorn Council for UK FinTech (UCFT), a coalition of UK-based FinTech unicorn founders aimed at accelerating and realising growth in the sector.

The Unicorn Council will provide the government with crucial policy recommendations to safeguard and bolster the UK’s leading global position in FinTech, addressing the investment and growth challenges over the next decade. Industry leaders in the UK’s FinTech sector are calling on the government to enhance tax incentives to attract more investment, as the lack of domestic investors is seen as a barrier to growth.

The Council will pinpoint key issues hindering the growth of UK FinTech companies and engage directly with senior government ministers and officials to suggest policy interventions. This will, in turn, help attract and increase direct foreign investment into the UK, enhancing its international competitiveness.

To remain competitive, the UK must continue to foster a supportive environment for tech companies. This includes maintaining strong collaboration between the public and private sectors, enhancing tax incentives, and ensuring access to capital.

UK Start-Up Investment Shows Signs of Recovery After 2022-2023 Corrections

Recent data from HSBC Innovation Banking (formerly Silicon Valley Bank U.K.) and market intelligence provider Dealroom suggests some signs of stabilisation, especially in early-stage funding.

According to Forbes, in the first quarter of 2024, British start-ups secured $3.9 billion in investment, a decrease from $4.8 billion in the previous quarter. Breaking this down, pre-seed and seed stages accounted for $279 million, while Series A rounds attracted $769 million. This marks an improvement in early-stage funding compared to the prior two quarters.

Series B rounds remained relatively steady, raising $742 million, while Series C saw $715 million in investment. Additionally, six late-stage mega-rounds collectively raised $1.4 billion.

The investment landscape is evolving, with FinTech’s apparent resurgence slightly skewed by significant deals involving established companies. While FinTech remains a strong sector for investment, emerging fields such as climate-tech, quantum technology, AI, and biotech are gaining momentum.

Long-term efforts are needed to encourage UK-based start-ups to list on the London Stock Exchange, as this is crucial for retaining capital within the UK post-IPO.

While the outlook for a surge in investment for UK start-ups in 2024 is cautious, stability after a challenging period is a positive sign. The UK continues to hold its position as Europe’s leading investment destination.