Valuation of a Fintech Startup

Valuation of Fintech company

Fintech has become popular because many of its products touch our lives every day. Hence valuation of a fintech company is critical. A Fintech operates in Financial services sector but leverages the power of technology to simplify, automate and improve the delivery of Financial services to end customers.Fintech operates in various sub sectors including Payments, Investment management, Insurance, lending and borrowing.
Fintech have been able to achieve substantial funding from their investors with US being the most active country in terms of the number of startups followed by India and UK.

Why Fintech valuation are interesting?

There are few interesting points we need to look at Fintech valuations before we begin to value a Fintech company.

  • Why are Fintech valued more than a traditional bank, insurance and asset management company?
  • Why startups reach high valuations in short time?Are these valuations real or fictitious?
  • What is the logic behind these huge valuations.Is it based on intrinsic value or sentiment?

Valuation exercise uses a multiples – [EBITDA or revenues] approach to value a company and chooses a number based on overall strategic, business, competitive and return requirements.These approaches are useful for stable mature businesses with predictable cash flows and established business models.
The traditional valuation approach is not relevant to Fintechs because their cashflows are unpredictable and even negative sometimes, their business models change rapidly and they do not have any physical assets unlike a bank or an insurance company.

Valuation drivers for Fintech

A Fintech business is different from a conventional business in terms of:

  1. Nature of the problem it solves.It brings in technology to solve a business problem which could not be solved earlier.
  2. Ability to scale up business rapidly across geographies without having the need to set up physical presence and infrastructure.
  3. The lower costs due to lean structures that no longer require heavy investments in physical IT infrastructure and manpower.

Let us look at key variables in order to qualitatively assess the potential of a new age Fintech.

Solving new problems

A fintech needs to solve a disruptive problem that could not be achieved before rather than providing an incremental improvement to an existing solution that may not affect the incumbents position in a big way.

TAM – Total Addressable Market in valuation

Some business are easily scalable across large geographies. In the past, banks and mutual funds required an extensive infrastructure of offices, branches and distributors to service their customers. In the case of Fintechs, their services are accessible to clients across geographies that they operate in and can rapidly scale up their businesses.High scalability means Fintech are able to address a larger market to service customers.

New Use Cases in valuation

Fintechs are able to leverage technology to build new use cases that can potentially expand their market.A recent use cases is Paytm allowing customers to use their wallets to settle P2P transactions amongst friends or splitting bills and making low value payments to others.

Lower Operational Costs

Fintechs have lower marginal costs because their business models are tech enabled.This help in improving the business model profitability because once the revenues exceeds the fixed costs, remaining are the margins.

Revenue Models for Valuation

Fintech leverages network effects by connecting customers and business in a common platform.The revenue models could be through charging users or through advertising or data monetization.The Fintech company needs to be clear how it will monetize its users using its platform.

Cross selling

As Fintech are platform plays, they continuously keep adding products and features to its initial MVP.Cross selling can be high for Fintechs leveraging AI supported insights. AI can be used to understand customer behavior and their patterns.This makes it amenable for Fintechs to continuously expand the scope of the offering with relatively small effort.

Valuation Models used to value Fintech

Rather than applying traditional valuation methods, specific approaches are used for appraising Fintech investments.

Berkus Method of valuation

This method can be used to value a Fintech whose revenues are atleast $20 million.The fintech is assessed on five parameters – 1)Soundness of idea 2)Strength of the founding team 3)Quality of the product prototype 4)Existing customers and 5)sales volumes.

Cost to Duplicate Method of valuation

If the Fintech has a strong technology and a quality team that will take time and money to build for the buyer, one can use replacement value as a benchmark for valuing the company. This concept is similar to the replacement cost method used to value mature companies, but the only difference here is that the focus is on the technology set up and quality of skilled talent instead of physical assets and production facilities.

Venture capital method of valuation

In this case, the buyer typically works backward by looking at the returns that he is expecting on the investment based on the exit value estimation of the Fintech.For instance, the investor expectation is 15x and he expects the exit valuation of the Fintech to be $15 million, then the post money valuation will be 1 million. When the investor invests $250,000 for a 25% stake, then the Pre-Money valuation will be $750,000.
Other traditional methods like DCF and EBITDA multiples approaches can be used in conjunction with the above models to arrive at the target company valuation.

Valuation is art or science?

There are arguments whether valuation is an art or a science. The answer is that it is both.In the early stages of the Fintech, valuations are more of an art based on the vision of the founder, market size, potential and subjective judgement.
As the Fintech matures then the valuation becomes more scientific and is done based on the data available on market share, revenues and cashflows.

Final Takeaway

Valuation models are basically the different approaches used to try and calculate the cash generation capability of the business in the longer term. It is the potential cashflow that determines the value of the target company and the ROI that the investment will generate.