With record levels of investment from venture capital groups being ploughed into payment start-ups, is there a risk of another dotcom-style boom and bust?
by Victoria Conroy
The halcyon days of the dotcom era were characterised by small internet-based start-ups in a range of industries being bought up in waves by larger established businesses, and a swathe of initial public offerings valuing these businesses in the millions and sometimes billions of dollars. According to the National Venture Capital Association of the US, around $7.2 billion was invested in internet companies based in the US between 1995 and 2013.
Deal flow information
However, internet commerce in the late 1990s and early part of the millennium was at such an early stage that initial promises and potential vanished as consumers became frustrated by the-then clunky and slow functionality of internet commerce websites and the limitations of dial-up internet. As the bottom fell out of the stock market in the early part of the millennium, so did the value of these companies with the result being that the start-ups, which once held so much potential, went bankrupt or closed down business completely as investors pulled out in their droves.
Over a decade later, enhanced internet commerce website functionality, the wide availability of broadband internet and a plethora of payment methods have made e-commerce in all its forms a rapidly growing area. Just as in the dotcom era, a wide range of internet, e-commerce and mobile commerce start-ups are blazing a trail across several industries. What is notably different this time around is that finance is witnessing an unprecedented level of interest as seen by the frenetic pace of investment over the last couple of years. From venture capital companies to established large corporates, investment is being pumped into start-ups engaged in mobile and online payments, mPOS, remittances and payment processing.
Another dotcom boom and bust?
Figures from CB Insights, a global consultancy firm, show that in 2013, payment technology-related companies raised in total over $1.2 billion across 193 venture capital deals, a five-year high. On a year-over-year basis, venture capital funding and deals linked to payment tech companies rose by 5% and 6% respectively compared to 2012.
But are we witnessing another dotcom-style boom – and eventually bust? Hooman Mazaheri, European CEO of mobile payment specialist ZNAP, told PCM: “A dotcom-style boom and bust may well be on the way. However, organisations that have a strong business model, backed by a solid technology and proposition, and are serving a real need and solving specific business issues, will be in a strong position to ride the highs and lows of the market.
“If the bubble bursts, the companies that have the right attributes will survive, and in time, most likely consolidate as the market cannot support such a plethora of providers. On the flip side, those with the wrong proposition or ‘hype without substance’ will inevitably fail.
“If businesses deliver real value by solving genuine problems, then they’ll be far better placed to rise above the crowd should the bubble burst. And this theory has been tested time and time again – we only have to look at the likes of Amazon to see how solid business models can continue to thrive though boom and bust.”
Early adopters and early investors
When it comes to start-ups in particular, investment comes in the form of early stage seed funding, where venture capital groups plough money into a start-up to expand its capabilities and market share. Typically, the start-up funding process involves each round of funding serving a different purpose. Earlier rounds are aimed at enabling a business to develop and launch products or services, while middle (mezzanine) and later rounds are to help businesses expand before investors make their exits, with the general rule being that as start-ups progress to later funding stages, they are more likely to be an acquisition target or suitable for an IPO.
According to CB Insights, over the last two years around 42% of all deals related to the payments space have comprised seed funding. On a wider basis, payment-related deal activity has also continued on an upward trajectory, with over 60 deals taking place in each of the past four quarters.
And this rise in early stage funding is setting the scene for a wave of acquisitions. According to CB Insights, over the last two years, early stage funding for payment-related companies comprised around 87% of total global payments funding deals. The number of ‘seed/angel through series B’ funding deals for payments start-ups increased from 153 in 2012 to 174 in 2013, with these deals accounting for 90% of total payments deals as compared to 84% in 2012.
On the flip-side, the number of payments start-up deals for series C funding or later fell from 23 deals in 2012 to 19 deals in 2013, while the share of deals for those funding stages declined from 13% in 2012 to 10% in 2013. When it comes to traditional M&A activity, on a year-over-year basis, there has been a 16% drop in M&A and IPO activity, perhaps due to higher valuations overall. It seems that investors see more opportunity in the early stage start-up space as the returns can be so much bigger once a company is able to pursue an IPO.
According to Michael Rolph, founder of Yoyo, a marketing engine for retailers, powered by in-store mobile payments: “We have to separate the venture capital approach from the corporate venture approach as both have different drivers. From the venture capital perspective, finance is a very interesting area of opportunity as it can become scalable quickly. Everyone in the world, whether they are banked or unbanked, has some form of financial need. That makes finance one of the biggest market opportunities going. Getting a small percentage of any of those niche verticals in finance can create fantastic businesses. There is a lot of room because the market is so big.”
Just in the last couple of years alone, the likes of Intel, Google, American Express and MasterCard have all made bets on payment-related companies and start-ups. Interestingly, players like American Express are also hedging their bets with each-way punts on start-ups competing in the same space. American Express has made investments in mPOS specialists iZettle and SumUp, for example.
Series funding stages over 2013
Rolph told PCM: “The mPOS space is very interesting. Square has done a very good job of highlighting the opportunity in the market, but the reality is that mPOS isn’t solving a problem for the majority of retailers. Retailers will have an ePOS system already, and where they haven’t got ePOS, it’s because they’re an independent retailer which is not tech-savvy. Bringing in the ability for them to pay with a payment card isn’t revolutionary for them. Even if they haven’t got ePOS, they’ve got the ability to take card payments.”
However, is it the case that venture capital groups investing in payments are following the trail blazed by established corporates? It appears that the opposite is true – finance, payments and banking have become far more friendly to outside investors in the last few years, due to the fact that in the previous dotcom boom, investments centred around services and merchandise whereas the current wave of investment is centred on technology platforms and services that underpin the internet commerce chain. Technology is also much more scalable than other lines of business. But there are challenges to overcome.
According to Rolph: “In the area of more traditional consumer or business payments, mobile is hanging over our heads, and it has been since the early 2000s and since 2007 with the advent of smartphones. With that, there has been this expectation that everyone will use their mobile to pay. But here we are, almost 10 years later, and that’s still not the case. There is this pent-up willingness and wanting for the mobile payments space to take off.
“For mobile wallets for example, players like Google have tried to get a foothold in this space, and other corporate names have done a very good job of shouting about the things they’re thinking of doing in mobile that have created a false economy of fear. How that has translated over time is that nobody really has anything that works in the way that makes sense for a consumer.”
This view is echoed by Mazaheri, who told PCM: “The majority of mobile payment players are trying to solve a problem that doesn’t exist – payments. In most markets payments work reasonably well and simply don’t need fixing. Instead, mobile platforms must solve real business needs. This includes deeper intimacy with the consumer; a single view across all channels; targeted one-to-one offers and coupon redemption; greater traffic in-store; seamless loyalty; and the ability for consumers to use any payment method. As everything converges, start-ups need to focus on omni-commerce rather than simply e-commerce or m-commerce if they are to be successful.”
Investment in innovation
Rolph told PCM: “Naturally, corporates are realising that innovators in this space are leading the way in a way that big players find difficult to do in big environments. Innovation is happening outside these big organisations and so corporates are placing early bets on smaller companies that will solve that problem for them. It’s an issue of how to achieve innovation which big corporates have typically struggled with.
“If you’re a venture capital investor, you want to back the guys that are going to get bought by the corporates. Start-ups are in the business of solving problems for long-established companies. Corporate ventures equally know that they want to get in early if they want to be paid over the odds for their investment in the long run. It’s always more interesting if there is a history or heritage of companies which have been in this space being bought by big corporates because the potential return on investment or the path to exit or IPO becomes more exciting.”
Another area of payments is also raising interest among potential investors – digital currencies. bitcoin in particular is being watched by several venture capital investors, although the level of investment ($97.5 million publicly reported to date) is far lower than the $500 million in venture capital investment that was ploughed into internet start-ups in the year 1995. Several notable names in venture capital, like Andreessen Horowitz, have invested in bitcoin-related start-ups such as bitcoin exchanges and bitcoin wallet services.
However, Rolph is sceptical that bitcoin will attract the same kind of ongoing investment compared to what is taking place in the payment tech start-up space. “Is bitcoin a currency or a stock that people are putting value into? You can exchange bitcoin but it doesn’t mean you can exchange it for cash easily. It’s incredibly early in the bitcoin story and I think there are a lot of smart people that believe in bitcoin, but I’m not necessarily convinced that bitcoin will revolutionise digital currency.
“The business I founded, Yoyo, is technically a digital currency because what happens at the moment is that people upload a balance into their Yoyo account, and they’re using that Yoyo balance to make purchases. We’re essentially transferring a digital currency between the consumer and the merchant. At some point you have to be able to convert a digital currency into cash in a bank account, which makes the distinction between Yoyo and PayPal and the likes of bitcoin, because it’s not so apparent how you can translate bitcoin at a fair value.”
The post Payment investment – Start-ups – boom or bust? appeared first on Payments Cards & Mobile.
