The fintech sector in UK is on the precipice of change. Whilst there is plenty of opportunity to be seized, on the flip side, UK Fintechs face acute challenges from competition, Brexit, the impact of Covid-19 and increasing regulatory scrutiny.
The funding gap
Looking beyond bootstrap and seed funding rounds, UK Fintechs are increasingly finding it difficult to access capital to transition beyond the start-up phase. The so-called "funding gap" for Fintechs, being the difference between demand and supply for capital, has been widening in recent years, and has worsened with the pandemic.
The June 2020 Growth Capital Report identified a £2 billion per annum funding gap in the fintech sector, and a recent survey showed that nearly 70% of smaller UK fintech companies have a cash runway of 6 months or less.
Proposal for a Fintech Growth Fund
To support UK Fintechs looking to scale up from Series B to the pre-IPO stage, the recent Kalifa Report calls for the creation of a £1 billion Fintech Growth Fund (FGF) to act as a catalyst in developing a leading fintech ecosystem in the UK.
The recommendation to create this fund represents a significant change to the status quo: UK private institutions (rather than overseas investors) need to be incentivised to participate in domestic fintech funding.
What do we know about the FGF?
- The FGF would be modelled on the Business Growth Fund for SMEs and rely on large institutions to form the basis of the initiative.
- The £1 billion fund would be funded by domestic private investors (10 x £50 million sourced from large institutions, including insurers and pension funds, with the remaining £500 million from smaller institutions).
- The fund would be deployed over five years with the aim to fill 10% of the funding gap per annum (equal to £200 million of funding per annum).
- The FGF will likely be eligible for regulatory concessions to unlock barriers that have impeded funding from large institutions (e.g. removing barriers which have discouraged defined contribution (DC) pension schemes from investing in high growth assets).
What don't we know about the FGF?
- What form will the funding take – equity and/or convertible loans?
- The Future Fund (2020) provided funding to targeted companies on a convertible basis, which was criticised for being incompatible with the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
- It is unclear whether the FGF and its investors will be able to take advantage of EIS/SEIS tax advantages. That said, the Kalifa Report does recommend that the EIS and SEIS be expanded to apply to regulated Fintechs.
- If funding is given on a convertible basis, would the terms of loan repayment be company friendly or investor friendly?
- Is there potential for the fund to provide agile funding to "top-up" capital between investments rounds?
2. Would the FGF take a lead investor role on Series B+ investment rounds?
- It is common for VC investors or angel investors to take a more active role in managing the affairs of the business in Series A+ rounds.
- Will the FGF insist on a minimum set of terms in return for funding? If so, consideration should be given to governance rights, veto rights, lock-up, anti-dilution rights, liquidation preferences and information rights.
- FGF may look to invest on BVCA standard terms to promote transparency and consistency in the UK market.
3. Will the FGF (or the institutional investors) be listed on the cap table as the relevant shareholder?
4. Who will be responsible for making investment decisions?
- The Kalifa Report suggests a specialist fintech investment team will be established to set the investment strategy for FGF.
- Will companies seeking to apply for funding be subject to a transparent and independent process?
- How will the valuation of scaling companies be stress-tested by the investment committee?
5. Will there be any limits/caps on the funding amounts?
What's happening next?
The proposal to create the FGF has been met with mixed reviews. Most view the recommendation as a long-overdue reform to support emerging technology, which will enable the UK to remain competitive with VC investment in the United States. Others are less convinced. Critics argue that funding would better help early-stage companies (pre-series B) who are yet to secure VC funding.
It will be interesting to see how the government responds to the FGF recommendation in detail. The Kalifa Report calls for progress to be assessed in a year’s time.
Read about the 10 takeaways from the Kalifa report in our recent insight.
The findings of a highly anticipated independent strategic review into UK fintech have been published...The recommendations are wide-ranging and bold