There exists a major issue that affects almost all early-stage startups – the funding and expertise gap between their seed and Series A rounds.
Ask any founder of any type of startup that has navigated through this and they’ll tell you that it is one of the most difficult, and precarious, stages of their company’s journey. The seed money has been exhausted on building a minimum viable product and conducting market testing, but then a giant leap forward is required in order to raise institutional investment so that customers can be acquired at scale. Finding an institutional investor that has the capital, let alone the right level of expertise and networks, can be tough, and here we have one of the first major hurdles for early-stage startups.
The complexities of early-stage fintech growth
This gap, between seed and institutional investment, is even more pronounced for fintech startups, and arguably not well addressed by generalist VCs which don’t always have the necessary domain expertise for fintechs navigating an often unique set of challenges. Most fintech startups will need to develop complex technologies and undergo extensive regulatory compliance. Then there’s hiring senior operators who can be expensive in financial services relative to other sectors. In the case of B2B fintechs, proving enterprise sales cycles can be very challenging in the available runway.
A generalist VC firm may have the capital, but unless they have individuals with connections and deep industry knowledge who have gone through these challenges multiple times, either as fintech founders or backers of fintech companies, the value they’ll be capable of adding at this stage is limited. That’s if they even spot the potential in the first place. We know first-hand from our portfolio that many generalist funds pass on fintechs at the pre-Series A stage. In fact, the ones from our portfolio that have gone on to outperform were the most unloved in the early stages. Founder bias, business model bias and lack of domain expertise all contributed to why they were overlooked.
The fintech funding gap
We refer to this post-seed, pre-Series A stage, as the ‘Fintech Funding Gap’, as it’s where an abundance of fintech start-ups are seeking capital from much-needed specialist firms like ourselves, and where demand far outstrips supply. If we zoom in on the UK market, the number of fintech-only funds deploying capital in the country can be counted on two hands. Based on the size of their most recent funds and % allocation to the UK, we’ve worked out there is a supply of roughly £0.3bn. This value is dwarfed by the £6bn (20x) of potential demand required by the early stage fintech ecosystem looking to raise rounds between £2-5m.
Early-stage fintech startups must look for VC firms that provide capital in the post-seed, pre-Series A gap, as well as the know-how and network to scale and reach Series A/B and beyond, where there will be a bigger pool of investors with capital readily available for larger, later-stage rounds of £10M or more.
Now is the time to start-up
How do things look as we head into a potentially generation-defining recession, off the back of skyrocketing inflation and investment slowdown? We have already seen an unprecedented number of technology companies announcing layoffs as valuations are cut and VC firms act more cautiously than can be remembered.
We are entering a new world, and while that might feel disconcerting, we and many others feel confident that now is a good time for founders to start companies, and for early-stage VC firms to back them.
Those raising their seed and Series A rounds now will, once the market returns to normality and the economy starts to grow, be in a strong position, with sustainability and a rational mindset baked into how they operate.
The VC ecosystem may be going through a period of correction, but there is still a great deal of dry powder available for startups particularly once they reach Series B and later. The big difference that we’ll see over the next year or so will be a return to more sensible and sustainable deals being made that are in the long-term interests of founders and investors.