No profit, no funding - FinTech and high-growth businesses' hunt for profitability
For those of us in the startup ecosystem, it's not been an easy month so far. The winds have shifted for startup funding – that’s all anyone is talking about in the space.
In 2021, 46 new unicorns were created, and India’s startup ecosystem pulled $42 billion in funding. However, as the current year passes us by, there are fewer unicorn sightings, an epidemic of lay-offs, and an overall environment of cutting costs.
What dulled the sheen of investing in these companies? Funding has sapped, thanks to slashed interest rates, inflation, the rise in fuel prices following the Russian invasion of Ukraine, and the hit taken by tech company valuations the world over.
Investors are now indiscriminately tightening their purse strings. The picture becomes clearer when you see the measures taken by some of the biggest investors. Here’s a snapshot for context:
Tiger Global led investment rounds in 13 unicorns in 2021 and participated in a total of 22. In 2022 so far, it has only backed five unicorns and was the lead investor in just two.
After losing $26 billion to its Vision Fund, SoftBank announced it will invest only a half or quarter of its total investment in 2021.
Silicon Valley’s Y Combinator cautioned founders to ‘plan for the worst’ as the next six months or one year would peak the downturn.
What investors want
Across the board, investors are urging existing founders on their portfolios to rein in costs and save cash as funding projections seem bleak for the future. Unsurprisingly, axing employees is what most companies have resorted to. Vedantu, Cars24, Unacademy, and more fell victim to the summer of lay-offs.
Moreover, funding, where there is any, favors companies with clear business models and long-term profitability on their radar instead of short-term scalability. As a result, companies with high cash burn models are being left out, while startups with strong unit economics are able to secure investment.
The challenge, however, is that profitable companies are rarer than a unicorn among startups. In 2021, of India’s 100 or so unicorns, only 19 were profitable – most of them by razor-thin margins.
But here’s the good news. As their investor prospects suddenly turn conservative, startups bedazzled by the goldrush of 2021 are inspecting the bones of their business models. And startups with high-cash burn core offerings are correcting their long-term business strategies for profit generation by monetizing ancillary services.
Businesses burning cash are creating inroads into profitability by cross-selling financial services.
Companies are embedding financial services into their platforms and leveraging it to create additional revenue streams. But can non-financial companies take advantage and branch out into financing while also cutting corners?
My sense is, market players know that in this highly competitive environment, hitting the brakes on innovation is in no way the solution.
Yes, building a financial services arm in-house comes with several costs like the cost of building new credit models, technology costs, and a large human resources cost for financial pros needed to build and run a financial offering. But non-financial startups are now finally accepting the thesis that the road to better unit economics goes through building new revenue streams, and fintech - for all its lure and definitive margins - is the top contender for the job.
Check out our blog for more on whether building a fintech offering hurts core business.
Nuts and bolts
Uber’s seamless in-app payments or Tesla’s car insurance come to mind when you think of embedded finance. However, smaller non-financial companies closer home are now starting to integrate financial services into their platforms.
For instance, expense tracking apps leverage platform data to offer loans to users on the app. E-commerce players with large order sizes are plugging buy, now-pay later at the time of checkout. Online retail-tech companies are rolling out credit lines on the platform for merchants to grow their businesses.
The question then remains – how has in-platform financing broken ground for improved profitability? How can it open the floodgates for more business opportunities for non-financial companies? This is a question with various answers depending on the company type, scale, products offered and so on but here's an attempt to answer it briefly:
Customers simply transact more when financing is offered within an app, at the point of sale, without breaking the user journey. They place larger orders, giving a boost to volume and value. This results in improved economies of scale.
Sourcing new customers and retaining existing ones become cheaper than advertising. Platforms reduce costs of customer acquisition while also increasing customer lifetime value.
It creates a flywheel for improved subscription revenue as users utilize the financing to grow their business and become more likely to buy the platform subscription.
Platforms enter revenue-sharing partnerships that allow them to charge lenders for exposure to their customers or charge a fee on each loan disbursed.
Businesses reduce multiple supplier dependencies by consolidating the product/service and financing in one place. This makes their platform the go-to marketplace for all their needs.
To conclude
The present investment climate has woken us up to the sober reality that businesses that last are built to last – with the long-term objective of profitability. The accurate valuation measure can’t just be the shiny new product, but whether or not the business model supporting it is strong enough. And for high-growth companies, embedding finance offers perhaps the most straightforward route to amping up that contribution margin.
I will see you next week.