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11:YEARS part four: investment
In the fourth part of our series, we take a close look at the factors that encouraged investment in UK fintech after Financial Crisis of 2007-8.
But after an inspiration, an idea and a team comes money, and the industry is currently flush with it. In 2018, the UK fintech sector attracted £3.3 billion in investment, which flowed in from all over the world. Whether backed by private equity, venture capital or corporate venture capital, UK fintech has attracted a wealth of funding in its relatively short lifetime.
So it’s worth asking: how did we get here?
A number of government tax incentives boosted the flow of money coming into start-ups from smaller investors, many of whom were affluent individuals (known as angel investors). Chief among them were the EIS (Enterprise Investment Scheme) and the SEIS (Seed Enterprise Investment Scheme), as well as Research and Development (R&D) tax credits.
The EIS encourages investment into start-ups and growth-stage businesses across all industries. Under the scheme, investors receive relief on income and capital gains taxes if they purchase new shares with a total value of less than £1 million and hold them for a minimum of three years.
Once investors understood the potential of digital-only firms, they began to see them everywhere
Launched in 2012, the SEIS helps start-ups and early stage businesses find funding as they start to trade. Investors are exposed to greater risk compared to the EIS, but the potential rewards are greater as well: up to 50% of the investment can be claimed back in income tax relief, and the SEIS also provides significant reductions to capital gains taxes.
In addition to the EIS and SEIS – both of which encouraged significant angel investment in fintechs – R&D tax credits rewards companies that put money into the development of innovative technology. Eligible firms can claim cash payments and/or tax reductions depending on whether they are profit- or loss-making.
Many digital-only firms recovered from the financial crisis relatively quickly. Their proficiency with new technology helped them adjust to the new market environment, which included a renewed focus on maximising profitability. Companies like Google even succeeded in attracting the attention of investors who had been wary of the industry since the dot-com bubble of the late 1990s.
Once investors understood the potential of digital-only firms, they began to see them everywhere. After 2008, other fintechs started to demonstrate that success in the field could be replicated which added to the segment’s appeal.
UK fintechs offered an attractive alternative. Regulators didn’t just accept these firms; they encouraged them
The peer-to-peer lending industry did particularly well after the crisis. Many of its firms were founded before 2008, so they were able to leverage their experience and capitalise on banks’ reluctance to lend, attracting more investors in the process.
The regulatory changes introduced post-2008 also helped UK fintechs prosper. The US fintech industry was already well-established at this point, but its regulatory environment remained confused. As a result, investors were hesitant to put money into firms whose activities could be declared illegal at any point.
UK fintechs offered an attractive alternative. Regulators didn’t just accept these firms; they encouraged them. This boosted their appeal to both domestic and international investors.
As of October 2019, Brexit and the resulting political instability have yet to impact the volume of fintech investment. Investment in 2019 could even be on track to exceed 2018’s totals, according to Innovate Finance.
It should be noted, however, that while the volume of capital is increasing, the number of deals declined in H1 2019, continuing a UK fintech investment trend. That decline is potentially worrying: it suggests more money is flowing to fewer companies, which could lead to earlier-stage and small-scale companies basing themselves elsewhere to get the funding they need. A thriving ecosystem needs a constant stream of new entrants to ensure ongoing competition and innovation.
It seems likely that the UK will continue to entice those seeking good value investments
That said, firms attracting larger rounds later and scaling internationally are doing a job of representing UK fintech. The region has a history of successful companies, which appeals to investors. It also sets a positive example for new firms, and its network of experienced founders boosts its attractiveness for would-be investors.
Overall, it seems likely that the UK will continue to entice those seeking good value investments. While returns are not yet on par with the US, they are becoming increasingly likely.
Combined, these factors will stand the UK fintech sector in good stead when it comes to attracting the funding it needs to flourish.