Funding Circle achieved an IPO in September 2018, raising £300 million and valuing the company at £1.5 billion. Since then the share price has fallen by around 70 percent (as of October 2019). The market capitalisation of the company is now less than the total equity that has been invested in the business since inception in 2010.

An interesting aspect of this case is that the current price is still above the level of the share price in the first 4 venture rounds (the 4th round was in 2013). Many of the investors in these early rounds would have sold out at the IPO and made a substantial gain. However, the current price is below the level at which shares were issued in the 5th, 6th and 7th rounds of venture investment – and some of these investors were not able to sell all their holdings at the IPO because of lock-ins.

This weak share price performance could be any combination of company specific issues, problems with the business model of online lending marketplaces, or an issue with fintech valuation more generally. However, it illustrates the challenges for later round investors in highly valued fintech companies. Excessive valuations at early rounds can also be a problem for founders and early stage investors if an exit is not achieved at a level above the later round valuations. This can lead to heavy dilution if later stage investors are given downside protections.

It is clear from my research on fintech financing, performance and valuation that the marginal returns for investors at later stages of investment for companies that have been operating for several years are relatively low. Some of this investment will be existing investors putting more money into the companies to keep them going as they get closer to an IPO or trade sale, but new investors in these later rounds are more exposed to downside risk.

We also know from the research that the vast majority of fintech start-ups are losing money, and even most of those operating for more than 5 years are continuing to lose money. Funding Circle was a good example. In some cases, these companies are reporting that profitability is imminent, or that they are profitable already in their home market while they invest heavily in expansion into new markets.

Recently, the digital bank N26 has raised US$170 million and said that profitability is not a core metric they are focusing on. However, founders and investors need to be careful they are not deluding themselves about the underlying profitability of the businesses they are creating or relying on vague ideas of cross selling more profitable products in order to get to profitability.

Valuation is an imprecise science, particularly for private companies with limited data available. Externally visible metrics like revenues or customer numbers are not good guides to valuation in at least the first 5 years of operation for a start-up. The case of Funding Circle suggests that there are different perceptions of valuation between private and public markets, and that high valuations are extremely fragile for unprofitable fintech companies with business models which have not been proven in the long term.