PE-Focused Fintech Unlocks a Multitasking Opportunity for Acquirers
Specialization among fintech innovators gives a chance for private equity investors to adopt the solutions they acquire
The financial technology (fintech) market continues to mature from an ecosystem made up of early-stage disruptors competing for venture capital backing to one made up of more established operators, ripe for growth and consolidation. Private equity investors are paying attention, and fintech has become an attractive M&A target in a tepid dealmaking environment.
More recently, a niche has emerged within fintech that targets private equity not only as a potential investor but as a customer. Innovators are exploring how technology can address finance-related challenges experienced by private equity firms and their portfolio companies.
Some industry participants and dealmakers say this presents an opportunity for PE firms to use the solutions they acquire. Such a strategy could drive modernization of PE firms’ own financial back-office operations, boost visibility into the financial health of their portfolio companies, and support customer acquisition for the fintech business—if private equity can overcome resistance to digitization.
An Attractive Investment Target
Current market volatility could generate an uptick in M&A activity within the fintech space, according to analysts.
A recent S&P Global Market Intelligence report notes that sinking share prices at publicly listed fintech companies have spilled over into the private markets, creating advantageous pricing for acquisitions and the opportunity for take-private deals. A separate Katten survey found financial services and technology to be this year’s largest investment opportunities identified by middle-market private equity leaders, similarly citing falling valuations.
“As valuations start to come down, you’ll probably see more consolidation,” says Miguel Tejeda, principal at Motive Partners, a B2B fintech-focused private equity firm. “You’ll see more actionability on assets that are really good but may not be able to raise growth rounds the way that they have historically. We’re probably entering a five-year period where the exit opportunities for these extremely exciting growth businesses, which normally would have kept financing hypergrowth until a massive IPO, are now going to bring their goals down to a more reasonable level.”
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Beyond favorable purchase prices, Tejeda says the fintech space is attractive for the sheer size of its growth opportunity. B2B fintech companies are in a particularly advantageous position, having embraced subscription and recurring revenue models targeting high-spend corporate customers with long-term contracts.
We’re probably entering a five-year period where the exit opportunities for these extremely exciting growth businesses, which normally would have kept financing hypergrowth until a massive IPO, are now going to bring their goals down to a more reasonable level.
Plus, he adds, businesses tend to view financial solutions as mission-critical, rarely on the chopping block amid market downturns and budget constraints. “You start to think of these longer-term growth drivers and a market that’s a $1.5 trillion revenue opportunity, and you realize that this is an industry you can invest in,” notes Tejeda, citing recent data from Boston Consulting Group.
Specializing for Private Equity
As private equity acquirers explore the investment opportunity in fintech, they’re also finding that fintech businesses are increasingly designing solutions developed specifically for private equity-specific challenges.
Motive Partners has seen this trend firsthand. The firm joined middle-market private investment firm Charlesbank Capital Partners last September to invest in Accordion, a company that offers financial technologies and consulting services designed to help private equity firms and their portfolio companies modernize the finance function.
Will Stuis, director within Accordion’s CFO Practice, says private equity firms have many of the same financial pain points as any business: siloed systems, poor data quality and a lack of real-time visibility.
But the fast-paced demands of the PE ecosystem, as well as tightening audit and regulatory requirements, make fintech adoption an especially impactful strategy. “Slow and complicated processes, especially around reporting, just don’t cut it,” Stuis says. The COVID-19 pandemic and current market downturn have also heightened pressure for PE firms to remain agile. “Technology allows you to be more proactive when it comes to market volatility,” Stuis adds.
John Signa, founder and CEO of E78 Partners, a middle-market PE-focused professional services firm with fintech offerings, says his past experience in private equity exposed him to the industry’s largest hurdles around financial reporting and visibility.
“I experienced how challenging it was to manage a portfolio of assets across a variety of funds,” he says. “There really was no standardized way for the 30-plus portfolio companies that we owned at the firm I was with prior to founding E78, across seven different fund vehicles, to do portfolio monitoring and valuation efficiently.”
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E78 has responded to this need by launching its Adaptive Workday product, designed to help investment firms gain widespread visibility into their portfolios, and track and report across those various lines of business. “I’ve always said private equity is another form of a holding company,” says Signa. “They own controlling interest in privately owned companies. Those companies have CFOs, they’re obligated to report results up to the private equity firm, and the private equity firm’s CFO has a fiduciary responsibility to take that information and report it to LPs.”
As the fintech space continues to mature, more solutions targeting the PE ecosystem will emerge. Tejeda says products designed to accelerate reporting and improve transparency across the portfolio, which were once limited to financial reporting, are now expanding to other areas, like ESG assessments.
Investing and Adopting
PE-backed E78 and Accordion sit at the intersection of private equity firms’ opportunity both to invest in fintech and adopt the solutions they acquire.
That’s easier said than done, however.
“PE companies tend to be more conservative in terms of adopting technologies,” notes Accordion’s Stuis, who adds that this hesitancy can extend to a firm’s own portfolio. “Introducing something new is tough for a lot of finance and accounting teams. …Bringing on a new initiative, like adopting technology—it’s not easy to fit into the day-to-day job.”
E78’s Signa agrees, noting that fintech adoption today is most common among the largest investment firms with the resources available to develop proprietary solutions. “Then you get to the middle and lower ends, where I would say adoption is incredibly low,” he says.
It’s “ironic,” Signa notes, as PE firms will often first identify digital transformation as a value creation opportunity within their own portfolio companies—yet they struggle to embrace this evolution themselves. Signa says that while its private equity sponsor hasn’t adopted E78’s solutions, the firm has been instrumental in connecting the company to the broader PE ecosystem and driving customer acquisition.
Motive’s Tejeda isn’t surprised by some PE firms’ hesitancy to adopt fintech solutions, even the ones they acquire. But he expects the space will play a very different tune in five years as market pressures drive investors to embrace differentiated strategies to boost returns and add value. PE firms can become “pseudo strategics,” he says, fostering the development of a fintech ecosystem with overlapping customers and opportunities for joint ventures.
Tejeda notes that his firm has not only implemented Accordion solutions, but such adoption should be a priority among PE acquirers.
“As a FinTech investor, we have to practice what we preach,” he says. “And there’s no better diligence than being a customer.”
Carolyn Vallejo is Middle Market Growth’s digital editor.