The first half of 2022 was the last of a period of fintech irrational exuberance that crested post-COVID-19 pandemic. During this period of euphoria, the potential for ‘embedded finance’ and fintech more generally was practically limitless, as were the valuations assigned to leading fintechs. Embedded finance had the potential to permeate all aspects of life, and to absorb the entire multi-trillion-dollar global financial services revenue pool. The second half of 2022 was the beginning of a new reality in fintech, a reality requiring grit, efficiency, and ultimately cash flow. Valuations, both public and private, came crashing back to earth. Even the best fintechs began to see their flaws in the mirror – expenses too high, margins too thin, over-estimated demand.
Now Q2 2023, we start to see a new normal. Yes, embedded finance does have limitations, and yes, you do need a business model founded on profitability and the capital to see you to the light. But we also recognise that fintech is still a great place to invest and to work. Great fintech products are improving lives, penetrating the market rapidly, and generating tremendous revenue growth.
Within this year’s report summary, we assess the new normal in fintech including a dive into the following key topics shaping the market in 2023:
Slowdown in M&A and venture funding, coming fintech shakeout
Realities of embedded finance
Software-integrated payments – an accelerating growth engine in Europe
Payment orchestration set for a breakout
Development and potential for A2A payments
B2B, the next big wave of European fintech growth.
Public equity valuations in fintech began to crash in late 2021, bringing a period of great uncertainty in 2022. Lower public valuations trickled into private valuations by mid-2022, resulting in a substantial slowdown in activity. As shown in Figure 1 below, Q1 2023 was the slowest fintech M&A and fundraising quarter since prior to the pandemic. Based on our own work, we believe that Q1 represents the bottom of the market, at least in terms of private deal activity. There is simply too much capital waiting to be deployed – and too many fintech companies that want or need capital – for the slowdown in deal activity to continue into 2024.
Figure 1: Europe – financial services M&A and fundraising deal count
We are seeing deal activity picking up, and we anticipate this will continue throughout 2023. While we expect deal activity to accelerate into H2 2023, we do not expect a return to the rosy days of 2021. Deal activity is picking up in part due to an acceleration of distressed sales. Many fintechs will fail in H2 2023 and even more in 2024. There are many hundreds of fintechs that are not prepared for a sustained period of conservative capital and high-interest rates, which is exactly what we expect. On the flip slide, H2 2023 and 2024 will provide great opportunities for well-capitalised companies to acquire strong capability assets at more reasonable valuations.
Figures 2a and 2b highlight the relative paucity of payments and fintech deal activity in Europe from Q2 2022 thru Q1 2023 (Figure 1 includes a broader universe of activity including bank fundraising). Flagship isolated payments related acquisitions and payments and related fintech fundraisings exceeding USD 10 million. Relative to this same article one year ago, the number of deals and scale of fundraising were orders of magnitude lighter than these same graphics in last year’s edition of the report.
Figure 2a: Timeline of payments acquisitions (Q2’22 – Q1’23)
Source: Global Data, Flagship Advisory Partners analysis
Figure 2b: Timeline of notable fintech fundraising (Q2’22 – Q1’23)
No fintech topic was hotter but also more misunderstood in 2022 than embedded finance. Depending on whom you ask, embedded finance effectively includes the entire universe of fintech. 2023 brings a more rational perspective. Not every use case demands embedded finance. And not every embedded finance business model is future-proofed.
Figure 3: Embedded finance in concept
Figure 3 outlines a baseline definition of embedded finance, focusing on payments, banking/issuing, and lending. Embedded payments are clearly the most mature domain within embedded finance. Payments are now deeply integrated into many forms of software, mobile apps, marketplaces, tech platforms, and other technology environments, across dozens of vertical use cases. We circle back to the ongoing development of integrated payments within the next section.
Figure 4 highlights a variety of embedded finance use cases and ranks the relative maturity of each. Embedded card issuing is also a big domain with a range of mature to immature vertical use cases (e.g., retail or airline co-branded credit cards are mature, whereas cards embedded into gig platforms or B2B software are still accelerating). Embedded bank account use cases are also expanding, although this domain is also going through some resetting, with the initial wave of neobanks and crypto platforms having crested. Embedded account-to-account (A2A) payments offer huge potential for ongoing innovation and embedding (a topic to which we also circle back).
Embedding lending, beyond credit cards, is still relatively immature although consumer BNPL accelerated into a relative state of maturing over the last decade. B2B lending – for example, trade finance – is particularly immature; we observe huge demand for embedded B2B trade finance and a wave of earlier-stage fintechs looking to supply this demand.
Figure 4: Embedded finance in practice
The huge variety of clients and use cases across the universe of embedded finance also drives many different business models. In Figure 5, we summarise these various business models. Effectively, many or even most fintechs have some form of embedded finance business model. Some, such as Banking Circle, focus on being a wholesale provider of embedded banking services for other fintechs. Others, such as GoCardless, focus on working with billing and technology partners to power A2A use cases. The lesson we took out of 2022 is that specialisation matters. In our observation, the broader your product ambition and the less focused your go-to-market orientation, the less sustainable the embedded finance business model.
Figure 5: Embedded finance business models
Source: Flagship Advisory Partners market observations
The single most important force of innovation and value-creation in North American fintech over the last decade was integrated payments, specifically the embedding of payment acceptance and payment initiation into commerce and business management software. Integrated (or embedded) payments in the US market span a huge array of C2B and B2B vertical use cases. There is a tendency to focus on embedded payments in the context of commerce software (e.g., those shown in Figure 6a), but in fact, many forms of software benefit from integrated/embedded payments in North America (including the CFO software led fintechs shown in Figure 6b).
Figure 6a: Payments revenue earned by leading commerce SaaS providers
*Note: Shopify’s payments revenues are reported under Merchant Solutions (primarily driven by payments) Source: Public financials, Flagship Advisory Partners analysis
Figure 6b: Payments revenue earned by leading CFO/B2B software providers
Source: Public financials, Flagship Advisory Partners analysis
In contrast to the US market, embedded payments in Europe are far less penetrated across the broad range of vertical use cases and vertical software platforms. As shown in Figure 7, certain verticals, such as web shop software, are also mature in Europe. But many mature verticals in the US are far less mature in most European markets (e.g., restaurants). Most verticals in Europe are still in a state of infancy on the journey toward embedded payments (e.g., B2B financial automation, professional services, etc.). In 2023 and for many years beyond, the evolution of integrated payments across verticals will power payments value creation in Europe.
Figure 7: Maturity of European integrated payments across verticals
In addition to deeper penetration of verticals, the US market is also more mature in terms of the operating and commercial models for partnerships between payments services providers and tech partners. Figure 8 illustrates the range of widely used partnership models in the US, where there are more than 250 Visa registered payment facilitators (more than half of which are software companies) and more than 1,300 Visa registered ISOs. In Europe, there are c. 150 Visa registered payment facilitators (a few of which are software companies) and c. 475 Visa registered ISOs.
Figure 8: Maturity of European integrated payments across verticals
Full payment facilitation is more challenging in Europe as money intermediation requires a payment institution license (in the US, no license is explicitly required although many payfacs determine that state-level money transmitter licenses are prudent). Setting aside certain of these types of structural differences between the US and Europe, we fully expect Europe to follow the growth pattern seen in the US over the last decade:
Deep integration and embedding of payments across most forms of vertical and functional software and use cases
Winning PSPs will have both a strong tech partner orientation and a vertical focus.
This analysis is the first part of a two-part series. To read the second part, please visit our Voice of the Industry section or click directly on THIS link.
This article was first published in ‘The Global Overview of Payments Providers 2023’, the most recent market overview and analysis of key payment providers in the B2B and B2C commerce payment ecosystem.
Joel is a trusted global advisor to the payments and fintech industry with 24 years of experience around the world. He is a recognised thought leader on strategy and value creation in payments, digital commerce, and embedded finance. Joel is also a trusted M&A advisor, having advised clients on hundreds of fintech M&A transactions globally.
About Flagship Advisory Partners
Flagship Advisory Partners is a boutique consultancy focused exclusively on payments and fintech. We provide strategy and M&A advisory support to financial institutions, PSPs, fintechs, technology providers, brands, and investors. We serve clients globally from offices in Europe and the US.
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