European fintech faces an 'existential crisis' as funding has dropped 'from surplus to scarcity,' McKinsey report says

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• European fintech faces an "existential crisis" because the COVID-19 pandemic poses serious challenges for continued funding, according to a report by consultant McKinsey.
• Venture capital funding has become more scarce, despite the fintech sector having grown rapidly by over 25% from 2014 onwards.
• The scale of funding dropped by 11% globally and by 30% in Europe in the first half of 2020, compared to the same time a year ago, McKinsey said.
• The pandemic "has in effect shortened the runway for many fintechs, posing an existential threat to the sector."
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European fintech firms are facing an "existential crisis" as venture-capital funding has dropped from "surplus to scarcity," a McKinsey study found. 

Economies in Europe are expected to contract by 11% in 2020, before returning to pre-virus levels only in 2023. This reality brings forth a larger focus on business-model vulnerabilities and a shift in dynamics, thereby negatively influencing fintech funding, McKinsey said.

"This has brought the sector's underlying profitability and long-term business model sustainability into sharp focus—to a point where we believe the path to profitable scale for many fintechs has been structurally altered," senior partners at the consultancy wrote in the report.

The scale of funding has dropped substantially during the COVID-19 crisis after the sector grew by over 25% every year since 2014. In the first half of 2020, investment into the sector fell by 11% globally, and by 30% in Europe compared to a year-ago, McKinsey found.

Even after a slow rebound seen in European economies in July, investment fell even more sharply at 18% globally and 44% in Europe compared to the previous year.

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The report highlighted three likely trends to emerge within fintech funding:

• At-scale fintechs and some sub-sectors gaining disproportionately
• General downward pressure on valuations (it's a buyers market)
• Increased relevance of incumbent/corporate investors

McKinsey

The glaring drop poses a serious challenge for fintechs that are not yet profitable, and have consistent capital needs as they continue to work on the ideation cycle of product discovery. 

The pandemic "has in effect shortened the runway for many fintechs, posing an existential threat to the sector," the report said.

For the second half of the year, as much as 5.7 billion euros ($6.7 billion) will be required to sustain the European fintech sector, McKinsey said, citing data from Dealroom.co. There is no clarity on where these funds might come from.

Due to their pre-profit status and typically-high salaries for engineers and other talent in the sector, fintechs are unable to access loan bailout schemes, McKinsey said. The group pointed out that while venture capital will continue to back some companies, most cannot meet the required need without support. 

You can read McKinsey's full report here.

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