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Bill Harris, former PayPal The CEO and veteran entrepreneur took to a stage in Las Vegas in late October to declare that his latest startup would help fix Americans’ fractured relationship with their finances.

“People fight with money,” Harris told CNBC at the time. “We’re trying to bring money into the digital age, redesign the experience so people have better control over their money.”

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But less than a month after launching Nirvana Money, which combined a digital bank account with a credit card, Harris abruptly shut down the Miami-based company, laying off dozens of employees. Rising interest rates and a “recessionary environment” are to blame, he said.

The reversal is a sign that more carnage is yet to come in the fintech world.

According to investors, founders and investment bankers, many fintech companies — particularly those that deal directly with retail borrowers — will be forced to close or sell themselves over the next year as startups run out of funding. Others will accept financing at deep haircuts or onerous terms, which extends the runway but comes with its own risks, they said.

According to Pete Casella, partner at Point72 Ventures, high-profile startups can weather the storm with three to four years of funding. Other private companies with a reasonable path to profitability usually receive funding from existing investors. The rest will run out of money by 2023, he said.

“What eventually happens is you get caught in a death spiral,” Casella said. “You can’t get funding and all your best people are jumping overboard because their equity is underwater.”

‘Crazy Stuff’

Thousands of startups were formed after the 2008 financial crisis, when investors poured billions of dollars into private companies, encouraging founders to try to disrupt an entrenched and unpopular industry. In a low interest rate environment, investors sought yield beyond public companies and traditional venture capitalists began to compete with newcomers from hedge funds, sovereign wealth and family offices.

The movement shifted into high gear during the pandemic as years of digital adoption rolled into months and central banks flooded the world with money and pushed companies to become similar Robin Hood, Chime and Stripe are household names with huge reviews. The frenzy peaked in 2021 as fintech companies raised more than $130 billion and coined more than 100 new unicorns, or companies valued at least $1 billion.

“In 2021, 20% of all VC dollars went into fintech,” said Stuart Sopp, founder and CEO of digital bank Current. “You just can’t put that much capital into something in such a short amount of time without crazy things happening.”

The flood of money meant that whenever a winning niche was identified, copycat companies were funded by app-based checking accounts known as neobanks to buy now and pay later entrants. Companies relied on shaky metrics like user growth to raise money at staggering valuations, and investors hesitant to bid on a startup round risked missing out as companies’ values ​​doubled and tripled in months.

The thinking: Attract users with a marketing blitz and then figure out how to monetize them later.

“We overfunded fintech, no question about it,” said one founder-turned-VC, who declined to be identified, to speak openly. “We don’t need 150 different neobanks, we don’t need 10 different banking-as-a-service providers. And I’ve invested in both categories,” he said.

An assumption

The first cracks appeared in September 2021 when shares of PayPal, block and other public fintechs began a long decline. At their peak, the two companies were worth more than the vast majority of established financial institutions. PayPal’s market capitalization has been surpassed only by that of PayPal JPMorgan Chase. The specter of higher interest rates and the end of a decade-plus era of cheap money were enough to drain their stocks.

Many private companies formed in recent years, particularly those that lend money to consumers and small businesses, had a key assumption: Low interest rates forever, according to TSVC partner Spencer Greene. This assumption has come up against the Federal Reserve’s most aggressive rate-hike cycle in decades this year.

“Most fintechs have been losing money their entire existence, but with a promise, ‘We’re going to see it through and be profitable,'” Greene said. “That’s the standard startup model; it was true for Tesla and Amazon. But many of them will never be profitable because they were based on wrong assumptions.”

Even companies that previously raised large amounts of money are now struggling when they are unlikely to become profitable, Greene said.

“We saw a company that raised $20 million that couldn’t even get a $300,000 bridging loan because their investors told them, ‘We’re not investing a dime,'” Greene said. “It was amazing.”

Layoffs, rounds of failure

Throughout the lifecycle of a private company, from embryonic startups to pre-IPO companies, the market has declined at least 30% to 50%, according to investors. That follows the decline in public company shares and some notable private examples, like the 85 percent rebate Swedish fintech lender Klarna snagged in a July fundraiser.

Now, with the investment community exhibiting newfound discipline and tourist investors being flushed out, the focus is on companies that have a clear path to profitability. This is in addition to previous requirements for high growth in a large addressable market and software-like gross margins, according to veteran fintech investment banker Tommaso Zanobini of moelis.

“The real test is, does the company have a path of shrinking its cash flow needs that will get you there in six months or nine months?” Zanobini said. “It’s not, trust me, we’ll be there in a year.”

As a result, startups are laying off employees and retiring from marketing to lengthen their runways. Many founders are hoping that the funding environment will improve next year, although this seems increasingly unlikely.

Neobanks under fire

As the economy slows further into an expected recession, companies that lend to consumers and small businesses will suffer significantly larger losses for the first time. Even profitable legacy players like it Goldman Sachs Unable to sustain the losses needed to create a scaled digital player, it withdrew its fintech ambitions.

“If loss rates go up in an environment of rising rates on the industry side, that’s really dangerous because your economics on credit can get really thrown off balance,” said Justin Overdorff of Lightspeed Venture Partners.

Now investors and founders are trying to figure out who will survive the coming downturn. Direct-to-consumer fintechs are generally in the weakest position, several venture investors have said.

“There is a strong correlation between companies that have had poor economic performance and consumer companies that have become very big and very famous,” Point72’s Casella said.

Many of the country’s neobanks “just aren’t going to survive,” said Pegah Ebrahimi, FPV Ventures managing partner and former MorganStanley Executive. “Everyone thought of them as new banks that would have tech multiples, but at the end of the day they’re still banks.”

Outside of neobanks, most companies that have raised money in 2020 and 2021 with nosebleed valuations of 20 to 50 times revenue are in a predicament, according to Mesh Payments CEO Oded Zehavi. Even if such a company doubles revenue from its most recent round, it’s likely to have to raise new funds at a deep discount, which can be “devastating” for a startup, he said.

“The boom resulted in some really surreal investments with valuations that can’t be justified, maybe ever,” Zehavi said. “All of these companies around the world are going to struggle and need to be acquired or shut down in 2023.”

M&A flood?

However, as in previous down cycles, there are opportunities. Stronger players will win over weaker ones through acquisitions and emerge from the downturn in a stronger position, enjoying less competition and lower costs on talent and expenses, including marketing.

“The competitive landscape changes most in times of fear, uncertainty and doubt,” said Kelly Rodriques, CEO of Forge, a trading venue for private company stocks. “Here the brave and the well capitalized will win.”

While private stock sellers were generally willing to accept larger valuation discounts during the year, the bid-ask spread is still too wide as many buyers wait for lower prices, Rodriques said. The deadlock could break next year as sellers become more realistic about pricing, he said.

Bill Harris, co-founder and CEO of Personal Capital

Source: Personal Capital.

Ultimately, established companies and well-funded startups will benefit, either by buying fintechs outright to accelerate their own development, or by picking up their talent as startup workers return to banks and wealth managers.

Although he didn’t reveal during an October interview that Nirvana Money would soon be among those to be shut down, Harris agreed that the cycle was turning against fintech companies.

But Harris — founder of nine fintech companies and first CEO of PayPal — insisted the best startups would survive and ultimately thrive. The opportunities to disrupt traditional players are too great to ignore, he said.

“In good times and bad, great products win,” Harris said. “The best of the existing solutions will emerge more prominently, and new products that are fundamentally better will also win.”