Although traditional merger and acquisition activity has slowed in 2023, many banks are showing increased interest in acquiring financial technology companies. As boards and executive teams consider technology strategies, they should begin with a clear understanding of the economic factors behind this trend, along with the risks and challenges inherent in fintech acquisitions.
What’s Driving Fintech Acquisitions
Rather than collaborating through joint ventures or other contractual arrangements, many banks today are opting to either acquire fintechs outright or make significant controlling investments in technology companies.
Such acquisitions often target tech companies that are developing or deploying payment-handling systems, specialty lending applications or mobile banking platforms. Wealth management platforms have also generated some interest among acquisition-minded banks. Many banks also are pursuing additional banking as a service capabilities.
The focus on fintech acquisitions is driven by several factors, the most obvious being changes in the technology sector. Some tech company valuations have plunged in the past two years, making them much more attractive acquisition targets. In addition, the downturn in capital markets has limited the ability of some fintechs to access funding via equity investments, making them much more amenable to being acquired outright.
At the same time, today’s higher interest rate environment provides more robust revenue streams to fund banks’ acquisition strategies. A natural consequence of attractively priced available targets is an increase in bank-fintech acquisitions.
When one bank acquires another, the two organizations generally have a common understanding of the basics of the business and the regulatory environment. That often is not the case when a bank acquires a technology company.
Regulatory factors. Fintechs sometimes struggle to understand what it means to operate in a highly regulated industry. Sellers often are surprised at the questions bank executives ask during due diligence, unaware of the information banks need to disclose to regulators to demonstrate the deal’s feasibility.
Cultural and strategy factors. Beyond regulatory issues, there often are fundamental philosophical and cultural differences between the two organizations. Fintechs have different business priorities, with a greater emphasis on growth and expanding the user base and less focus on cost and regulatory issues. Other significant differences might exist in compensation agreements and pay scales for core employees, complex ownership structures and a generally less mature risk management approach.
Market factors. Banks also should bear in mind that they might be competing with private equity buyers or other bidders that are under pressure to minimize idle capital and invest funds quickly. This can put banks at a competitive disadvantage as they cope with pricing limitations and regulatory costs. Directors and executives should not grow frustrated or relax their discipline if they get outbid.
The Board’s Role
Banks seeking to acquire fintechs need to dust off their M&A playbooks, think through the process and anticipate what could go wrong. For their part, boards should begin by having a clear conversation with the executive team about the directors’ view of today’s environment. They should ask management to help them understand what conversations the bank is having with fintechs, what opportunities bank executives are considering and how the team approaches those opportunities.
Board members also should consider how today’s environment could affect the bank’s strategic plan, particularly in terms of how the plan addresses technology. If the strategy already embraces fintech acquisitions as a viable tactic, it is time to consider how today’s trends can affect that strategy. On the other hand, if technology is not integral to the strategy, it could be time to revisit and adjust the plan. Boards should not be reactive or chase after popular trends, but it can be prudent to at least review the strategy in view of changing circumstances.
Finally, when management proposes a fintech acquisition, directors should be sure they have a full picture of all the potential risks and costs. Critical considerations include:
The bank’s existing regulatory burden and what aspects it will need to enhance.
Other contracts the fintech already has in place and any conflicts or costs associated with them.
That the fast-growing fintech’s infrastructure might not fit with the bank’s structure and systems.
Other hidden weaknesses stemming from the technology sector’s current pressures.
Gaining a good understanding of the potential risks of a tech acquisition can be time-consuming, but it is a fundamental board responsibility. In view of the current frequency of such transactions, directors must take extra care to verify that their bank is taking a disciplined approach.
If an outright acquisition is not feasible for the bank, directors might explore fintech partnership opportunities and can find a third party to help navigate opportunities and their inherent finance, risk, compliance, and privacy and security considerations.