Fintech startups that have raised significant funds in recent years are struggling as the market outlook becomes gloomy and investors reevaluate their growth potential. Berlin-based digital bank N26, like others, recently experienced a significant drop in valuation due to several internal and external factors and has also struggled to achieve profitability since its inception. Allianz X, the corporate venture capital arm of Allianz, recently valued N26 at $3 billion, a huge discount from the previous $9 billion valuation that the neobank had in 2021.

Fintech World and its Trends
The word “fintech” derives from the combination of “technology” and “finance” and describes the new industry that democratizes, improves, and automates the delivery of financial services. It has the objective to make financial operations easily accessible through the implementation of user-friendly applications. Fintech challenges the financial sector to react quickly to changing needs and to structure its services on faster, easier-to-use, more inclusive products that improve customer experience. The revolution is driven by the fundamental understanding that technology is not something to compete with, as it was considered in the past, but an additional tool to accelerate the development of the financial industry. Looking at the role that fintech has in our everyday lives and at its incredible development, it is easy to forget that the fintech industry, as we know it today, did not exist before the late 1990s. The basis for its growth was set in the 70s and 80s, with the invention of the internet and subsequently electronic banking in the financial sector. Since then, it has been characterized by rapid and dynamic changes.

The development of the fintech industry may be related, at least partially, to the general health of the banking sector. Indeed, the 2008 financial crisis has been an inflection point in fintech history. The lack of trust in the banks, together with regulatory changes, opened the market to new providers of non-traditional banking and financial services. It was the beginning of an ‘era of start-ups’, with venture capital raising billions to drive the wave of innovative technology applied to finance-related products and services. The beginning of 2023 brought about a whole different scenario: the crisis of the US banking sector has worsened an already complex situation of global uncertainty. The increase in investors’ risk aversion towards traditional banks negatively affected the fintech industry, reversing a trend of impressive growth between 2020 and 2021. Even if still highly influenced by the banking environment and its health, the fintech industry is developing its independent alternatives to challenge traditional financial institutions. Among them, neobanking has been one of the most successful. A neobank is a type of bank that operates exclusively digitally, providing its services like payments, debit cards, money transfers, lending, and others via mobile and desktop devices. There are two principal categories of neobanks: those with a banking license, including N26, and those without. The neobanking industry is relatively recent but its growth has been exponential: its global market size has grown from $79.1 billion in 2022 to $118.51 billion in the first months of 2023, with a compounded annual growth (CAGR) of 49.8%. From the beginning of this stunning development in 2017, the number of users has more than quintupled, peaking at 145 million in 2021 after the COVID-19 pandemic with expectations of even faster growth in the upcoming years. US’s market share in the neobanking sector has been decreasing, leaving more space for Europe, which is currently the largest region looking at a cumulative transactions value of about $570 billion in 2022. Furthermore, during the years of the pandemic, Germany registered one of the highest numbers of users in digital banking, ranking just after the US. Surely, this “European trend” is driven by a favorable regulatory environment, as well as the presence of some of the biggest players in the market like N26.

The Rise of a Unicorn: N26 
N26, known as Number 26 until July 2016, is a completely digital bank headquartered in Berlin, founded in 2013 and launched in 2015, making it one of the first digital banks. 
As a neo-bank, N26 operates online without a physical branch network and offers both traditional and personalized services using technology and leverages artificial intelligence in its products. Due to the full German banking license attested by the BaFin in 2016, N26 is certified to meet all government regulations, ensuring all customers with its safety and transparency. 
Initially launched in 17 different European markets, N26 aims to be the first ‘global app-only bank’. It provides a fee-free deposit account that can be opened directly by computer or phone in less than 8 minutes. The bank account offers all the services provided by a traditional bank account such as depositing and transferring money from different accounts, withdrawing money from any ATM, and additionally, customers can request overdraft or investment products. The services offered do not imply any fee and this also applies to basic banking transactions or credit card payments in foreign currencies. The company has built its business model around providing a seamless and user-friendly banking experience through its mobile app, which includes features such as real-time spending notifications, budgeting tools, and easy money transfers. Additionally, every account is insured by the German Deposit Protection Scheme or Compensation Scheme of German Banks for up to €100.000 in all the countries where N26 is available. 
 
In 2015 Europe’s first mobile bank accounts were launched without holding a banking license using an interface provided by the later-on exposed fraudulent Wirecard. In the same year, N26 received €10 million in the first series A round by Valar Ventures. In 2016, once BaFin granted the license, customers were asked to transfer their accounts to N26 Bank's infrastructure, getting a new IBAN (International Bank Account Number) number. A second round of funding occurred in 2018 of $160 million by Tencent Holdings and Allianz X. With this transaction, Allianz X, the digital investments arm of Allianz Group, became one of the group’s largest external investors, holding more than 5% of N26. In the same year, N26 reached 2 million customers across 24 different countries. One year later, N26 raised an additional $300 million in a series D round, led by Insight Venture Partners, reaching a valuation of $2.7 billion. In July 2019, the platform was launched in the US and the series D round was extended with an additional $170 million investment, valuing the company at $3.5 billion. By the beginning of 2020, N26 ceased doing business in the UK since, after Brexit, financial institutions could operate there only with a particular British banking license. Two years later, in January 2022, pulled out of the US market, a move that was induced by N26’s desire to focus on the core European business and the intention to develop new services for its European clients. After a series of extensions and new raising, the digital bank was valuated at $9 billion and declared as Germany’s highest-valued fintech by the end of 2021 and over 8 million customers worldwide in 2022. However, In April 2023, Allianz X, an investor in the neobank, conducted a revaluation of its stake in preparation for a possible sale. The outcome was a valuation of around 3 billion, which represents a discount of around 60%. Despite this discount, if Allianz decides to sell now, it would still be able to triple its initial investment in five years, yielding almost €160 million.

N26 Funding Rounds
Source: Crunchbase

The rationale behind a huge discount
Fintech has been a very hot topic in the past years with several VC funds constantly seeking investments in this sector. This pushed many entrepreneurs to dive into industry resulting in hundreds of startups, especially in the online financial services sector, many of which managed to raise significant amounts of money. These newly established companies expanded very quickly employing a lot of workers. As a result, many companies are struggling and realizing that they had over-expanded in the past years, and many are laying off staff. Those who will remain will establish themselves in the market and establish rather large market shares allowing them to benefit from the projected growth of the industry. N26's drop in valuation can be explained by various reasons. First, rising inflation forced Western central banks to raise aggressively interest rates, which significantly increased the cost of new capital for start-ups. The increase in discount rates has caused the current value of future earnings for tech companies, whose worth is mostly determined by projected cash flow, to rapidly decrease. On the other hand, investors started to reevaluate the real growth potential of fintech start-ups in times of a gloomy economic outlook. This will make it more difficult for N26 to raise money through other funding rounds in the future, possibly slowing N26’s growth. In 2021, N26 added only half the number of customers that it added in 2020, going from 2 million new customers yearly to 1 million. Another important factor to note is that N26 has not yet been able to report a profitable year since its inception. In fact, since its last funding round N26’s yearly net losses kept growing from -172 million in 2021 to -180 million in 2022.

N26 Net Income
Source: Statista & N26 

Many fintechs like N26 have been subject to huge drops in their valuation affecting their valuations, plans for an IPO, and additional funding rounds. Just last year, the European tech industry lost over 400 billion in value. Fintech was among the subsectors that were affected most. As mentioned before, N26s’ valuation dropped by 60%. Klarna, a buy-now-pay-later provider, raised 800 million at a valuation of $6.7 billion in a previous funding round, while only receiving additional funding at a valuation with an 80% discount in 2022. Another fintech company that was affected is Checkout.com with its external valuation, during one of its previous funding rounds at $40 billion, however, now the company internally values itself at $11 billion. This drop in valuation in the industry (the listed fintechs) is also made visible by the STOXX Global Fintech Index which includes fintech leaders like Visa, Mastercard, and PayPal, which underperformed the S&P 500 last year.

STOXX Global Fintech Index vs. S&P 500 from January 2020 until today
​Source: States

A gloomy outlook for a fintech like N26?
The high net losses combined with N26’s internal problems and the eventual exit from the UK and USA markets forced them to change their internal strategy from a growth-focused one to prioritizing financial health and operational efficiency. The urgency of this shift in their internal strategy is also emphasized by their recent promise to investors to reach break-even without the need for additional funding. To offset this slower growth, there were talks that the company would issue hybrid bonds, but the plan was quickly scraped after the controversy with AT1 Credit Suisse bonds. This has left N26 in a difficult position as previously it had promised that the last funding round was a Pre-IPO one, but its financial health says that they need at least another funding round before its IPO. After the collapse of payments firm Wirecard in 2020, the German financial regulatory authority BaFin has been constantly tightening regulations. BaFin fined N26 €4.25 million in 2020 due to delayed reports of suspicious activity in money laundering. Even more importantly, BaFin has limited N26 to only 50.000 new customers per month, a decrease from the previous limit of 170.000 new customers, severely hindering their growth potential. N26 has also been at a disadvantage compared to competitors due to the limited range of products in its app. It has struggled to add features like equities trading and it still doesn’t have the tech necessary to pay interest rates on overnight deposits. In order to enrich their product line, N26 wanted to buy Dutch broker Bux, but in the end, the deal didn’t go through. The reasons for the failure of this deal are not clear yet, but a few “rumors” have circulated. One of the rumors says that, because Bux had delayed their funding round, N26’s leadership believed that they would be desperate to make a deal. N26 lowered their initial offer of €200 million and Bux eventually rejected the bid. Another rumor says that the deal did not go through, because of Bux’s controversial contract-for-difference trading, which left retail investors exposed to large losses. To add even more, N26 saw three of its top managers leave very recently, with another one that has already noticed his departure. The managers’ reasons mainly regarded leadership and poor governance issues accusing the two co-founders of promoting a “culture of fear” that threatened to drive the group into a “downward spiral”. The co-founders were accused of a “lack of trust in executives and broad organization” that was resulting in “confusion”. In a scathing critique, Tayenthal and Stalf were also said to have a habit of “rewriting history on agreed topics” and a tendency to “shoot the messenger” if decisions taken turned out to be wrong. In addition, the new supervisory board led by Marcus Moses has conflicts of interest with the CEO as they have been acquaintances for a while. But is this a good moment for Allianz to sell its stake, or will N26’s valuation benefit from the projected growth of the online banking sector? As more consumers shift their financial activities online, N26's digital-first approach is well-positioned to capture a growing share of the market. In addition to its core banking services, N26 has introduced a range of additional products and services, including insurance, investment products, and premium account offerings. By diversifying its product offerings, N26 is able to attract a wider range of customers and generate additional revenue streams. However, whether N26 will manage to establish itself in this sector will depend on the extent to which it manages to overcome a series of issues the company currently faces. The bank said in a statement that it will be “launching interest-bearing savings this quarter”, adding that an “N26 trading product” will go live “within the next 12 months”. Regarding BaFin’s restrictions on new customers, N26’s leadership had constantly believed that this limit would’ve been removed. However, since the reasoning for the limit was that the company still hasn’t “put a proper business in place”, N26’s top management should focus on their internal leadership and poor governance issues. Solving these issues would probably ease BaFin’s regulations and help remove the limits which would allow N26 to onboard more than three times the customers it currently does. Overall, the outlook for N26 is positive given the potential for continued growth and expansion in the global fintech market. N26's timing and effectiveness in approaching each issue it currently faces will play a very important role to drive its future success. While the macroeconomic situation is likely to remain rather critical in the medium run, N26's strong brand and focus on digital innovation and customer-centric services position it well for future growth in the fintech industry also considering its potential to expand geographically to further grow its customer base.

Sources:
Financial Times
Crunchbase
Statista
SVB Fintech Research
Reuters