Fintech venture capital

• Author: Armin Schwienbacher,Douglas J. Cumming
• Date: 01 September 2018
• Published date: 01 September 2018
• DOI: http://doi.org/10.1111/corg.12256

SPECIAL ISSUE ARTICLE

Fintech venture capital

Douglas J. Cumming

1,2

|Armin Schwienbacher

3

1

DeSantis Distinguished Professor of Finance

and Entrepreneurship, College of Business,

Florida Atlantic University, 777 Glades Road,

Boca Raton, FL 33431, USA

2

Visiting Professor, Birmingham Business

School, University of Birmingham, Edgbaston,

Birmingham B15 2TT

3

Department of Finance and Accounting,

SKEMA Business School—Université Côte

d'Azur, SKEMA Business School, Avenue Willy

Brandt, F‐59777 Lille, France

Correspondence

Armin Schwienbacher, SKEMA Business

School—Université Côte d'Azur, SKEMA

Business School, Department of Finance and

Accounting, Avenue Willy Brandt, F‐59777

Lille, France.

Email: armin.schwienbacher@skema.edu

Abstract

Manuscript Type: Empirical

Research Question/Issue: Where are fintech venture capital investments taking

place around the world? What is the role of institutional factors on the international

allocation of fintech venture capital?

Research Findings/Insights: We document a notable change in the pattern of

fintech venture capital (VC) investments around the world relative to other types of

investments after the global financial crisis. We show that fintech venture capital

investments are relatively more common in countries with weaker regulatory enforce-

ment and without a major financial center after the financial crisis. Also, we show the

fintech boom is more pronounced for smaller private limited partnership venture cap-

italists that likely have less experience with prior venture capital booms and busts.

These fintech VC deals are substantially more likely to be liquidated, especially when

located in countries without a major financial center.

Theoretical/Academic Implications: We build on the institutions and corporate

governance literatures by showing the importance of enforcement in driving relative

differences in investment patterns and investor participation. For entrepreneurial

startups, regulatory arbitrage drives investment into countries with a dearth of

enforcement and regulatory costs. We argue that the spike in fintech venture capital

in certain countries is attributable to differential enforcement of financial institution

rules amongst startups versus large established financial institutions after the finan-

cial crisis.

Practitioner/Policy Implications: Regulatory arbitrage in the context of fintech ven-

ture capital can spur booms and busts. Less experienced venture capitalists seem

more prone to undertake investments that exacerbate boom and bust cycles. National

governance is strengthened by the enforcement of regulatory standards, and corpo-

rate governance through investor experience and oversight can mitigate these swings,

and facilitate better investment outcomes.

KEYWORDS

Corporate Governance, International Venture Capital, Fintech, Financial Regulation, Regulatory

Arbitrage

“… without the financial crisis and the popular anger it

spawned against the whole banking system, there

would be no fintech”—“Fintech's Wakeup Call”,

Bloomberg, February 22, 2016

1

“After the 2008 crisis, banks faced additional capital

adequacy requirements and also came under fire for

non‐compliance on existing rules. So while fintech

startups are still subject to many of the same rules as

Received: 3 August 2017 Revised: 26 May 2018 Accepted: 3 July 2018

DOI: 10.1111/corg.12256

374 © 2018 John Wiley & Sons Ltd Corp Govern Int Rev. 2018;26:374–389.wileyonlinelibrary.com/journal/corg

their traditional counterparts, they don't have the

added burdens that come with litigation, fines and

other penalties that several large institutions have

had to deal with in recent years.”—“An Inside Look at

Fintech Marketplace Lenders”, Forbes, February 27,

2016

2

1|INTRODUCTION

Recent research has shown that corporate governance issues are fun-

damentally different in young entrepreneurial firms than in large, well‐

established ones, and that these issues may vary across countries

(Armitage, Sarkar, & Talaulicar, 2017; Bjørnskov & Foss, 2013;

Djankov, La Porta, Lopez‐de‐Silanes, & Shleifer, 2002; Luo & Junkunc,

2008; Wright, Westhead, & Ucbasaran, 2007). While the latter has

been studied extensively, the former has recently attracted much

interest in connection with entrepreneurial firms active on a global

scale (Zahra, 2014). Firms may obtain a comparative advantage when

located in countries with more favorable regulation, as they can

reduce their costs, enabling innovations to be developed that are more

difficult to implement in countries with more stringent regulation

(Blind, 2012; Bozkaya & Kerr, 2014; Braun, Eidenmüller, Engert, &

Hornuf, 2013; Dharmapala & Khanna, 2016; Hornuf & Schwienbacher,

2017; Levine, Lin, & Shen, 2015; Wang & Wang, 2012). Empirical evi-

dence suggests that differential enforcement of law may drive the

structure of corporate governance and patterns of startup activity. In

this paper, we examine a specific industry—‘fintech’, or financial tech-

nology—to see whether or not differential enforcement of banking

rules around the world affects the financing patterns of fintech

startups, including the shareholder structure and type of investors par-

ticipating in the financing. We further examine the impact on these

firms of going public.

Recent years have seen an increasing amount of hype about

fintech, and venture capital (VC) fintech in particular, around the

world. The hype in some camps is sufficient to remind some practi-

tioners of the dotcom bubble from 1998 to 2000. For example, at a

March 2016 seminar at the law offices of McCarthy Tétrault in

Toronto, one senior practitioner was overheard saying that some of

the junior roundtable participants should “settle down!”because “they

are not old enough to remember the dotcom bubble”.

The new fintech wave is also driven by ventures and no longer

just by investments by incumbents in internal projects. The worldwide

investment volume in fintech ventures amounted to US$12.21 in

2014 (Accenture 2015), and grew to US$27.4 billion in 2017

(Accenture, 2018). This new wave has been attributed by some

researchers and practitioners to the financial crisis for at least two rea-

sons (Arner, Barberis, & Buckley, 2015; Kelly, 2014). First, many skilled

employees of banks and other financial institutions had to leave their

job (or even be fired) and seek new opportunities by undertaking

entrepreneurial initiatives, leading to an increased supply of invest-

ment opportunities by venture capital funds (and thus increased

demand for venture capital by fintech projects). Second, since incum-

bents have been subject to stronger regulation and scrutiny by

regulators since the start of the financial crisis, fintech ventures that

develop products and services that are outside the scope of financial

regulators (such as crowdfunding platforms and alternative payment

systems) have become more attractive relative to incumbents. A strik-

ing example are crowdfunding platforms that are often structured so

that many of the services that are subject to strong regulatory over-

sight are either outsourced to other service suppliers (e.g., Paypal for

payments) or not offered at all (e.g., they may not provide ‘investment

advice’as a way to avoid compliance with markets in financial instru-

ments directive [MiFID] regulation). Thus, many platforms are able to

operate under light regulation and in some countries absent of any sig-

nificant license (Hornuf & Schwienbacher, 2017). Another illustrative

example relates to alternative payments systems. This may have

spurred more investment in fintech ventures, in the hope it will reduce

the costs of financial intermediation for the economy as a whole

(Philippon, 2016).

We investigate whether the financial crisis has changed invest-

ment behavior by venture capital funds in fintech ventures, and how.

More specifically, in this paper we address the issue of whether or

not there has been a change in the pattern of fintech VC investments

since the financial crisis. In the spirit of the Bloomberg quote above,

we expect that there is a spike in fintech VC. In view of the differential

enforcement of banking rules around the world for large established

organizations versus startups, as documented by Forbes and quoted

above, we expect the rise in fintech is more pronounced in countries

which do not have a major financial center where fintech startups

are more able to flourish with less risk of regulatory oversight. Simi-

larly, we expect smaller VC funds with less experienced management

to have a greater spike in fintech investments as such fund managers

are less likely to see the hype in the context of recent history of

booms and busts such as that experienced in the dotcom bubble or

the recent financial crisis. In view of the apparent boom, and tendency

to overinvest in the latest fads, we expect that fintech investments on

average are less likely to result in successful initial public offering (IPO)

and acquisition exits and are more likely to be written off.

To test these propositions, we extract all VC investments from

VentureXpert from January 1, 1990 to 31 December, 2015 and record

as fintech ventures all VC investments active in the financial services

industry, leading to a final sample of 2,678 investment rounds in 747

distinct fintech ventures. Similarly, we obtain a sample of 277,994

VC investments in non‐fintech ventures during the same time period,

which we use as a control group.

The data examined are consistent with our expectations. Control-

ling for other things being equal, we estimate that round investment

amounts for fintech went up in the full sample. We observe invest-

ment rounds at higher levels for the subsample of deals done by inde-

pendent VCs, but no material change for corporate or financial

institution affiliated VCs. Fintech VC round investment amounts went

up by a small amount among large VC funds, and by a much larger

amount among small VC funds. Fintech VC round investment amounts

significantly increased in countries without a major financial center,

but were unchanged in countries with a major financial center. Also,

controlling for other things being equal, we observe round syndicate

size went up for fintech VC for the full sample, and the subset of early

stage rounds, and the subsample excluding early stage rounds.

CUMMING AND SCHWIENBACHER 375