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Improving Rating Metrics for FinTechs

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Financial Technology (FinTech) Companies in Nigeria have grown significantly and attracted an increased number of foreign investors.

In February of this year, Flutterwave, one of the leading lights in the industry in Nigeria and Africa, closed a USD$250m Series D funding, raising its total valuation to over USD$3bn. This makes the company the highest valued African startup.

It is estimated that African startups raised about USD$700m in 2021 alone. Nigerian startups accounted for 45% or USD$345m out of this, with FinTechs responsible for over 54% of the amount.

Most startups looking to raise money during their formative years typically consider equity, which requires that founders give away shares in their business in exchange for capital. At that stage, the venture is extremely risky and thus does not appeal to most financing options (like debt that requires repayment at an agreed-upon date with interest), except venture capital.

Today, the gold standard driving the lion’s share of debt in the global economy and public markets relies on Credit Rating Agencies (CRAs). Favorable access to the debt market, venture capital, public funding and investor lending depend on them.

CRAs assess a company’s ability to pay back its financial obligation and assign a risk rating, which ultimately determines the rate and terms at which a company receives funds from lenders.

Over the years, a traditional method has been adopted in carrying out this rating exercise which entails assessing the creditworthiness of a company using key financial indicators in terms of Profitability or Turnover, Asset size, Asset Turnover, Liquidity amongst others.

However, due to the uniqueness and intangibility of assets and resources used by FinTech startups, the standard approach of assessing creditworthiness often does not work for them, as they lack the metrics that the traditional method relies upon.

Studies have shown that many of the best startups choose to run up negative cash flow and delay profitability to fuel exponential growth. They often run through significant pivots in business models to find product-market fit. They do not have years of stable operations when compared with an established business, making it challenging to assess future revenue or cash balance.

There is therefore the need to develop more adaptable metrics for assessing the chances of default by Tech startups.

Guy Kurlandski, an industry analyst posited that it is important that the emerging standard for assessing the creditworthiness of tech companies be forward-looking. It should also be based upon and aligned with the company’s future growth.

Away from this popular opinion, asset size or some key performance indicators do not really matter when it comes to a startup getting an Investment Grade Rating.

One main advantage of credit ratings to FinTech startups is that they can serve as a check for the effectiveness of their corporate governance. Corporate governance can be neglected by these companies because they tend to be run by tech experts. Therefore, credit ratings can help grade their corporate governance and provide information on improvement techniques.

This can in turn boost investors’ confidence. Sustainability can also be checked based on cost efficiency, profitability and trajectory in revenue generation. Therefore, Rating opinions can thus be drawn on some of these indices.

 

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