Overconfident founders and BaaS: The UK's 2023 mergers and acquisitions landscape

Despite 2022 being, on average, a strong year for M&A, 2023 has got off to a slow start. In fact, according to data compiled by Bloomberg, globally it was the slowest start to a year in two decades. In the UK’s public markets space, for example, there were only 12 announced bids in Q1, representing a decrease of £1.44bn (36%) for the same period in 2022. Market conditions characterised by uncertainty due to the tumultuous geopolitical landscape, volatile stock markets and rising interest rates and inflation have led to a stagnation in activity in this space.

Since central banks are suggesting interest rates will remain high and the global polycrisis continues, however, it is unlikely that the scope will change any time soon. Companies will therefore need to determine whether they can afford to continue being cautious or if they need to push ahead with transactions. With this in mind, arguably we will see a marked increase in M&A activity in the UK towards the end of Q3 and throughout Q4. 

Less money, less risk

One of the main catalysts for movement will be the scarcity of money as a resource. We’ve seen quiescence in tech and fintech IPOs, with companies deterred by the substantial drops in share prices of those that took the leap to go public in the past few years. The five largest listings from 2021 were down nearly 47% on average by the end of Q1 2023. One of which – Deliveroo – for example, has seen a 61.08% decrease in share price since its IPO in March 2021. Investors are now looking to limit risk by only funding businesses that are already financially successful, or at least on the road to profitability. Or else they’re keeping their powder dry for a less turbulent time. 

As a result, there is a vast mismatch between what founders and early investors believe their companies should be valued at and what the current market is willing to offer. Data from Carta shows that the number of down rounds had nearly quadrupled in Q1 2023 compared to the same time last year. As 2023 progresses, these founders will be forced to face reality, lower their expectations, and finalise transactions they’ve had on hold. 

VC funds too will struggle to fundraise since it is increasingly difficult to showcase success stories to potential investors in the current macroeconomic environment. This means VCs will start to put pressure on their companies to consolidate, merge, and create bigger organisations that will appear more capital efficient, and thus have the potential for a more meaningful exit down the line. 

Trimming the fat 

Another driver for M&A will be companies, especially larger corporations, conducting internal evaluations to see which assets are core to their business. Those considered inessential will be earmarked for divestiture to free up cash for higher growth areas. While ultimately a means of reducing costs, there are myriad advantages to such a process. Not only does it aid fintechs in streamlining productivity, it also enables them to hone in on and finesse their key activities, taking advantage of downturn headwinds to become more mature.  

It also gives cash-rich companies the opportunity to purchase spin-offs at a reduced price – a prudent decision going by the data from the 2001 recession. A PwC analysis revealed those that made acquisitions had a 7% higher median shareholder return than their industry counterparts one year later. 

BaaS and Gen AI are the future 

Looking ahead, the next year or two will be marked by increased M&A activity in the Banking as a Service (BaaS) and Gen AI sectors. The latter is already at the forefront of the zeitgeist and, with continued innovation, will remain there. Although it is an unpredictable entity, AI has the capacity to exponentially boost a company’s productivity and allow greener enterprises to disrupt big industries. Little wonder, then, that everyone will be looking to acquire AI businesses. 

In terms of BaaS, the demand for M&A will stem from the fact that their offerings are rapidly gaining popularity over traditional ones, yet it is simultaneously becoming more difficult for such companies to obtain a licence. Regulators are putting pressure on BaaS providers to strengthen control and their compliance functions, which will limit new entrants to the space. Therefore, licence-holding providers will become extremely valuable and increase appetite for M&A or consolidation. 

Overall, the second half of the year is set to be an exciting one for M&A in the UK. The gap between mismatched valuations and market value will continue converging, smaller companies will consolidate into more capital-efficient enterprises, and the demand for BaaS and Gen AI will increase as their offerings become more popular.