Types of FinTech companies

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Literature Review


FinTech companies are a business that uses technology to develop new financial services. It is an innovation of new technology that aims to defeat the old traditional financial methods. FinTech companies are effectively operating in many countries with customer from all over the world, these companies provide services such as; lending, equity finance, investment and banking services. It also provides Robo-advisory service which can introduce customers to a professionally managed portfolio with low fees. Nowadays, many people prefer doing their financial transaction using their Smart phones and laptop via platforms and web applications. For this reason sooner or later the traditional financial methods will disappear.
What is shocking! Despite the major development of financial services there is no academic consensus on common definition of FinTech and since the question “what is FinTech“ currently one of the most searched query over searching engines, so in the following part we will try to find a comprehensive meaning of the word FinTech.
According to Oxford Dictionary FinTech is “Computer programs and other technology used to support or enable banks and financial services”. Oxford definition of the FinTech is literally unjust and weak. Hence the needs for a broader definition drive us to explore more behind the heading meaning of the word. Arner, Barberis and Buckley (2015) defined FinTech as, firms that mix technology with business models to enhance the financial services. Past researcher tries to define FinTech Company as those that offer technologies for banking and corporate finance, capital market, payment and personal, data analysis firms and finance management. Silicon valley bank report adds to the definition, firms that use technology in personal finance and lending, payment and retail investment, equity finance, remittance, institutional investment, consumer banking, financial research and banking infrastructure, also E-commerce and Cybersecurity are included (Stockholm FinTech report, 2014). In the following section the main sectors of FinTech industry will be presented

Types of FinTech companies

Lending Technology
FinTech lending companies operate as online peer-to-peer lenders (P2P). Simply, they lend money to Business and individuals through an online platform that match between the borrowers and lenders. They provide loans to individuals or institutions that were not able to get finance through traditional lending Banks. The P2P platform uses machine learning technologies and algorithms to estimate the client’s ability to repay the Debt. In most cases, loans are unsecured or backed with alternative collaterals. During the last decade the P2P companies experienced exponential growth, their volume had reached more than USD 100 billion by the end of 2015 (Huang and Robin, 2018). Many small and medium enterprises have been attracted to online P2P lending companies, this is because banking institutions are becoming more complex and time-consuming. One of the advantages of online lending is that they are able to reach the client wherever they are because they are not bound by a specific location, but there is also a concern about the potential failure of customers to repay their debts. Examples of FinTech lending companies are; LendingClub and OnDeck Capital.

Wealth Tech management

Tech companies that help individuals manage their personal bills, accounts or credit, as well as manage their personal assets and investments (KPMG and CB Insights, 2016). Wealth tech is a segment within FinTech that focuses on improving wealth management; these companies seek to transform the market by targeting inefficiencies in wealth management and create digital solutions to transform the investment management industry. This segment benefit includes; optimal portfolio management, improve the client experience and greater transparency. This subcategory of FinTech companies reached 74 financing agreements worth $657 million in 2016 and has been growing. CB insight identified 90 firms in 2016 that offer alternative traditional investment and developed technology to support investors. Robo-advisory alone (which is automated services that use machine learning algorithm to offer clients advice regarding their investment and receive 30% of all wealth Tech financing) will manage a trillion dollars by 2020 and 4.6 trillion dollars by 2022 (FT partners). There are more than 200 Robo-advisory registered in the US Financial market, among them the popular companies Wealth front and Betterment and the latter worth $800 million.

Payment and billing technology

Payment and billing tech companies are companies that provide solutions varying from facilitating payments processing to payment card developers to subscription billing software tools (KPMG and CB Insights, 2016). The total value of the global retail payment transaction was estimated at 16 trillion US dollars and Digital payment contributed to 8% of the overall global retail payment market in 2015 and it is expected to increase to (18-24) % by 2020 (BCG, 2016).

Money Transfer

Money transfer companies include primarily Peer-to-peer platforms to transfer money between individual cross countries (KPMG and CB Insights, 2016). According to the world bank, the estimated total value of remittances in 2015 was $582 billion, $133.5 billion was sent from the USA that have 19% of the world’s migrants. The biggest recipients were; Mexico, $24.3 billion; China, $16.2 billion; and India, $10 billion (World Economic Forum 2016). FT partners “global money transfer” research identified two broad segments of the non-bank (global) money transfer industry, which are; (1)”International Payment Specialists”, who provide a solution to consumer with needs for cross-border and foreign exchange payments, (2) “the Consumer Remittance Providers” who provide service for clients to send remittance to their native countries. The consumer remittance provider attracts clients by lowering the prices and commission and offering mobile-based technology, popular examples of money transfer companies; Qiwi PLC and Xoom Corp. (Financial Technology Partners, 2017)

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Blockchain- cryptocurrency

Blockchain and bitcoin companies are a well-known sector of FinTech. Companies in this sector are technology firms in the distributed ledger space, ranging from bitcoin wallets to security providers to sidechains (KPMG and CB Insights, 2016). Companies provide blockchain software or services for the trade in cryptocurrencies such as; Bitcoin, Ethereum and Ripple. These digital currencies are traded 24 hours a day and all transactions are done via platforms on the internet. Bitcoin or the “digital gold”is a non-physical currency was created by“Satoshi Nakamoto” in 2009. Satoshi Nakamoto (2008) define the Bitcoin currency as peer to peer electronic cash system that allow for online payment from one party to another without interference of regular financial institutions. It is anonymous currency that has no kind of support from government or institutions (Grinberg, 2011). The total value of Bitcoin currency reached $112 billion US during 2018 (Blockgeek, 2018). The technology behind Bitcoin is Blockchain which is “distributed data store” or “Public ledger” that hold large record of all transactions. Blockchain technology registers all transactions that occurred automatically, without human intervention. Thus, making the blockchain technology efficient, compared to the traditional way of processing transactions. It makes the process quicker and lowers the costs because everything is done by computer algorithms.

Initial public Offer (IPO)

An initial public offer “ IPO” or “ public offering” is the process, in which unlisted firm is going public and selling new issued securities to public for the first time. Firms are motivated to go public to raise funds to finance its expansion plans or to pay its debt. There are potential benefits of going public. IPO provides liquidity to the existing shareholder and establishes a value to the firm and present a prestigious image.
At some point in time, a firm need to acquire a huge amount of money to introduce a new product or to expand in the market, such kind of capital is hard to get. Financial institutions and banks will not be able to lend such funds because they consider such investment is too risky and even for venture capitalists, who are interested in financing such firm activity. They may find themselves not able to continue investing until the firm show positive cash flow. Thus, the optimal solution for the company is to raise capital by going public. Also, Listing provides liquidity to the existing shareholder and entrepreneurs who are interested in diversifying their investment portfolio, in order to obtain a higher rate of return. This can be achieved by selling some of their shares to other investors. However, such sale must not be made during the initial public offer because public investors and investment bank will be a skeptic and worry about such behaviour when entrepreneurs or private equity investors are leaving the company.
There are also disadvantages of the initial public offer; (1) There are significant legal, accounting and marketing cost associated with an initial public offer, (2) The company is periodically obligated to disclose its financial and business information, the consequences of information disclosure weaken the company position to competitors. (3) It also requires managerial attentions, time and effort to provide business reports and review financial statements. (4) In some case the firm fails to go public and subsequently the offer will be withdrawn which will have a negative effect on the company image and investors will not be interested to consider investment in such offer (lerner, 2007).

IPO process

The initial step in IPO is to select the underwriter which is called the “book-running” manager and other co-managers. There are specific criteria for the selection of the underwriter among them, the underwriter reputation which is based on his previous IPO’s performance, knowledge and experience in the firm industry, his outstanding research analyses of the market and to what extent he is committed to provide sufficient feedback about the value of the firm and estimated Earnings.
The underwriter is responsible for; (1) forming the syndicate that will help in selling of the stocks to public and (2) the letter of intent” which is a written agreement between the underwriter and the firm. The letter contains terms and condition that protect the underwriter against any other expenses “uncovered expenses” that could result from withdrawing the offer and also specifies the underwriter percentage of the gross proceeds which is 7% of the initial public offer proceed (Chen and Ritter, 2000), and it also contains a commitment by the issuing firm to allow 15% overallotment option to the underwriters (Ellis, Michaely and Maureen, 2000). This option is used to stabilize the market and support the stock price after the initial public offering. Furthermore, the intent letter doesn’t contain any information regarding the final price or the number of shares that will be distributed to public. After completing the agreement the underwriter start what is called “The due diligence process” in the process the underwriter review the company financial statements and business reports and meet with the company management and talk to investors and suppliers. Meanwhile, the company start the registration process by filing a draft with the U.S. Securities and Exchange Commission (SEC( “The securities act of 1933” prohibit selling any securities to public unless the company is registered. Once the registration form is submitted to (SEC) the registration form is transformed into “Red Herring” which is a statement of the firm prospect that is used to market the initial public offer. The underwriters start to market the IPO through “road show”.
First the “Red Herring” is sent around the country to all financial institutions, investors and sales people to inform them about the upcoming IPO event. Then both the underwriters and the firm start the “road show” by conducting regular visits to potential investors to present the firm business and its prospect of the public offer. Meanwhile, the underwriter starts to receive investor’s interest in the offer. However, the company cannot by any way sell any shares to investors prior to the official IPO date, the investors interest just represents a market indication that can help in determining the final share price and doesn’t hold any obligation for the company.
Pricing process is one of the important steps in public offering after the SEC approval on the registration form. The firm’s management board meets the underwriter on the day before the effective IPO date to determine the final share price and the number of shares offered taking into account “the order book” that contain records about investor interest in the public offer. After required price amendment is done, the firm executes the initial public offering on the effective date and the underwriter and the syndicate become legally obligated to sell the shares at the determined issue price to the Public.
The role of underwriter continues after the IPO. The underwriter is responsible for monitoring the stock performance and support the stock price in the market. This process is called “After market stabilization”. In a short period, only within 30 days after the IPO, the underwriter can support the stock in the market through executing “the overallotment option”, which is also called “green shoe”. According to the NASD regulations “Green shoe” option gives the right to the underwriter to buy from the company additional 15% of the firm shares at the initial offering price (Ellis et al, 2000). In most cases the underwriter sells 115% of the company share to the public if the stock price rises in the day after the public offering, the underwriter will declare that the offer size was 15% larger than the anticipated size. If the offer is weak and the price drop below the initial price, the underwriter will not execute the “green shoe” option and buy back the additional shares. This action will support the stock in the market and stabilize the price (Lerner, 2007).
The final step in the process lasts for 25 days after the official date of IPO and it is called “The quiet period”. In such period the underwriters and the syndicate provide the company with information regarding the valuation of the IPO and estimated earnings.

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The well-known phenomenon underpricing has been of the major interest of researchers during the last 30 years. This anomaly occurs when the offer price is below the real intrinsic value of the stock. Underpricing is the average of the stock initial return and it is calculated as the difference between the offer price and the first day closing price divided by the offer price, according to the following formula by Beatty and Ritter (1986):
Many researchers and studies documented the underpricing anomaly over many periods and across many countries. In the following literature we will shed the light on their empirical findings and results. Also, discuss the causes of underpricing and the relation between underpricing and the ex-ante uncertainty

Evidence of Underpricing

One of the first empirical evidence on the existence of the IPO underpricing phenomenon was given by Ibbotson (1975), who confirm 11.4% average positive initial return on the US initial public offers during the period from 1960 to 1969. Ritter (1984) examine 1075 American companies during 6-year period among which 569 technology companies, from 1977 to 1982, 16.3% average initial return was documented. Furthermore, Ritter (2017) showed that the level of underpricing changed over time, the average underpricing during the period from 1980 to 1989 was 7.3% and that from 1990 to 1998 was 14.8% while during the “internet bubble period” from 1999 to 2000 was 64.5%, and during 2001 through 2016 the underpricing level was 14.4%. The following graph show the number of initial public offers and the average of initial return from 1980 to 2017 (Figure 1)

1. Introduction
1-1 General
1.2 The purpose of the thesis
1.4 Main results
1.5 Set up thesis
2.Literature Review 
2.1 FinTech
2.2 Types of FinTech companies
3. Initial public Offer (IPO)
3.1 IPO process
3.2 Underpricing
3.3 Evidence of Underpricing
3.4 Causes of underpricing
4. Hypothesis
4.1 Underpricing of US FinTech companies
4.2 Age
4.3 Market capitalization
4.4 Proceeds
4.5 Number of uses of proceed
4.6 Venture backed IPO
4.7 Reputation of the Underwriter
5.1 Descriptive statistics
6.1 Underpricing
7. .Results 
7.1 Underpricing of USA FinTech companies
7.2 The relationship between underpricing and ex-ante uncertainty proxies
8. Conclusion
9. Reference list
10. Appendix

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