Periodically, Klaros nonbank clients ponder the potential impact on their enterprise valuation if they were to seek a bank charter. Klaros is an advisory and investment firm, so we leave valuation questions to our friends within the investment banking profession, but the following general parameters may be helpful for fintechs and others considering pursuit of a bank charter.
1. Business Model is Key Driver of Valuation
Banks are valued like banks because of their business model and regulatory framework. Regulators require banks to maintain a minimum level of capital relative to their assets. To the extent a bank is relying on assets to generate income (e.g., through interest income), the potential growth in earnings will be limited to the growth of the capital base. That equation limits the ability of most banks to achieve exponential growth in earnings and is why banks are often valued as a multiple of capital or book value.
The more a business looks like a bank, the more likely it will be valued like a bank, i.e., with a focus on price-to-book value. Some banks will be able to generate stronger earnings growth than others and thus merit a premium valuation versus peers. This return metric can carry a premium valuation but does not change the positioning or identity of a company in such a fundamental way as to make it appeal to a different group of investors. In other words, generally, technology investors don’t buy banks and financial services investors don’t buy software companies.
All other things being equal (and with exceptions):
Fee income businesses (SaaS, transaction fees, etc.) will be valued like comparable service businesses regardless of whether they are affiliated with a bank charter
Lending businesses generating spread income are likely to be valued like banks
The valuation of a fintech with a bank charter will depend on the mix among businesses that are more or less capital-intensive. That said, the market’s perception of the mix of businesses may be skewed from reality. “Oh, it’s all now a bank that should trade at book” is a potential problem to consider, but also one that is eminently manageable through a thoughtful investor relations effort (targeting either public or private investors). A number of existing fintechs that have taken the plunge into “bankland” demonstrate that.
2. Unit Economics Matter
If the unit economics of the business only work with a bank charter (i.e., low-cost deposit funding, direct access to the Fed payments system, etc.), then the company will most likely be valued more like a bank or see its valuation methodology and valuation multiples re-rate, becoming more comparable to a bank over time.
3. Valuation in the private market can vary dramatically from the public market
Companies financed with multiple private capital raises may achieve a higher or lower valuation in the public markets. Given that private companies are generally only valued at the time of a funding round or sale, if a private company has been fundamentally overvalued in a prior round, the public market valuation will be lower. If the private company is thematically compelling and unique to public institutional investors and retail investors, the public valuation may exceed the most recent private valuation. Public companies are valued daily, so valuation can change quickly.
4. Unique Businesses Can Be Hard to Value
With notable exceptions, unique business models, particularly companies with few, if any, public comparables, can be challenging for markets to value - with or without a bank charter.
5. High-performing banks and banks with leading technology strategies can trade at attractive valuation multiples
Except in times of economic stress, we have seen such banks trade at attractive multiples of book value given the growth trajectory in earnings they can generate. We have observed significantly higher valuation premiums for unique models enabling high-growth sectors or business lines, but these have proven to be unsustainable over time due to a variety of issues, including compliance, regulatory, activist pressure, credit, technology, and capex needs.
The bottom line is that valuation is both science and art. The science is that there are numerous fundamental and economic analyses that market participants will seek to apply in valuing a company, including multiples of revenue, cash flow, trailing and forward earnings, and net book value, as well as comparison to key performance, operating and valuation metrics of existing public companies. The art is that embedded in any public company's valuation is a quantification of management's vision, strategy, and product innovation, as well as an implied assessment of the leadership team’s experience, trustworthiness, credibility, and nimbleness. Adding a bank charter certainly adds something to the mix, but it may not be the determining factor in valuation.