Investors and entrepreneurs alike are faced with the unavoidable existence of regulators and regulation in fintech. Few other industries are impacted by regulation, which is why I am always flummoxed by either a lack of understanding or lack of consideration for complying with regulation.
Historically many investors shied away from investing in fintech. Many businesses were capital intensive, most of them were regulated by acronyms that elicited only dismay or bland looks (OCC, SEC, CFTC). As such fintech investing was left to more fin than tech actors. This is not the case anymore, obviously, given the explosion of interest and investment in the space. Many tech actors are actively involved.
Here are explicit regulatory related narratives I have heard recently:
1) We are a tech company, we do not need and should not be regulated.
2) We do not handle cash, we will not be regulated.
3) We have only built a platform and wrote code to help others transact, so we should not be regulated
4) Getting regulatory approval is too expensive, we will deal with it later.
Here are implicit regulatory related narratives I have witnessed recently:
1) Let’s go to market first. We can deal with regulatory issues later
2) Let’s grow fast, our size will help with regulatory issues
3) Let’s fight the regulator, they are wrong, we are right, we are a tech company
Needless to say I am ambivalent at best when encountering the above narratives and strategies.
Why? Prosper being shot down by the SEC, Ripple being fined by FINCEN – Ripple is a R66 portfolio company – Paypal being fined by the CFPB, and of course the myriads of fines banks have suffered of late are but a few examples highlighting why. Remember that some of the consequences of ignoring regulatory fiat may be civil as well as criminal.
I propose startups take on a different approach where productiveness and open collaboration are central. I do not imply the above companies did anything wrong or did not follow my approach – I have no clue what they did and why exactly they were fined. I also advise investors to use the below as a cheat sheet when engaging with fintech companies.
First, ANALYZE. Analyze the various regulatory bodies, the laws you may be subjected to, the licensing you may need. Consultants are surprisingly eager to engage with startups on a pro bono basis with startups as they also need to learn and build their pipeline of future clients.
Second, EDUCATE. Educate the regulators in your space. Tell them what you are doing or trying to do, be opened and transparent. Educate early and continuously.
Third, BUDGET. Budget the potential cost of regulatory approval and licensing early on in your forecasting and fund raising process. Your investors and potential investors will be eternally thankful.
Fourth, HIRE. Think about hiring the right skills early on. If compliance around KYC/AML is an issue, start mapping, exploring and networking towards hiring a Chief Compliance Officer.
Fifth, COMPLY. Being regulated usually means two things. You may need a license or need to register with a regulatory body. You may need to show that you comply with certain rules and laws. You can comply without being licensed. Not that I advocate or condone this at all. Still, know that getting proper licenses may take up to a year what with the time it takes to prepare a license, to file in various jurisdictions if need be. The process might take a year or more. In the meantime, working on a compliance handbook, AML/KYC processes and procedures, documenting what you do, getting close to or achieving a certain level of compliance is a major win for any startup, and will hopefully mitigate regulatory risk.
Sixth, INTENT. Think of building the right intent through everything you do as a startup. In words and deeds. Intent is probably as important as the letter of the law – hiring, complying, educating are all part of your intent by the way. So is your attitude. Belligerence, obfuscation or willful evasion from a regulatory burden are your enemies.
Seventh, ITERATE. Output from all the above will have an impact on your business plan and value proposition. The sooner you get on this regulatory path, the sooner you will be able to apply lessons learned to your business and start iterating.
Eight, APPLY. Subject to the right timing and the right funding, start applying for whatever licenses you will need. Don’t delay.
Ninth and last, IGNORE AT YOUR PERIL.