Part 1: Your Startup Operates in a Regulated Space, So What?
When entrepreneurs initially set out to build a FinTech company, they are driven to solve the existing gaps in the financial management system. Perhaps it’s to make the financial system fairer or create products that are more efficient, tech-savvy, and put customers first.
Once the initial idea sets in, the next question that typically arises is, “What are the regulations around this?” which quickly becomes one of those, “What did I get myself into…?” moments of truth a team will inevitably face. Don’t be alarmed, most entrepreneurs have no idea.
For a typical startup, building quickly on a lean budget means they can scale quickly and cheaply to get a proper return on investment. For example, Instagram scaled to 10 million users in under a year. Can you think of your favorite FinTech company that has scaled that quickly? With a few exceptions, there aren’t many options to choose from.
A FinTech startup operating in a regulated space faces a few challenges up front that forces it to consider growth differently in order to succeed.
Your market is constrained by different rules. Chances are you’ll need regulatory approval every time you enter a new country, state, or province.
Time isn’t on your side. For a FinTech startup, it takes longer to get to market. Regulatory approval takes time but regulators aren’t in the same rush that you’re in. You need to factor this reality into your runway time.
Regulation can determine your onboarding experience. While you’ve been dreaming of creating an amazing user experience, regulation can determine large swaths of your onboarding experience. You may need to call your customer. You may need to get their paper signature. Whatever it is, it is highly unlikely that you’ll have a frictionless onboarding. Last year, the Swiss regulator FINMA approved new rules to include video and online customer identification — a game changing regulatory shift that reduces the cost and speed of onboarding.
Your economics are more constrained. The costs of reporting and compliance are very real, especially when you need to get lawyers involved. When some companies are hiring a Customer Success Manager, you’re spending your money on a Compliance Manager. At NorthOne, we had a national law firm review the wording on our website to ensure we didn’t violate Canada’s Bank Act (S.C. 1991, c. 46). The Act sets out restrictions on a company’s ability to use the words bank, banking, or banker. The last thing you want are the consequences of using those words incorrectly, such as a hefty fine or worse, a court date.
You need partnerships and their regulation can become your regulations. Many FinTech firms need to partner with another regulated financial institution. You need to be vetted by their legal and compliance teams who are not only making sure you meet internal requirements, but that you meet the governments’ as well. Tech suppliers to banks need to think about what the bank’s expectations (and obligations) are around how data is used, protected, stored, etc. They should expect a very high standard of scrutiny. This is a good thing, by the way. We all benefit from having a robust financial system.
The implications of this lengthy process for FinTech startups is that your investors can get unnecessarily worried if they don’t understand why things are moving slower than they’d expected. It’s in your best interest to make sure that your investors understand your industry well.
In the next post, we’ll discuss who the relevant regulators are and how you can save time navigating the regulatory space. Stay tuned!
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Note: This is the first article in a 5 part series on regulation for Canadian FinTech startups. It does not contain any legal opinions. It is focused on what we believe are some of the most important issues for discussion. It should empower you to ask smart questions to your lawyers, regulators, and policy makers.