Entering the fintech space – what you need to know from a legal perspective
The fast-growing fintech industry is best described as the use of technology in the financial sector to assist consumers and other parties involved in that space. Essentially, entrepreneurs use software and modern technology to “disrupt” the way that commerce is done in the financial sector.
A significant amount of fintech disruption has occurred in South Africa over the last few years, as devices such as smartphones have become increasingly accessible to the public. In fact, it has become such a fast-growing industry that UCT now offers a “fintech degree” which is a master’s in data science, specialising in financial technology. This is a significant sign that fintech is becoming increasingly important in the South African context.
Some successful South African start-ups in the fintech arena that are worth mentioning are SnapScan (a point-of-sale solution using cellular phones), Yoco (a point-of-sale solution using very simplified tech to allow credit/ debit card sales for vendors of any size) and Luno (a Bitcoin exchange and Bitcoin wallet service).
Due to the vast number of lucrative opportunities in the fintech industry, it has arguably become saturated with start-ups who are trying to enter it with similar or overlapping initiatives. The fintech gold rush is alive and well.
Another challenge within the fintech space is legal compliance. These initiatives are often regulated by legal principles that are not cognisant of the nuances of the latest developments in commerce. This means that the legislators are constantly playing catch-up and the pace is getting faster every day. This has resulted in the cost of legal advice being exceptionally expensive. Attorneys often have to liaise with regulatory bodies to get certainty as to where the regulatory framework around an initiative is heading, as the existing laws may be a few steps behind the latest developments.
Here are four tips for entrepreneurs or start-ups on how to overcome the legal challenges of entering the fintech market:
1. Get a clear idea of the product that you are developing and the direction that you are heading in
What are your other founders’ expectations regarding the funding of your company? How are you going to get funding to operate for the next two years whilst you are (probably) not profitable? Are you all on the same page as to who should be running the company and the direction that you are going?
These are all important questions to ask (and there are many more to ask). If you cannot answer these fundamental questions, then you may want to go back to the drawing board with your business partners and discuss it all in more detail. In our experience, the biggest disputes between founders in start-ups and established companies are over money and control of the business. If you start the relationship agreeing on these two points, you are certainly on a much better footing.
2. Get relevant legal advice
Although this may seem like the last thing that a start-up would want to do or spend money on, the reality is that if your product does not comply with the relevant law in South Africa, you have effectively wasted your time. If you’re not legally compliant, no investor would want to invest and your product will not be able to go to market.
It is also very important to put the nuts and bolts in place. As mentioned before, many start-ups undergo serious stress due to the fact that the roles of each founder have not been clearly defined. The best way to define the role is to put pen to paper and get an expert to explain how that relationship should work from a legal perspective from the start.
3. Get the necessary contracts and legal policies in place
A start-up/entrepreneur involved in fintech should generally have a good compliance roadmap in place, especially in the financial field where products and services tend to be more heavily regulated.
For companies, a shareholders’ agreement and an updated Memorandum of Incorporation (not the standard CIPC MOI) should be in place, setting out the relationship between the parties, vesting provisions of shares in the company, voting rights, reserved matters and other important aspects related to the running of a company.
We highly recommend operating your business from a company; they are cheap to form and far more attractive to investors compared to other business entities.
Another interesting manner that we have adopted for dividing up equity for start-up founders, is the grunt fund method. This method bases the division of equity holding in the company on various contributions (monetary, skills, assets, etc.) made to the business by the founders. This may be a good option for those particularly bootstrapped start-ups, where founders are contributing more than just money.
4. Protect your intellectual property
This is possibly the most important aspect to be aware of for the fintech start-up. If you are outsourcing your coding to an external developer, who does that belong to? You may think that it automatically belongs to you because you pay for it, however that is not always the case. Also, if you develop a product after hours, but whilst employed by the company, does that product belong to you or the company? Again, you would think that it belongs to you, but it is not always as straightforward as that.
Your intellectual property is your most important asset to protect and if you leave the protection of it exposed, you leave your business exposed. It is essential to get advice from a legal expert to see how you can best protect your intellectual property.
Whichever way you look at it, there are countless opportunities open to start-ups in the fintech space. Entrepreneurs shouldn’t fear entering the industry, simply because it seems daunting from a legal perspective. Look for a legal partner that offers high-quality legal advice that is suited to bootstrapped companies. Most importantly, choose a legal partner that is willing to grow with you, rather than cripple you at a time when you need help the most.
Daniel Van Zuydam joined Dommisse Attorneys in 2017 as an associate in the transactional team. His areas of focus are corporate finance, mergers and acquisitions, and corporate restructuring.