Beyond the Dragons’ Den: What lawyers bring to a fintech venture
Travers Smith solicitor Alex Edmiston provides a brief biography of a start-up
The story of fintech (or at least the story that journalists are keen to write about) is one of nimble, young businesses creating user-friendly, innovative and efficient products which meet a need that was previously served by the old-school banks.
There is a kernel of truth in that. “Disruptive” is the buzz word. There are some fantastic ideas that have been turned into fantastic businesses. This is particularly the case here in London, which is arguably the global hub for payments companies, as well as crowdfunding and lending platforms, which have successfully grabbed a bit of a pie that was once the sole preserve of the banks.
However, anyone who has ever watched an episode of Dragons’ Den can tell you that a great idea does not necessarily make a successful business. The difference between an exciting prospect and a fully functioning company with longevity is cold, hard cash. Companies need lots and lots of it. Cash to pay the staff they will need to develop the business and design the product, cash for nice shiny offices (with obligatory ping pong table) and cash to protect the IP rights and develop the brand. Finally, a lot of cash will also be going out the door to pay for legal advice and marketing. In particular, a lot of regulatory advice will be needed as this sector is understandably subject to all sorts of rules and regulations.
Money, money, money…
So where does all the money come from, and what can lawyers do to help?
As discussed above, the basis of any fintech business is the idea. A lot of time will be spent developing and testing that idea before bringing it to market.
This stage can be fairly cheap. Once it is time to start selling the service or product you have created, you will need money and lots of it. Companies at this stage will usually first seek financing from wealthy individuals (known as angel investors) or venture capital funds which often specialise in a particular industry. As the company grows and hits certain milestones it may undertake additional rounds of fundraising. These rounds of fundraising are known as Series A, Series B, Series C and so on and so forth. The amount raised usually increases with each subsequent round. As the business matures, the ‘venture’ element becomes less appropriate and people will start talking about ‘growth equity’.
Flies in the ointment
A lot of successful pitches in Dragons’ Den actually fall apart in a back room when the cameras stop rolling.
Usually this is because the aspiring entrepreneurs and the established celebrity ones cannot agree on the details of the deal. Lawyers will be heavily involved in these negotiations. The most fiercely debated topics will be the nature of the rights that attach to the different types of shares. Investors will be keen to ensure that they get their money back first once the company turns a profit for example, whereas the founders may want an option to buy back shares from investors at a future date. These sorts of considerations are a corporate lawyer’s bread and butter.
Assuming everything has gone to plan, what was once just a brilliant idea is now a profitable business that can stand in the market on its own feet. That makes it an enticing target for the next level of funding, or even a takeover.
Private equity firms have become an increasingly important force in growth equity and mergers and acquisitions. In a sense their business is well… business. They snap up promising companies hoping they can find ways to make them more efficient (and therefore profitable) and eventually sell them on. Rather like the Dragons, many PE funds also bring genuine industry connections that can help the business plan blossom. Private equity is now so established that many firms have dedicated corporate teams that focus on these clients. Travers Smith’s corporate team is divided into two departments: private equity and corporate finance (more on them later).
Fintech firms are also attractive takeover targets for bigger tech companies of course as well as our old friends, the traditional banks. Recent regulatory changes brought in by PSD2 (the eagerly anticipated sequel to the Payment Services Directive) may drive a wave of acquisitions of fintech firms by banks. One of the things PSD2 does is to give fintech firms access to the so-called “plumbing of the financial markets”. These are technological platforms that facilitate the moving of money around the world, services such as BACS (most salaries are paid via BACS) and CHAPS (house deposits are usually transferred by CHAPS). These systems are owned by and paid for by the banks. PSD2 allows fintech firms to access these technologies without having to bear the costs of maintaining them. It is the closest thing that you will find to a free lunch in the world of finance.
Given the big banks have to pay for the nuts and bolts that allow many fintech firms to provide their services, it makes sense for the banks to snap up these firms and bundle their products into their own offerings. For example, access to cheap FX services (which is one area where fintech firms have excelled), might be a nice thing to have bolted onto the credit card issued by your bank.
Hitting the jackpot
A fintech firm that is doing really, really well may decide to conduct an Initial Public Offering (IPO). This is when a company decides to list its shares on a public market such as the London Stock Exchange. This is a way to raise a lot of money, though becoming a listed company also means complying with a whole host of regulations to protect investors and the integrity of the market. This sort of work is the corporate finance team’s territory.
Travers Smith’s corporate finance team will guide an IPO candidate through the application and listing process and ensure the company is able to meet all its regulatory obligations. This process can last over a year. It is a lot of work for the company, but the rewards can be transformational. Once a company is listed it will be able to issue more shares in the future to fund acquisitions of its own, development of a new product or overseas expansion. Unlike a private company, people can freely invest in it, and a successful business will see its valuation soar as investors decide to ride the wave.
A bright future
Brexit notwithstanding, the UK, with its thriving tech scene and extremely sophisticated capital markets, is likely very well-placed to remain one of the world’s fintech hubs.
Alex Edmiston is a commercial, intellectual property and technology solicitor at Travers Smith.
For more on fintech, check out the video of our recent ‘Global Commercial Law in 2017: What’s next for the world’s legal capital?’ event at Travers Smith.