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3 ways in which regulation can boost profitability and valuation of fintech firms

CEOs of the world’s largest financial services firms will concur that regulatory change and compliance is one of their top 10 business challenges. Annually AON surveys more than 1,400 executives from the world’s largest corporations across 60 countries to understand the risks faced by them. Regulatory change usually ranks within the top 5 risks.

Let’s face it, regulation is usually viewed as a headache that weighs down on a business and gets in its way. However, counterintuitively, in this article, I will show you three ways in which regulation can actually enhance your business operations and its overall value. Of course, this is only if regulation is embraced in a positive way and deliberately implemented to add value.

Even some of the largest corporates in the world usually only implement regulation just to comply. In return they get little to no return on their investment. For these organisations, regulation does indeed become a resistive force because no one can see its benefits.

Fintech firms are revolutionising financial services, bringing new ways of doing things. Many firms, unlike their incumbent counterparts, are equally taking a more positive approach to regulation. In the United Kingdom, peer to peer lenders and crowdfunding firms actually asked to be regulated.

Recently, we helped a peer to business lending client become licensed by the Financial Conduct Authority (FCA). The firm was unable to trade until they got their license. The licensing process spanned a tiring 18 months because of the newness of this business model and the regulation. The FCA was for the first time, assessing this new type of business against new regulation.

Just prior to being granted the license to trade from the FCA, the firm went on its first pre-money fund raising around. Subject to regulatory authorisation, the firm was valued at £1 million, even before they started to trade.

Granted that the founders are well respected and highly experienced financial services entrepreneurs, with extensive connections to ramp up the business once given the regulatory go ahead. However, a large proportion of the valuation was attributed to the FCA authorisation. Without it, the funding wasn’t guaranteed. Being regulated instills a certain level of trust and certainty in the minds of investors and other stakeholders, which inevitably enhances the perceived value of the business.

3 Ways in Which Regulation can add Value to Fintech Firms

1. Seize a Greater Share of the Market

Entrepreneurs are tempted to avoid regulation because it’s seen as a headache. The regulatory licensing process is often complex, gruelling and long winded, especially for innovative businesses that don’t t the standard business model. The process itself creates uncertainty because the business often can’t start to trade until they are licensed. Not all fintech businesses need to be licensed, for example Bitcoin. However, this door is likely to close very soon, as these areas are increasingly gaining regulatory and central bank attention.

Quite legitimately, a fintech firm can decide to start trading without being licensed. The regulatory framework makes provision for certain exemptions and exclusions. As long as the firm meets the conditions imposed by them, they can continue to trade. These conditions, however, severely restrict the type and scope of business that the rm can carry out. Often such unregulated firms will only be allowed to trade with a very small segment of professional or business clients. The business restrictions cap the potential market share that the rm can gain. This in turn limits the ability of the fintech firm to scale to any great heights.

The unregulated path may be a valid stepping stone to a fully regulated business. However, without regulation, it’s unlikely that the fintech firm will ever reach the heights of an Uber or Air BnB in the world of financial services.

2. Operational Efficiency and Enhanced Valuations

The case study highlighted above demonstrates how being regulated can actually enhance the value of the rm, which can be hugely beneficial on an exit or further fund raising rounds. Going through the regulatory process and having to comply on an ongoing basis, brings about other benefits. Recently we helped a crowdfunding client set up their business for a successful FCA authorisation. The founder is a serial entrepreneur and philanthropist, who  successfully founded and exited four non-financial services’ businesses.

Going through the process, he commented:

“I have never had to set up my business in such a thorough way before. We had to think through the very last detail of how our business will work on a day to day basis. Then we had to document all our processes, policies and methodologies. This process was gruelling, but it gives us certainty that the business will sustain itself through the startup phase and continue to thrive because of the discipline that we have put in place right up front before launch.”

As I set out in my previous article, having well thought out and documented policies and processes enhances valuation multiples, especially on a trade sale, as it gives buyers the comfort that the business can continue to trade without its founders. Documented and standardised processes also allow the business to expand quickly and consistently in other geographies or markets. Having to comply with regulation can yield many other operational benefits. Consistently embedded systems and controls (required by the regulator), help to anticipate and proactively manage risks, preventing failures and operational losses and improving overall business efficiency. This leads to higher profitability which has the potential to enhance market share and the overall value of the firm.

3. Attracting Partnerships with Giants

Fintech has caught the attention of many incumbent players, who, realising that they can’t beat such innovative firms, are now looking for ways to partner with them. Many banks, for example, have partnered with peer to business lenders to enter into a referral program to refer business borrowers whom the bank is unable to provide a loan to.

Often, I come across clients who desperately seek to be regulated (even when their business activities don’t require them to be regulated) just so they can partner with bigger players.

Because banks, hedge funds and pension funds, among many other financial services firms, are themselves highly regulated, they have to be cautious of who they partner with. They prefer to do business only with regulated firms, knowing that the regulator performs stringent due diligence before allowing them to trade. The ongoing compliance burden also ensures that such regulated firms are run in a proper way and on an ethical basis.

Winning partnerships with giants can allow a newbie fintech firm to scale almost instantly, and without the mountain of costs going into marketing to acquire new customers. Without regulation,it’s unlikely that you will get their attention.

In closing, I urge fintech firms to take a more positive approach to regulation. Rather than viewing it as a burden, open your mind to the commercial possibilities it can bring. If you have to comply with stringent regulation, then ensure that you find ways to gain maximum returns from your investment.

by Jay Tikam, Managing Director at Vedanvi


Jay Tikam is the Managing Director of Vedanvi, a professional services firm dedicated to helping fintech and Alternative Finance firms launch and rapidly grow their firm in highly regulated markets.

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