The Fintech Times sat down with Roman Filatov, Managing Partner at FJM, to talk all things entrepreneurial. Filatov got frank about how to protect your business from unlawful investors and why candour at an early stage is key to startups.
How do you work with startups at the investment stage?
It varies depending on the startup itself, the nature of the business and what investment stage they’re at. My first questions when I hear a proposal are, what are you trying to achieve and what do you need to get from investors? On that basis, I can discuss the balance between what they offer and what they’re going to get. In many respects that is what VC is about: striking the right balance. Ultimately, it’s a matter of leverage… If you’re at a very early stage and need guidance as well as money, the investor will expect more of a stake. If you have some documentation prepared where it says what you want and what you need, you’ll have a better choice of investors, you’ll have better leverage against those investors and in the end you’ll get a better deal.
There are always people who think if they throw ideas up in the air someone will catch them, and help to develop them but this never happens. From a legal point of view, you can’t protect an idea. So the first conversation is about what you actually have and from there we can start developing a framework for approaching investors.
What are the main things to pay attention to when you get a term sheet from VCs?
The main thing is whether the money they’re offering is worth the share they’re asking for. For some startups, £10K at the initial stage is worth more than £1m at a later stage. You should focus on who the investors are bringing on board, who you’ll actually be dealing with, and whether they’re going to dedicate their time to it. All that can be put into the term sheet, and the subsequent documentation.
I’m often asked how to protect a company from unscrupulous investors and my response is always this. There’s the legal environment and the unlawful environment. In the former investors may try and squeeze you out or exploit any grey areas. In the latter, they downright deceive you and abuse your trust. Whilst there are ways to protect against this, in the worst case scenario can involve the court. So what can we do? We choose to operate within the legal environment, bringing everything down to the legal obligations of the parties.
Once those legal obligations are set, should conflicts arise you have certain avenues you can explore: litigation, arbitration, alternative dispute resolution, negotiations etc. Essentially, when you get the term sheet you should include terms to protect yourselves and insist on them. Because it’s not a binding document, the term sheet is a basis for negotiation. You look at which obligations the investors are prepared to take on and start throwing your own tools in the box and see how they react. It’s basically a test run for the main agreement.
I try to strike the balance between the time you negotiate the term sheet and the time you spend on the main agreement. Some other parties prefer to actually negotiate the term sheet to death and then they just copy and paste it into the normal agreement when they’re done. Others do really broad strokes in the term sheet and then negotiate the technical details:
It’s down to what the parties want. When you look at a term sheet initially, you see straight away which of these three methods the party is using and then you react accordingly. A lot of young startups don’t like irritating investors by negotiating too much — that’s a mistake. Often people are so relieved to have an investor, that they agree to sign off on the term sheet assuming that, because it’s not binding, it can be dealt with in the negotiation process. That doesn’t work in practice because the investors simply take the principles from the term sheet and place them in the shareholder’s agreement and expect you to honour your promise. If you choose not to, you lose the deal. So you need to address those things immediately or risk losing the investor.
How have MiFID II & GDPR affected the fintech startups you represent?
Not much is needed for the startups I currently work with to implement the changes required by MiFID II regulations. However, just as with any changes in legislation or regulation, it is always wise to check whether they apply to your business and how to abide by said regulations. For startups, it is even more important, because the consideration should include not only the relevance of new regulations to the business as it stands but to any future developments of the business that may bring it within the scope of the regulations. It can be difficult to look forward that far, but in terms of attracting investors and showing visibility on where the business may go, this is invaluable.
Regarding GDPR, the process is more complicated for larger companies, but the wording of the regulation allows those who approach their data storing and processing with prudence and due focus on security to follow the rules with minimal effort. Ensuring compliance should really be a bespoke service, but in many cases, simple sensible approach to running a business means not much is required in terms of changes.
Do you think banks are likely to become passive infrastructure as a result of GDPR? What is your view on the opening of their APIs?
I doubt the effect will be quite so dramatic after all the majority of customers still use traditional banking and are likely to prefer it for years to come. The trend seems to be closer cooperation between fintechs and traditional banks; the latter using Open API to create better customer experience and facilitate new revenue streams. Banks have the resources to research and implement any system that allows them to explore new avenues. Cooperation with successful Fintechs is not only a good method to keep their place in the markets, but create a new type of service of the customer. The main issue with Open API is security and banks realise this, just as Fintechs do. I think the key is combining efforts; with time a new platform will develop allowing to banking to remain as we know while permitting the recent developments to improve it.