Fintech Term Sheet Negotiations: Key Issues Beyond Price

Originally appeared in Kaye Scholer's Term Sheets and Tech Deals: Key Considerations Report

Fintech startups and the regulated financial services companies (FSCs) they hoped to disrupt have realized the benefits of cooperation over competition. FSCs are seeking out the technologies, talent and business models developed by fintech startups to complement organic growth and M&A strategies, as well as to develop competitive advantages. Likewise, fintech startups wish to leverage the global product distribution platforms and compliance infrastructures offered by FSCs. For venture backers and startup founders, FSCs also now serve as primary paths to liquidity events.

As a result of the mutual interests and benefits, the volume of venture investments, joint ventures and acquisition transactions between FSCs and fintech startups has increased significantly. The following issues are often overlooked in term sheet negotiations, complicating the transaction process and placing the benefits of cooperation at risk.

Implications of "Control" Under the Bank Holding Company Act.

The Bank Holding Company Act and its related rules (BHCA), to which most FSCs are subject, can complicate transactions because the BHCA provides that a FSC "controls" the startup if it holds more than 25 percent of the startup's voting stock, controls its board or otherwise has a controlling influence (for example, contract-based negative consent rights). A fintech startup controlled by a FSC also may need to implement portions of the FSC's compliance programs and governance practices, which could affect the startup's culture and cost efficiencies. As a result, the structure of a joint venture or minority investment must balance the benefits of keeping the startup separate from the FSC, thereby maintaining its culture of innovation, with the FSC's ability to protect its investment and achieve its strategic objectives. To mitigate BHCA-related issues, FSCs and fintech startups should analyze the implications of control on the post-closing business model and consider whether each party's transaction objectives can be achieved in a structure where the FSC does not control the startup.

Potential Accounting Impacts.

Transactions between FSCs and fintech startups often use earn-outs and milestone payments to bridge valuation gaps. Venture investment transactions and joint ventures also frequently include purchase options that enable the FSC's complete acquisition of the startup. FSCs and...