Most fintechs fail on the legal foundation

When I talk to fintech founders, I always notice a common mindset popping up. Many of them seem to feel a bit invincible, thinking things like:

1. “We’re too small for regulators to notice us.”

2. “We can skip getting a license for now; we’ll sort it out later.”

3. “Terms and conditions? I’ll just grab something off the internet.”

Now, at the start, these shortcuts might seem harmless and even clever, saving time and effort. But that’s a risky way to play the game.

It’s really more of a gamble. If you skip key compliance steps, you’re leaving your business’s future up to chance.

And depending on luck isn’t a good plan.

When regulators come around, they are not focused on how small your company is or where you are in your growth. They're all about whether you've followed the legal rules that apply to your business.

So, instead of asking, “Will I get lucky?” ask yourself, “Am I ready when the regulators start looking at me?”

My Steps To Build A Good Foundation

To build a strong legal base in the fintech space, here are some of my recommendations for fintech founders in India:

1) Business Structure & Registration

- Company Incorporation: Make sure to register as a Private Limited Company under the Companies Act, 2013. Going with something less formal, like an LLP or sole proprietorship, won't give you the protection or credibility you need in fintech.

- Clear Business Objectives: Be sure your Memorandum of Association (MoA) clearly describes what your fintech business does, so there’s no confusion about your model.

- GST Registration: If your revenue goes over ₹20 lakhs (or ₹10 lakhs in certain areas), getting GST registration is mandatory to stay compliant.

- PAN/TAN Registration: You’ll need a Permanent Account Number (PAN) and a Tax Deduction and Collection Account Number (TAN) to handle financial transactions and tax laws properly.

2) Regulatory Licenses

- Identify Required Licenses: Make sure your business model matches up with the right licenses for what you’re doing:

  - If you’re into payment services, get a Payment Aggregator or Gateway license from the Reserve Bank of India (RBI).

  - For lending, you’ll need a Non-Banking Financial Company (NBFC) license or team up with someone who’s already licensed.

  - Investment advisory needs registration with the Securities and Exchange Board of India (SEBI).

  - For insurance distribution, get the right license from the Insurance Regulatory and Development Authority of India (IRDAI).

- Avoid Operating Without Authorization: Putting off getting these licenses can lead to serious troubles. That attitude of “We’ll handle it later” could end up being a regulatory nightmare waiting to happen.

- Understand Grandfathering Provisions: Some rules allow for transition periods, but it’s important to apply before the deadlines to dodge penalties.

3) Data Protection & Privacy Compliance

- Effective Privacy Policy: Make sure your privacy policy is solid and follows the Information Technology (IT) Act of 2000 and the Data Protection and Digital Privacy (DPDP) Act of 2023.

- Data Localization: Financial data has to stay stored in India - no exceptions on that front.

- Consent Mechanisms: Set up clear and informed consent processes for collecting and processing data, ensuring your customers understand how their info will be used.

- Data Breach Response Plan: Create a response plan detailing how to act and who to notify if there’s a data breach, paying special attention to reporting timelines - some situations may require notifications within six hours.

4) Customer-Facing Legal Documents

   - Terms of Service: Create straightforward and thorough terms that clearly explain your rights and those of your users.

   - User Agreement: Put together user agreements that match what you’re offering, whether it’s lending, payment processing, or investment services.

   - Refund and Cancellation Policies: Make sure your refund and cancellation policies are clear so you’re following consumer protection laws.

   - Grievance Redressal Mechanism: Set up a clear process for handling complaints, including appointing someone to oversee it and outlining how customers can escalate issues.

5) Anti-Money Laundering (AML) & KYC Framework

   - Comprehensive KYC Procedures: Have good Know Your Customer (KYC) processes in place to detail how you’ll identify and verify customers.

   - AML Monitoring Systems: Create systems for anti-money laundering that include monitoring transactions and reporting any suspicious activities.

   - Record Keeping: Keep thorough records of customer data for the required amount of time to meet regulatory needs.

   - Regular AML Audits: Carry out both internal and external audits regularly to make sure you're sticking to AML regulations.

6) Cybersecurity & IT Governance

   - Information Security Policies: Write and maintain policies that explain how you’ll protect data and secure your IT systems.

   - Regular Security Audits: Do regular vulnerability checks and penetration testing to spot and fix potential security risks.

   - Incident Response Plan: Set up clear steps for dealing with security breaches, including who’s responsible and how communication will work.

   - Business Continuity Planning: Make plans to keep your business running smoothly, even when unexpected events pop up.

7) Financial Compliance & Reporting

   - Statutory Audits: Hire chartered accountants to handle annual audits as required by law.

   - Regulatory Reporting: Ensure you submit necessary reports on time to regulators like the RBI, SEBI, or other relevant authorities.

   - Tax Compliance: Keep up with income tax, GST, and any other tax obligations to steer clear of problems.

   - Capital Adequacy: Maintain the minimum net worth set by regulatory authorities to stay operationally viable.

8) Employment & HR Compliance

   - Employment Contracts: Clearly lay out the employment terms for all employees and contractors, making sure their roles and responsibilities are defined.

   - IP Assignment Clauses: Add clauses in contracts to ensure any intellectual property created during employment belongs to the company.

   - Confidentiality Agreements: Safeguard important company information and trade secrets with good confidentiality agreements.

   - Labor Law Compliance: Make sure to follow labor laws related to Employee Provident Fund (PF), Employees’ State Insurance Corporation (ESIC), and other statutory requirements.

A Few More Steps To Build Your Foundation Right

If you want to reinforce your compliance and legal status right away, here's an action plan you can also follow:

A) This Week

- Take a good look at your current legal and regulatory compliance situation.

- Spot the gaps between where you are now and the compliance standards you need to hit.

- Create a timeline and budget to tackle these compliance gaps efficiently.

B) This Month

- Bring in legal experts who know their stuff in fintech.

- Start the application process for the essential licenses you need to run your operations.

- Get the ball rolling on basic compliance frameworks that are suited to your business model.

C) This Quarter

- Aim to wrap up all the necessary legal groundwork for your operations.

- Set up ongoing compliance monitoring so you stay on track with regulatory standards.

- Train your team on what they need to know about compliance, building a culture of adherence in your organization.

Final Thoughts

The most successful fintech companies aren’t just lucky; they’ve worked hard to create a good legal foundation right from the start.

Don’t take chances with your company’s future.

Focus on creating a strong, compliant, and lasting business model that stands out in the competitive fintech scene. Build it right, build it strong, and build it to last.