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Financing, investment and government support
Does the government provide any incentives or support programmes to promote fintech innovation in your jurisdiction (eg, tax incentives, grants and regulatory sandboxes)?
Arizona passed regulatory sandbox legislation that allows companies to launch products on a limited scale to test their services, business models and delivery mechanisms without incurring traditional regulatory costs and burdens. Arizona began accepting applications for its sandbox in August 2018.
Has the government concluded any international cooperation agreements to promote and facilitate the cross-border expansion of fintech businesses?
The Cooperation Arrangement between the US Commodity and Futures Trading Commission and the UK Financial Conduct Authority states that “in order to enhance mutual understanding, identify market developments and trends, facilitate innovation with respect to financial technology ("FinTech"), and foster the use of technology for more effective and efficient regulation and oversight of financial markets and participants”.
Financing and investment
What private financing and investment schemes are available and commonly used for fintech start-ups in your jurisdiction?
From a legal perspective, raising capital for fintech start-ups is much the same as for other venture capital and emerging growth companies. However, the investor base may be smaller or more concentrated given the specialised nature and regulatory complexity of many fintech companies. In some cases, the more limited scope for growth of fintech companies (eg, projected valuation capping out at $100 million to $200 million) may deter ‘unicorn-hunting’ venture capital firms seeking that magic billion-dollar valuation. However, the nuts and bolts of fintech financing are not that different from other start-ups. Most initially raise money from family, friends and angel investors in a seed round, before hopefully proceeding to series investment rounds until the much-hoped for exit – which is almost always a merger or acquisition and not an initial public offering. Unfortunately, most fintech companies, like most start-ups, fail along the way. Most series financing rounds follow the form documents published by the National Venture Capital Association (NVCA).
Increasingly, fintech companies are swiftly joining incubators or accelerators, some of which are sponsored by industry participants (eg, Wells Fargo and some indirectly such as Plug and Play). Specialised fintech venture capital funds and the venture capital arms of financial institutions often wait until later financing rounds to invest in start-ups, including fintech companies.
Most fintech companies will raise some mixture of series seed convertible preferred, series convertible preferred shares for subsequent financing rounds and the occasional convertible note and even warrants offered as sweeteners. A typical capital raise involving a new series of convertible preferred shares will involve a purchase agreement, an amended and restated certificate of incorporation, an investor rights agreements, a right of first refusal and co-sale agreement and a voting agreement, again typically utilising NVCA forms. These securities are offered in transactions exempt from the registration requirements of the Securities Act 1933, either under Section 4(a)(2) of the act or Regulation D.
Some fintech companies may also seek venture lending from banks such as Silicon Valley Bank or Comerica, particularly if they need to invest in regulatory licences or other infrastructure. These are typically secured lendings.
Some fintech investments may qualify investors for the qualified small business stock (QSBS) exclusion (Section 1202 of the US Internal Revenue Code). Under this provision, investors are permitted to exclude a percentage of the gains on the sale of QSBS that is held for more than five years (currently 100%). However, fintech companies structured as holding companies of regulated companies may not qualify. A qualified small business generally must be a C-corporation for federal income tax purposes with aggregate gross assets that do not exceed $50 million before and immediately following the QSBS offering. The corporation must also be engaged in one or more qualified businesses, which must have:
- no more than 10% of their assets consisting of stock or securities of other corporations; and
- at least 80% of their assets involved in the active conduct of one or more qualified businesses, during substantially all the time that the investor holds the stock.
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