Every fintech company comes with many new opportunities. Its chosen business structure is critical to optimising the fintech venture. The proper structure can provide growth opportunities and risk isolation but may also increase administrative costs. It is important, therefore, to consider the company’s specific circumstances and evaluate its short- and long-term goals, investment needs and risk appetite when deciding on the corporate structure, whether at the time of its incorporation or the scaling-up stage.
Many fintech ventures find that the benefits of a more complex corporate structure outweigh the drawbacks as it facilitates their scale and expansion into multiple markets or other products. Given the likelihood of limited resources, scale, or market focus, the benefits might not outweigh the costs and complexity for early-stage startups. However, as the business grows and scales up, a restructuring is still possible and should be contemplated.
Even a straightforward dual company structure (two legal entities organised as holding and subsidiary) can protect the core business by isolating regulatory and operational risks to specific entities. It may allow for more efficient capital allocation based on risk profiles of different activities and/or enable the company to take on riskier ventures or innovations without jeopardising the entire business. Moreover, it can make the fintech venture more attractive to different types of investors by allowing for strategic investments or partnerships in specific entities.
This article explores the rationale for setting up multiple legal entities for fintech startups and scale-ups and the considerations necessary to optimise their corporate structure.
The Basics
Fintech startups usually trade as companies.
A company or “incorporated” entity is a separate legal entity. This means it has a separate legal existence to its founders (the natural persons who formed the company), directors (those who control the company), and shareholders (those who own the company).
Having a separate legal existence allows the company to generate revenue, which is owned by the company; incur expenses, which are payable by the company; attract legal liability to pay taxes to taxation authorities; and typically pay tax at lower rates than individuals.
Most importantly, an incorporated entity insulates the individuals participating in the business—founders, directors, and shareholders—from personal liability that may arise from doing business.
Most fintech companies must be licenced by or registered with the regulatory bodies and, as a prerequisite, must be incorporated. Incorporation, licencing and registration are critical components of the regulatory framework for fintech companies.
Many fintech startups begin as a single legal entity. This is understandable and generally justifiable at a time when available funds are meagre, cash inflows are practically non-existent, the management structure is lean, and business priorities are focused on getting the product out and generating revenue.
There is, however, a common misconception amongst many first-time fintech founders. They mistake setting up a dual company structure with opening a new legal entity in a new country, aspiring to create new opportunities and to reach new regions. The reasons for this aspiration may be rather compelling, ranging from a slower-than-expected application for a current licence in the company’s home country and an intention to create a backup in a new country, expecting it to be easier and faster, to founders experiencing FOMO when one of the competitors opens their new office in a new country.
Yet, more often than not, a legal entity in a new country at this stage is not an asset but a liability for a fintech startup. Most first-time fintech founders don’t recognize that having a legal entity in a new country requires maintenance in terms of corporate filings, reporting, and other admin and can tangibly undermine their growth. In most jurisdictions, there are also non-negligible requirements for employing local talent. The new legal entity may become a target for regulatory scrutiny and trigger the necessity to maintain government affairs, tax planning, and other efforts. It dilutes management attention by dragging the whole executive team, which is already stretched and often inexperienced, to follow the operational/tax/regulatory chores instead of solving strategic questions related to growth, product development, or innovation.
Big Tech and established fintech companies have grown globally, having only 1-3 entities during their first 10 years in business. They delay creating additional entities until they have developed a profitable local business from the parent location on a cross-border basis.
If the business cannot build momentum in a particular country without the local entity, it does not have a strong business case there or has not tested the market.
Therefore, the question is when, where, and whether it is worth it for a fintech company to set up separate legal entities.
Why divide the business
The company might be divided, and new legal entities might be set up for a variety of reasons, which include protecting assets, isolating risk, limiting liabilities, optimising the operations of a business, attracting outside investment without giving proprietary rights in the entire group or a parent company, trading in a foreign jurisdiction and obtaining benefits within that country (the ability to trade without tariffs, such as in the EU; the benefit of lower tax rates; regulatory licence).
Broadly speaking, the reasons for dividing any business into several business entities usually fall into these categories:
• Taxes
• Liability protection
• Management structure
• Transferability For fintech companies, the fifth category - regulatory requirements – tops the list.
Regulatory Requirements
Most fintech startups are looking at carrying out regulated financial activities. Before they commence those regulated activities, they need to become authorised and regulated. In the UK they need to be authorised by the FCA. Some firms, such as payment service providers, e-money institutions, and small registered UK alternative investment fund managers, may only need to be registered with the FCA rather than becoming fully authorised.
Getting a Licence
Licencing and registration are critical components of the regulatory framework for fintech companies. These processes ensure that fintech entities comply with relevant laws and regulations, maintain operational standards, and prioritize consumer protection.
Preparing the documents, which must include a regulatory business plan, a compliance manual and monitoring program, financial projections, profit and loss, capital and liquidity/cash-flow forecasts, risk management and governance frameworks, IT systems, policies and procedures, and senior management responsibilities, to name a few, may take substantial time. The FCA's review and approval may take 3 to 6 months. The FCA has up to 12 months to review and decide on authorisation.
It is usually not feasible for any company, let alone a startup, to wait a year for licencing.
FinCo/TechCo
Being a regulated company significantly complicates opening a bank account and obtaining professional indemnity insurance (PII). Banks and insurers need to understand the specific risks associated with the regulated activities, making the process more complex and expensive.
Upfront planning of the appropriate corporate structure can be of material benefit. A fintech can use a FinCo/TechCo structure, thus separating regulated and technology entities. The TechCo focuses on the development and maintenance of the fintech platform and technology infrastructure, while the FinCo legal entity focuses on the regulated business function.
While FinCo is getting regulatory approval, TechCo can start operating without the complexity and timeconsuming nature of setting up operational frameworks for regulated entities
Business activities can be structured using different legal entities as subsidiaries or connected companies.
Locating the regulated entity in a suitable jurisdiction can, in certain circumstances, and if properly structured and operated, give rise to additional benefits such as access to wider markets. However, care is needed with respect to the location of the FinCo, the future operation of the FinCo and the general application of the UK regulatory regime.
Serving Global Markets
Most fintechs that want to serve global markets usually have a US entity to serve North America, an EU entity, and, thanks to Brexit, the UK. The US market in its own right is also very segmented, with individual states having very different regulatory and fiscal regimes.
There are also rather segmented markets in Asia, Africa, the Middle East, and Latin America. European and UK entities are overall better positioned to serve these markets than US ones because: • EU and UK banking systems and overall regulatory approach are considered to be one of the most fintech-friendly and crypto-friendly regulatory regimes
• the customers can enjoy a European level of security, fraud protection, privacy, and consumer rights – which is arguably the best in the world
• customer information reporting requirements in the US are cumbersome and onerous for customers in Asia, MENA, and Latin America
• there are more secure international banking relationships between Europe/UK and Asia and Africa
Taxes
In the UK, startups can take advantage of several tax regimes aimed at encouraging smaller businesses by offering tax relief to their owners, incentivising employees, or obtaining important early-stage investments.
These regimes include:
entrepreneurs' relief, which offers a reduction of capital gains tax payable on the eventual sale of their business from 20% down to 10% for up to £1 million of gain
• the Enterprise Management Incentive (EMI) share scheme to grant share options to employees on taxefficient terms • the Enterprise Investment Scheme (EIS), which offers tax relief for investors
• the Seed Enterprise Investment Scheme (SEIS), which offers higher tax relief for early investors
• Venture Capital Trusts (VCTs) incentive, which offers income tax relief for those who invest in VCT
In addition to the above, technology and fintech companies may be eligible for more targeted beneficial tax regimes:
• the UK's research and development (R&D) relief, which allows enhanced deductions against their profits for corporation tax or surrendering the losses in return for a cash credit
• the patent box regime, which allows for a lower rate of corporation tax on profits from exploiting eligible patents
• the UK's tax regime for "intangible assets” such as intellectual property, patents and design rights
To maximise these potential tax benefits, it is essential to incorporate thoughtful structuring from the outset of any business venture, engage in careful planning, and conduct ongoing reassessment throughout the business’s life cycle. Examples of milestones for such reassessment include the business becoming revenue-generating, the profit no longer fully reinvested in the business, or launching a new business activity or product. The company may consider corporate restructuring or putting in place additional corporate structures (creating new legal entities) to ensure that it
• maximises their tax position
• remains attractive to EIS and VCT investors • can secure maximum R&D benefits
• protects its “intangible assets”
• able to facilitate growth and future corporate activity
Liability Protection
An incorporated entity insulates the individuals who run and own the business from personal liability. Nonetheless, personal liability for directors may arise under UK legislation in relation to environmental and health and safety, employment, consumer protection and bribery/anti-corruption. A director can be liable for breaching FCA regulations if they were involved in or knew about the breach. The Financial Conduct Authority (FCA) can take enforcement action against directors who are found to be liable.
It might make sense to mitigate this risk by segregating the regulated entities, thereby protecting the directors and key employees of the unregulated entities from the more stringent requirements.
Introducing new business products or services (for example, a payment company introducing lending or investment services) may necessitate separate legal entities for different services to mitigate different levels of risk intrinsic to them.
Business activities can be structured using different legal entities as subsidiaries or connected companies.
Management Structure
In the startup's infancy, the founders have the ultimate freedom in business decision-making. Usually, the founders are the first directors, and the Board of Directors' decisions are unanimous. As the company grows, it is not uncommon for the founders to become less comfortable with their fellow directors’ judgment. Sooner or later, shareholders want to have their say in the election of the Board. A business founder may wish to establish credit for their business or maintain some form of control.
Transferability
The consideration of succession planning, as well as the possibility of stock or asset sales, may prompt the separation of the company into independent business entities and the structuring of each to maximize profit
Takeaways
Setting up multiple legal entities for a fintech company can be beneficial, but it also comes with challenges. A proper corporate structure can separate risks and protect assets for fintech ventures, offer flexibility for investors and partnerships and increase complexity and costs.
There is no one-size-fits-all solution. Each fintech venture must carefully and holistically consider its specific circumstances and short- and long-term goals while choosing a company structure. It may need to consider the unique regulatory requirements of each jurisdiction while establishing a regulated entity in another jurisdiction, corporate and international tax implications, the company’s liability protection, management structure, and transferability.
The chosen company structure should be able to support a fintech venture’s rapid expansion and provide a flexible and efficient framework for its growth and scaling up.
LEXeFISCAL’s team is ideally placed to help businesses achieve optimal corporate structure and secure long-term tax efficiencies and regulatory compliance.
Working alongside our market-leading tech and fintech advisors in the UK and Europe, LEXeFISCAL’s unique combination of technical and corporate specialism, tax legislation, regulatory licencing, and expertise in the fintech area will help your startup secure growth and plan the rest of the climb.
Contact us!
Email: fintech@lexefiscal.com
Article by: Victoria Pikovsky (LinkedIn)
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