Capital matters for fintech start-ups

The UK’s fintech sector is growing rapidly as new regulations encourage innovation and open up the banking and financial services sector to new competition. But are these fast-moving businesses ready to take control of their financial futures?

Speaking recently at the International Fintech Conference in London, Chancellor Philip Hammond commented that the UK’s thriving fintech sector contributes $7bn to the economy each year and investment in the sector doubled last year. In fact, London’s fintech sector is growing faster than other global tech innovation hubs, including Silicon Valley.

In this rapidly-expanding marketplace, businesses preparing to bring new apps and other fintech services to market must take extra care to ensure their accounting and capital management systems are robust, whilst staying abreast of changes in the regulatory environment.

Prior to market entry, new fintech businesses can apply to the Financial Conduct Authority’s (FCA) Sandbox for a chance to demonstrate the functionality and efficacy of their software or app-based service, using real customer data, in a controlled online space. This testing bed for new businesses is designed to ensure regulations keep pace with innovation at the same time as providing a credibility marker for newcomers. No fewer than 70 businesses used the regulatory sandbox last year and many more expected to do likewise this year.

When preparing to bring a new financial technology idea to market, the business concerned will require access to significant capital funding. Software development can be notoriously time intensive and the up-front costs involved in creating and marketing a new product or service can be considerable. Taking mobile-only challenger bank, Starling, as an example. The business was launched in 2014, by entrepreneur Anne Boden, backed by a marketing campaign inviting customers to take back control of their finances. However, its first current account was not launched until March 2017 and its account for small business customers and entrepreneurs has taken longer to develop launching to the marketplace earlier this year.

To facilitate phased investment, it is important that fintech businesses choose the right corporate structure from the start. By creating a holding company for example, it is possible for business owners to sell shares to investors over time – either in the holding company itself or in one of its subsidiaries. This flexible structure is ideally suited to innovation-led businesses that have a number of ideas under development at any one time.

Securing funding upfront can help a new fintech business to get noticed by the right people, in the right places. It is important to attend conferences and other events in the sector and seek exposure on influential channels, including podcasts and media websites.

In fast-moving regulatory and market environments, good capital management is also essential. Before investing, third parties will need access to accurate and reliable accounting and financial information. Traditional accounting systems that provide figures on a monthly basis will not be sufficient to secure the capital needed to grow. Most investors will expect to see real-time business information and accurate, well-presented cash forecasts.

It is also important to ensure accounts are presented in the best way possible to support the interests of the business as it evolves. For example, the peer-to-peer money transfer service, Transferwise, launched a service that was cheaper and quicker than a traditional bank transfer in 2011. More recently, the company has introduced an innovative borderless accounts service to assist businesses that want to receive or make payments in more than one currency. In this scenario, it would be wise to supplement statutory accounts with information about the company’s growth story to date and what it hopes to achieve in the future.

Regulatory compliance is another important issue for all fintech businesses and specialist advice may be needed to ensure the business achieves the right authorisation from the Financial Conduct Authority (FCA). For example, it may be necessary to apply for PSD2 or e-money authorisation, with the latter triggering a requirement for an annual statutory audit. If offering insurance or investor-based services, it may be necessary to hold clients’ money separately from that of the business, this will involve additional controls and potentially external assurance of adherence to the regulations.

The planned introduction of General Data Protection Regulation (GDPR) in the UK on 26 May 2018 raises a specific compliance issue for some businesses, in particular PSD2 businesses. In many cases, the business models of these firms are based on gaining access to and leveraging bank customer data. However, it remains to be seen whether growing consumer mistrust of data sharing will make it harder for them to establish their businesses without big brand support. To prepare for this possibility, businesses should take extra care with their cash management and financial reporting, and consider a structure based on minimising risk and maximising profits.

Mike Ayres is a manager specialising in business audit and compliance advisory services at accountancy firm, Menzies LLP.