Look Both Ways


I am a big fan of not looking in the rear view mirror when you are at a start-up with a new market opportunity. When you are not Coke vs Pepsi, looking behind you can be more of a distraction and more often companies go under from poor execution, lack of funding or some market shift than a competitor taking the space.

This said, there is one place where you do have to take your eyes away from your execution focus and make sure it does not take you by surprise. The Regulators. Capitalized it sounds like Hogwarts hall monitors and, without taking the metaphor too far, as far as you are concerned they could come out of the walls and hit you with a paralyzing spell before you even know it.

There has been a significant growth trend in Mexico towards Fintech, as this excellent Endeavor Mexico report summarizes (in Spanish). One key component of any fintech business, though, is the regulatory environment surrounding financial services. Here is where you have to take your blinders off and delve into what might not necessarily be your strong suit: studying existing laws applicable to your business and trying to anticipate upcoming changes or new ones.

You cannot outsource this to your lawyers. When we started online consumer lending in Mexico way back in pre-history, summer of 2013, we were the first to market and were testing a lot of new consumer interfaces. Would an e-signature be valid in courts in case of a dispute? Would we have to always print out and store our online applications to have them available for audits? Is the photo of an ID valid proof that you ‘checked their ID’? We got different answers from different law firms to these exact questions. Nobody really knew.

Our best, and really only, alternative was to go straight to the Regulators and ask them. Now this is a really scary proposition. I think that all entrepreneurs like to think of ourselves as slightly rebellious, out on the fringes. Not really subject to the mandates or mores of the existing regime. We are there to disrupt, after all. So the concept of shining a light upon yourself and saying, ‘This is exactly what I am doing. Is it legal?’ sounds anathema to many. But not doing it could very well be the thing that kills the business.

In February 2006 a business called Prosper  launched with a new concept called ‘social lending’. It was revolutionary and disruptive. Within 18 months they had raised $40M from top-tier VCs and owned the space. Until. Around mid-2007 a competitor appeared. This competitor, Lending Club, also wanted to enter into the social lending space, renaming it peer-to-peer lending (P2P, later yet again reborn as marketplace lending). But before launching they did something very few other startups in any industry had done before. They spent time and money understanding the legality behind their business model. Instead of trying it and then seeing what happened, à la Prosper, when they could not get a solid answer, they went to the Regulators, who scratched their heads and basically said, “No, this is not legal, but if you change it in several ways, then we could approve you”. Almost at the same time that Lending Club was given the ok to start selling P2P loans, that same Regulator closed down Prosper for making unauthorized loan transactions.

It took Prosper a year to clean it all up and $1M in fines. By the time they relaunched, Lending Club had take up all the mindspace of the segment and had a dominant place in the market. For most people Prosper is a latecomer me-too, when just the opposite is true.

In Mexico, Kubo Financiero, founded by successful serial entrepreneur Vicente Fenoll, learned the lesson and spent years getting the Mexican Regulators to look at what he was doing and explicitly authorize it, not just letting it exist in the grey ‘we guess it is ok’ world. In 2015 he got the authorization he wanted, becoming the first fully regulated P2P lender in Latin America.

There are significant legal changes coming down the pike for Fintechs in Mexico. As an example, there is a potential proposal to require fingerprinting every loan customer, regardless of acquisition channel. This would obviously be a significant hurdle for most consumer fintech models. Assuming any legislative changes are too far removed and will not impact your little start-up could be just as fatal as not raising your next round of capital.

UK-based Wonga, for example, went from being a mutlibillion dollar start-up, the first of the unicorn Fintechs, to a much more humble version if itself when the UK Regulators hit it hard with laws specifically designed to block their business model. Not only did they ignore the Regulators, Wonga thought it was bigger then them, trying to fight regulation with a PR campaign. No go.

Fortunately, you do not have to defend your company all alone. Since there are many start-ups in Latin America dealing with the same potential regulatory issues, organizations and associations have popped up to create lobbying forces that represent all members and their businesses. In Mexico the Asociación Fintech, led by Jorge Ortiz, is the largest and has a committee just focused on lobbying Regulators about the legal needs of Fintech models  (disclosure: I am a founding Board Member of the association).

Obviously nothing will protect you from being legislated out of business if the Regulators deem it in the best interest of the consumers to do so, but being in a position to influence the thinking behind laws, knowing in advance, and maybe shifting business models if necessary could make the difference between roadkill and a successful exit.

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