Legal Essentials Every FinTech Startup Must Know Before Raising Capital

FinTech startups have the potential to become enormous earners and can help to revolutionize the financial services sector. However, with great opportunities come great regulatory responsibilities.

Unlike traditional startups, FinTech startups have to navigate complex legal frameworks, abide by strict compliance requirements, and ensure high-level business practices are in place before they can legally start operations.

If your aim is to start and then raise capital for your FinTech startup, being legally prepared can save time and keep your new FinTech startup bulletproof against costly mistakes. Furthermore, a FinTech startup that is set up with the best practices in mind builds trust with investors.

FinTech . . . computer programs and other technology used to support or enable banking and financial services. It is often associated with innovative applications such as a website app, mobile app, and/or android app.

Here’s a list of legal essentials every startup founder should know before raising capital:

1. Choosing the Right Business Structure for a Fintech Startup

1. Choosing the Right Business Structure for a Fintech Startup

Selecting the best legal structure for your tech startup is crucial, as it affects liability, taxation, and the ability to raise capital. Within the United States, the following business structures are available:

Limited Liability Company (LLC)

Founders or owners of a Limited Liability Company (LLC) are called “members.” They are partners in the business and enjoy the usual protection reserved for corporations. They are also taxed like partnerships or disregarded entities, making this structure easy for new founders.

LLCs are great for pre-seed or seed-stage companies that don’t plan to raise venture capital money in the short term. An LLC can handle pre-seed and seed rounds, even if angel investors or small funds are involved or multiple classes of equity (e.g., common and preferred) are needed. Large companies, including behemoths such as Amazon, Anheuser-Busch InBev, Google, ExxonMobil Corp., and PepsiCo Inc., use LLCs as subsidiaries.

Among the most popular jurisdictions for forming an LLC are Nevada, Wyoming, and Delaware. These states are known for their forward-thinking and business-friendly environments and favorable tax treatment.

• Advantages: Provides liability protection for founders, offers tax flexibility, and has fewer regulatory requirements. Ownership is not restricted, meaning that individuals, corporations, foreigners, other LLCs, and foreign entities can be members of an LLC. They can even be taxed as an S-Corp (see below). 
• Disadvantages: Limited ability to raise venture capital, as investors often prefer corporations due to the availability of stock options. Often, an LLC can be dissolved upon the death or bankruptcy of a member, although this varies from state to state. In recent years, states have updated their statutes to allow LLCs to continue operating despite the death of a member. However, an LLC operating agreement has to be set up for it.

C Corporation (C-Corp)

The owners or shareholders are taxed separately from the entity. C corporations are subject to corporate income tax, and the profits that are generated from the C corporation are taxed at a personal as well as a corporate level. This often leads to a double taxation situation.

Examples of C corporations are Apple, Walmart, Microsoft, and McDonalds.

• Advantages: It’s easier to attract venture capital with a C corporation. You can issue different classes of stock, and a C-corp generally enjoys more credibility within the financial sector and among FinTech investors.
• Disadvantages: Double taxation (corporate and individual) and higher regulatory and reporting requirements.

S Corporation (S-Corp)

In this type of business structure, corporate income, credits, deductions, and losses “pass through” to the shareholders for federal tax purposes. Most often, only small businesses choose this structure since S-corps can have only up to 100 shareholders.

Examples of S corporations are small businesses, dealerships, and retail stores.

• Advantages: Since a pass-through taxation method applies within an S corporation, it helps against double taxation. S corporations have limited liability protection.
• Disadvantages: S corporations can have only up to 100 shareholders, all of whom must be U.S. citizens or residents, and only one class of stock is allowed.

Whether you are creating a website app or developing a revolutionary mobile application, choosing the right business entity depends on your startup fundraising goals, growth strategy, and long-term vision.

2. FinTech Startup Regulatory Compliance

FinTech startups operate in a highly regulated space. Therefore, ensuring compliance with local, national, and international laws is critical.

• Know Your Customer (KYC) & Anti-Money Laundering (AML) Regulations
  Most FinTech startups that handle financial transactions have to comply with KYC and AML laws. These laws are in place to combat financial terrorism and money laundering practices. These are especially applicable to money service or transmitter businesses.
• Consumer Protection Laws
  During 2024, the United States Securities and Exchange Commission (SEC) obtained a record $8.2 billion in financial remedies in total.
  Examples of 2024 SEC cases were those against companies such as Ken Leech, Macquarie Investment Management Business Trust, Rari Capital, and Inspire Investing for failing to be forthcoming and honest with their client base.
  All Fintech startups should take note of regulations such as the Truth in Lending Act (TILA), which protects customers against unfair or inaccurate credit billing and credit card practices, as well as the Fair Credit Reporting Act (FCRA), which protects customer information that is collected by consumer reporting agencies.
• Data Privacy Laws
  Depending on the location of your startup, and how you handle sensitive financial data, your startup might be subject to the General Data Protection Regulation (GDPR) (Europe) and/or the California Consumer Privacy Act (CCPA). Both of these regulations govern how the data that businesses collect about their customers are used, stored, and shared.

Since FinTech startups often work with sensitive financial information, you might be subject to certain data privacy laws as mandated by the country in which your company will operate. Many startups believe Terms of Service and Privacy Policies are just boilerplate documents that any law firm can provide on the cheap. In reality, these documents need to reflect rigorous data mapping that illustrates what type of information the startup collects and where it originates or is stored.

If your FinTech startup involves investments, crowdfunding, or cryptocurrency, compliance with the SEC and other financial regulatory bodies is necessary.

3. FinTech Startup Contracts and Agreements

The success of a FinTech company often lies in the strengths and weaknesses of its agreements and contracts. Companies are often dissolved because of disputes, the untimely death of a founder, or financial problems. A good contract can protect you from a bad lawsuit.

It’s exceptionally important to have agreements and contracts in place to protect you and your FinTech company. Whether it’s the founders’ agreement, fundraising documents, or vendor contracts, these documents are critical for protecting a company’s operations, intellectual property, and values.

The following is a list of agreements and contracts every business should consider. It’s also important to set up contracts that are legally binding. Therefore, seeking FinTech legal counsel is important during this stage. 

• Founders’ Agreement
  A FinTech Founders’ Agreement helps establish who the owners of the company are, their share percentages, voting rights, the roles and responsibilities of each owner (member/director), and the applicable laws and regulations that apply to the company, as well as equity vesting schedules, dispute resolution methodologies, and leadership roles.
• Investor Agreements
  There are various types of investor agreements, but in general, a FinTech Investor Agreement is a legally binding contract made between your entity and an investor. To prevent conflicts, it outlines the terms of the investment, the conditions of the investment, mutual commitments, the investor’s rights, and exit strategies.
• Non-Disclosure Agreements (NDAs)
  Non-disclosure Agreements are legally enforceable contracts that ensure confidential information between you and another person or business entity is protected as per the agreements made within the NDA.
• Service Level Agreements (SLAs)
  A Service Level Agreement is a contract between a service provider and a customer. It controls the quality, expectations, performance, and scope of the services that will be provided. If performance levels are not met, it also determines the consequences of such.
• Employee Agreements
  United States Law dictates the minimum requirements for employment but can vary from state to state. Therefore, if you are employing US citizens, your startup will be subject to complying with both federal and applicable state employment laws.
  A FinTech Employee Agreement establishes the relationship between your company and your employee and sets in writing the employee’s duties, compensation, benefits, conduct, etc.
• Contractor Agreements
  Startups often utilize the cost-effective services of freelance contractors. Developers from Asian and Latin American countries are especially sought after. You might require an official Contractor Agreement to establish the terms and conditions of the work the freelancer has to perform, compensation, benefits, and the like.
• Partnership Agreements
  When two or more partners start a company together, an official, legally binding contract is often forgotten about. However, history has proven that when it comes to doing business together, it’s always best to have a partnership contract in place.
• Supplier / Vendor Agreements
  If your startup relies on raw materials, and/or products or services from vendors, set up an agreement between your business and the mentioned parties to protect your business from supply shortages, outages, and the like.
• Data Sharing Agreement (DSA)
  A Data Sharing Agreement outlines the terms of how your company will collect, store, save, process, use, and share data. The agreement is usually publicly published via your website’s Privacy Policy, for example. If you’re doing business in Europe, you will need to comply with all General Data Protection Regulation (GDPR) laws.
• Software License Agreements (SLAs)
  Whether it’s a website app or mobile application, your FinTech software needs to be protected under a Software License Agreement. This agreement establishes the rights, obligations, duration, scope, fees, terms and conditions, and limitations when a consumer uses the Fintech software.
• Others
  Every startup is different; therefore, it’s always best to consult a FinTech Lawyer to establish the types of contracts or agreements your startup might need.

In PART 1 of this article, we outlined three of the most important legal considerations every FinTech startup should consider before raising capital, namely:
(1) choosing the right business structure,
(2) FinTech Startup Regulatory Compliance, and
(3) FinTech Startup Contracts and Agreements.

In PART 2 of our Legal Essentials Series for Startups we will take a look at
(1) Protecting Intellectual Property,
(2) Fintech Startup Fundraising Documentation Requirements, and
(3) Understanding Investor Expectations.

Subscribe to our Newsletter to be notified HERE when PART 2 becomes available.