Shearman & Sterling | Fintech 2020 | Scaling to the US
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Scaling to the US
Shearman & Sterling’s FinTech Foundry team is committed to fostering the growth of global FinTech and supporting our clients and the wider FinTech ecosystem. With seven US offices, we have a deep understanding of cross-border regulation, fundraising, M&A and capital markets, making us an ideal partner to support the expansion of FinTechs every step of the way.

In this section, we highlight some of the key considerations for FinTechs when setting up operations in the US, along with additional information on the US FinTech market. For additional information, please refer to our guide, “Entering the US Market: A Guide for FinTech Firms,” which can be accessed below.
   

 

Setting Up in the US Checklist

The below checklist includes a number of steps that FinTechs should take when scaling their business to the US.
 
  • Legal
    Set up US entity, draft employee contracts and equity agreements, file necessary trademarks and patents, establish data privacy measures, evaluate potential regulatory pitfalls
  • Fundraising
    Prepare pitch decks, executive summary and other relevant marketing materials for prospective US investors
  • Immigration
    Obtain visas and documentation for relevant personnel
  • Tax
    Determine how business activity will be taxed and set up tax compliance protocols
  • Insurance
    Evaluate insurance needs and obtain necessary policies
  • HR & Personnel
    Establish benefits and payroll systems, search for potential employees
  • Banking & Finance
    Reconcile US and home country bank accounts
  • Office or Coworking Space
    Secure office leases or coworking arrangements
  • Government Affairs
    Develop relationships with US development and regulatory agencies
  • Administrative
    Identify potential contractors and evaluate administrative needs
 
 

Key Considerations

Below are some key legal considerations for FinTechs that wish to scale their business to the US. While this list is not exhaustive, and every factor may not be relevant to every business, the considerations below are intended to help direct your further questioning and are intended to focus your attention on potential issues that should be addressed.
 

US FinTech Regulation

  • Depending on a FinTech firm’s activities, that FinTech firm may be subject to a myriad of federal and state licensing or registration requirements.
  • The number and complexity of potentially applicable US regulations to any single FinTech has drawn some criticism as a potential barrier to entry and hindrance to the growth of US FinTech generally.
  • At the federal level, key financial regulators include the CFPB, SEC, CFTC, OCC, FinCEN, FDIC and the Federal Reserve.
 

US Tax Law

  • How US tax rules apply will depend on a variety of factors, such as type of entity, means of capital formation and business location, among many others.
  • Non-US FinTech firms that hold multiple US corporations under a single US holding company may file a consolidated federal tax return.
  • Distributions by a US corporation to non-US persons or entities are generally subject to a 30 percent withholding tax; however, this rate may be reduced by an applicable tax treaty (i.e., the US-UK tax treaty).
  • In addition to federal tax rules, FinTech firms should also pay close attention to the tax rules of the states in which they operate.
 

Digital Banking and Nonbank Activities

  • FinTech firms that accept deposits and make loans, or partner with regulated banks in the US, are subject to US banking regulations and regulatory oversight.
  • State banks may choose to obtain insurance from the FDIC and/or to become a member of the Federal Reserve System.
  • Some all-mobile banks have applied for a national bank charter from the OCC, with one firm having its application preliminarily and conditionally approved.
  • Licenses may be required at the state level for FinTech firms engaged in nonbank financial activities like lending (in isolation from deposit-taking), money transmission or certain digital asset transactions.
 

Digital Assets and Tokenization

  • Digital assets are regulated by a multitude of federal and state regulators, often on a “facts and circumstances” basis.
  • Digital assets deemed securities will be regulated by the SEC, and digital assets deemed commodities (e.g., bitcoin and ether) will be regulated by the CFTC.
  • Capital-raising activities generally are subject to SEC rules and regulations. Further, initial coin offerings and other token issuances oftentimes will constitute an investment contract and hence a security that is subject to federal securities laws.
  • Firms and individuals that transmit digital assets may be subject to FinCEN oversight, depending on the manner of transmission and the role that the person or entity plays in that process.
  • Firms that engage in digital asset activities may be subject to IRS and OFAC oversight.
  • Firms that engage in digital asset activities should be cognizant of whether additional US state laws and regulations apply (e.g., New York’s BitLicense regime).
 

Data Privacy

  • Despite common misconceptions, the US has a strong data protection framework.
  • Significant areas of focus in US data protection laws include nonpublic personal information held by financial firms and the use of consumer credit reports.
  • The US data protection framework is made up of a patchwork of laws and regulations that are governed by several state and federal regulators.
  • Data privacy is a rapidly changing field in the US that has garnered significant attention, and several proposed federal and state laws (including the California Consumer Privacy Act) could have a significant impact on the US data protection landscape. 
 

IP Protection

  • IP in the US is generally protected by a combination of patents, copyrights, trademarks and trade secrets.
  • FinTech firms must enter into proper agreements with officers, employees, consultants, and others to secure ownership of their IP.
  • Firms that exchange IP on a cross-border basis may be subject to heightened scrutiny.
  • FinTech firms should be wary of patent trolls that may demand lump-sum payments or ongoing royalties.
 
 

Regional FinTech Hubs

The US FinTech landscape can generally be broken down into regions where local governments are actively encouraging new business formation and technological innovation. Each FinTech hub has its own distinct characteristics and specialties, and each ecosystem is supported by a number of community builders.
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Fundraising

The types of fundraising available to emerging growth companies in the US generally include the following:
 

Convertible Notes

Convertible notes are the most common type of early-stage financing. The company will issue a note to investors with an interest rate, a maturity date, and conversion mechanics, with the expectation that the notes will convert into the equity security issued in the company’s first round of equity financing. The conversion mechanics include a conversion discount and often, a conversion cap.
 

Safes (Simple Agreements for Future Equity)

SAFEs function much like convertible notes, but are not debt and do not have an interest rate or a maturity date. SAFEs are intended to convert into the equity security issued in the company’s first round of equity financing. The conversion mechanics include a conversion discount, and often, a conversion cap. SAFEs were created by Y Combinator, and more details can be found on their website.
 

Preferred Stock

When an emerging growth company raises a round of financing with equity, institutional investors will expect to receive preferred stock. Preferred stock is superior to common stock and includes rights, preferences and privileges, including a liquidation preference, anti-dilution rights, negative control provisions, registration rights and the right to elect one or more directors, among other rights. Equity financings using preferred stock are often completed using forms sponsored by the National Venture Capital Association, which may be found at https://nvca.org/resources/model-legal-documents.

There are also several other variations of preferred stock financing forms; early-stage firms may want to consider abbreviated forms, such as Techstars’ Seed Preferred Stock.
 

Bank Debt

Once an emerging growth company has raised money from institutional investors, it may be able to borrow money from a lender who specializes in lending money to emerging growth companies. This type of financing is traditional debt, with an interest rate, a term, sometimes an equity component in the form of a warrant, reporting obligations and negative covenants for certain actions that require the lender’s consent.
 

Subordinated Debt

Later-stage companies may also be able to raise debt capital from specialized lenders that lend money that is subordinated to other lenders. This form of financing requires a company to have substantial revenues and is often expensive, with a high-interest rate, a fixed term and typically requires that some form of equity instrument be issued to the lender.
   

Types of Funding Rounds

Emerging growth companies in the US typically proceed through one or more rounds of funding before achieving significant growth, such as the following:
 
 

Glossary of Relevant Regulators and Innovation Arms

Below is a list of relevant regulators that FinTechs should be aware of when operating within the US.
For more contact information, please download our full Guide
 

Commodities Futures Trading Commission (CFTC)

The CFTC is the primary US regulator for derivatives markets and their participants, including trading facilities, clearing organizations and market intermediaries, such as swap dealers, futures commission merchants and commodity trading advisors.
 

Conference of State Bank Supervisors (CSBS)

The CSBS is a national organization of the financial regulators from all 50 US states, the District of Columbia, Guam, Puerto Rico, American Samoa, and the US Virgin Islands.
 

Consumer Financial Protection Bureau (CFPB)

The CFPB has the primary authority to develop and enforce consumer protection regulations applicable to both banks and non-banks. The regulator also examines the larger US banks for compliance with certain consumer laws.
 

Federal Deposit Insurance Corporation (FDIC)

The FDIC is the primary federal regulator for state non-member banks whose deposits are insured by the FDIC. The FDIC is also a regulator of FDIC-insured branch offices of foreign banks, though there are no new FDIC-insured foreign bank branches, only grandfathered ones.
 

Federal Reserve

The Federal Reserve supervises federally chartered banks. The Federal Reserve also supervises bank holding companies and the US activities of foreign banking organizations.
 

Federal Trade Commission (FTC)

The FTC is, among other things, the principal privacy regulator in the US through its power to prohibit “unfair or deceptive acts in or affecting commerce” against inadequate and misleading data practices. The FTC has also been empowered to enforce numerous privacy regulations.
 

Financial Crimes Enforcement Network (FinCEN)

FinCEN is a bureau of the US Treasury Department that is responsible for the oversight and registration of money services businesses. Further, FinCEN is responsible for the enforcement of BSA/AML/OFAC requirements for such entities.
 

Financial Industry Regulatory Authority (FINRA)

FINRA is a Congressionally authorized SRO that is the principal regulator of broker-dealers. In addition to registering with the SEC, a broker-dealer applicant must become a member of at least one SRO (typically FINRA, a national securities exchange or both).
 

Internal Revenue Service (IRS)

The IRS is the federal tax administrator of the US. The IRS is responsible for enforcement of federal tax laws and the collection of federal taxes.
 

National Association of Insurance Commissioners (NAIC)

The NAIC is a national standard-setting organization made up of the insurance regulators from all 50 US states, the District of Columbia, Guam, American Samoa, the US Virgin Islands, Puerto Rico and the Northern Mariana Islands.
 

Office of the Comptroller of the Currency (OCC)

The OCC charters and supervises national banks and federal savings associations, as well as federal branches and agencies of foreign banks (although most non-US banks operate in the United States through state-licensed branches). The OCC does not supervise state-chartered banks.
 

Securities and Exchange Commission (SEC)

The SEC is the primary securities regulator in the US. The SEC has oversight authority over US securities markets and the key participants in such markets, including securities exchanges, broker-dealers, investment advisers and mutual funds, among others.
 

Small Business Administration (SBA)

The SBA is an independent federal agency responsible for supporting small businesses in the US. The SBA provides aid and counseling to assist and protect the interests of small business concerns.
 

United States Patent and Trademark Office (USPTO)

The USPTO is a federal agency within the US Department of Commerce that is responsible for granting US patents and registering trademarks.