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by InnReg

Regulation and Fintech Business Models - Part One

Categories: CCO Advisory

Fintech developers by nature are innovators who enjoy disrupting the marketplace with cutting edge concepts. So it may not be part of their personality to embrace the mundane aspects of running a regulated company like a lender or broker-dealer. That’s why many innovators tend to avoid the complexities of the full stack model without completely evaluating the benefits.

Full Stack Vs Partial Stack

It’s important to consider the strategic business implications of full stack vs. partial stack early in the development process. It’s a decision that will radically shape your business model, product strategy, operational set-up, staffing requirements, licensing requirements, technology set-up, etc. It can also have an enormous impact on your profit potential, because a full stack organization reaps the rewards of additional revenue streams from loan interest or brokerage commissions.           

This is such a crucial decision for a fintech startup that we're devoting two articles to the subject. In Part One we’ll look at the differences between full and partial stack as well as the pros-and-cons of each option. In Part Two I’ll share some specific examples of why we believe full stack is the only way to truly disrupt the marketplace.

What’s the Best Option?

Partial stack is less complex. Your product is an ingredient in a bigger program, and you won’t control the entire  end-user experience. Without the regulatory requirements it’s faster, easier and less expensive to launch and maintain.

Full stack is more complex, and it requires specialized expertise. A traditional bank or brokerage firm provides an end-to-end experience to the end-user, so they’re required to be a regulated entity. The launch timeline is longer, and the program is more expensive to maintain. However, the revenue potential is greatly increased.

These descriptions simplify the situation, but the reality of partial vs. full stack is not so black-and-white. And it’s important to understand each option in the context of your own individual situation to determine the best approach for your new product or service.

Partial Stack Pros-and-Cons

With the partial stack model you sell or license your ingredient technology to a financial services organization like a traditional bank, online lender or a broker-dealer. Your client who is the financial services organization interacts directly with the consumer, so as a full stack provider they’re required to be licensed by a government regulatory body like FINRA or the SEC.

It might seem attractive to bypass the regulatory agencies, but it could mean leaving a lot of money on the table. This happens because non-regulated entities aren’t allowed to share in the transaction revenues generated when the consumer uses your client’s products or services. For example, a brokerage firm is not allowed to share commission revenue with an unlicensed entity. Your technology might deliver a trading algorithm that differentiates your client’s online BD in the marketplace, substantially increasing their sales and revenue. However, you won’t be able to capture the full value of your contribution unless you control the customer relationship, which requires a full stack model with the appropriate regulatory licenses.

Another appealing aspect of partial stack is speed-to-market. However, this may not be true in every situation. One of our clients licensed their technology to a large established bank. Their launch timeline eventually extended out to 18 months after lengthy contract negotiations, a multi-pronged due diligence process, numerous stakeholder buy-ins across a variety of departments, in addition to the technology integration. Plus our client was required to conform to the regulatory requirements of the bank. So in the end their timeline and compliance requirements were very similar to the typical full stack process for becoming a regulated entity.

Full Stack Pros-and-Cons

With the full stack model you build a complete product or service that’s delivered directly to the consumer, without partnering with a regulated entity. In this case your company will very likely need to become a registered entity with a regulatory agency.

For example, Lenny Credit promotes a mobile-only lending app that processes loan applications and transfers funds online without a brick-and-mortar bank. So they were required to become a regulated entity. The benefit to Lenny Credit is that they control the customer experience and capture a larger share of program revenue.

Becoming a Regulated Entity

Many fintech innovators dismiss the full stack model, because they believe the process for becoming a regulated entity will be time consuming, onerous and expensive. However, it’s possible to minimize the time and cost to complete this process by leveraging the expertise of an outsourced compliance expert.

Becoming a regulated entity is normally a 3-step process:

  • First, you’ll need to meet specific requirements established by the regulators (e.g., experienced principals and sufficient working capital). The experienced principals can be in-house employees or outsourced manpower up to and including the Chief Compliance Officer (CCO).
  • Second, you’ll need specialized legal and compliance expertise. These experts provide intelligence and recommendations, and they also take the lead in meetings with regulators as they communicate your business model, product attributes and compliance strategy.
  • Third, you’ll need an extended timeline to accommodate the licensing process. You should allow 6 months to become a registered FINRA broker-dealer. You should allow one to two years to gain approval as a licensed financial lender or money transfer agent in all 50 states.


Accelerating the Timeline

An outsourced compliance expert can help you accelerate these timelines. They can’t make the regulators move faster, but they can manage the process in the most efficient way possible.

They’ll work with your project managers to parallel path the registration process with your product development and operations set-up, so you can minimize the impact on your launch timeline. For example, one of our clients launched their program in a single large US state that contained large numbers of their primary prospect audience. Their long-term plan was to rollout in other US states over time. This rolling launch allowed them to start generating revenues from their largest market, but they needed only one financial lender license in a single state. This process saved substantial time and energy.

Full Stack Impact on Back Office Operations

Your operations team is an integral part of the early discussion of full vs. partial stack, because a full stack fintech company will need a more complex operational structure. The company will need to fulfill their compliance requirements, and they’ll need to build a service organization to support users with transactional support, technology support and customer service support.  

The full stack approach requires additional departments that will incur additional operating expenses, but this approach also provides the incremental revenue benefits that come when you own the customer relationship.

APIS to the Rescue

The costs and timeline for building back office functionality can be streamlined. There are a number of technology companies that provide almost every necessary core functionality via API. As  cloud-based solutions their technical set-up is turnkey, and there’s minimal impact on your existing processes and systems.

There are plenty of good choices when it comes to outsourcing back office functionality, including: loan origination software, funds transfer, payments processing, customer service, user tech support, CIP (customer identification program), KYC (know your customer), AML (anti-money laundering), etc. In fact, regulators may be more comfortable knowing you’re leveraging a tested program instead of trying to build your own when you’re still new to the regulatory processes.

What’s the Best Compliance Stack for Your Fintech Startup?

Are you weighing the pros and cons of partial vs. full stack for your fintech startup?

Reach out today for a Complimentary Consultation. 

To continue reading about regulatory considerations when choosing business model for your fintech, click here: Regulation and Fintech Business Models - Part Two