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Most fintechs will deal with this question at some point in their life cycle, and if they go to a law firm for an answer, they will likely get a lot of:

“It depends, we can give you an exact answer for $20,000”.

If you pay for that answer, the law firm is likely just dusting off the 50 state survey they did for the last client.

In defense of the law firms, the “It depends” answer is not that far off, unfortunately. Most state statutes are a century old and written for traditional providers of financial products and not fintechs and so whether you fit within the statute’s definition is often up for interpretation.

And then, to make things more complicated, state regulators are notoriously inconsistent with enforcement. So whether the statute applies to you may depend on the particular mood of that state regulator, the political landscape in that state, whether you’ve somehow shown up on the radar of the regulator (usually through customer complaints which is why it’s really important to have a good customer complaints program as we discussed here).

That all said, here’s a framework to think about state licensing:

First, if you’re doing any sort of lending product (debit or credit card, business or consumer loan, financing), decide if you want to work with a bank partner or go at it alone. If you go at it alone, you will almost definitely need state licenses. Here’s the trade offs:

Go at it alone:

Roughly, about half the states require you to get a license to lend at any rate. So, to work in those states, you’ll need a license, period.

The other half of the states let you lend below a certain rate.

So, a good strategy is to work backwards from your business objective. What are the biggest markets for you to target initially to test out your product? And then, if you’re a lending product, what are rates you’re willing to go down to just to test your product.

You might decide California is a must have market in which case you will definitely need a lending license there. Other states, like New York, will let you lend below 16%

If you can get then the list of 20 or states to get started, you can easily expand from there.

Work with a bank partner:

If you work with a bank partner, your argument is that you are simply a technology platform acquiring the customer for the bank. You are not a financing company.

This is why it’s super important to carefully pick the words you use (as we discussed in “Superlatives are for High School Yearbooks”) especially on your website.

In theory, you shouldn’t need any lending licenses since the bank is doing the financial activity.

That said, some states (such as Connecticut and Massachusetts) have gotten savvy to the fintech-bank partnership model and explicitly call out any “agent or technology platform” working on behalf of the bank to get a license.

In this case, you have a strategic decision to make. Do you:

• Ask for permission now (i.e., get the license now); or
• Say sorry later (i.e., wait for that infamous regulator letter)

Most law firms will tell you to be proactive and get licenses.

But, there’s a very real and tangible cost to getting licenses.

You’ll need to (1) hire a law firm or agency to help you fill out the application process because it’s not a straight forward process; (2) deal with the back and forth questions with the regulator which could take 6 months; (3) do annual audits; (4) be ready for the state regulator showing up on your doorstep with a “request” at any time.

When you’re just figuring out your business model and cash is tight, being proactive may not be the best decision of your business. You may be crushed under the weight of audits before you can even get off the ground.

Other licensing regimes.

Depending on your business model, there are a few bucket of potential licenses that may apply to you.

(1) lending statutes intended to regulate entities that originate loans (covered above);

(2) holder statutes that regulate entities that purchase and hold loans;

(3) loan broker statutes;

(4) debt collection and servicing statutes; and

(5) credit service organization statutes.

Generally, (1) and (2) are addressed above. If you work with a bank partner, you probably have a good defense not to get these licenses. If you have to purchase loans from your bank partner, you can avoid (2) by purchasing receivables only or by working with a trustee who can hold title to your loans.

Loan Broker

Loan Broker statutes typically define a broker as as a person that, “in expectation of a fee, arranges a loan for a borrower, assists or advises a borrower in obtaining a loan, or holds itself out as a loan broker.”

Your typical loan broker is someone you’d hire to help you find money.

Most fintechs shouldn’t fall under this category but if you charge an origination fee, you could fall under these licensing regimes.

Debt Collection and Servicing.

These statues typically only apply to third party debt collectors which are collecting on behalf of another party (usually the original creditor). Debt collectors are notoriously aggressive because their only incentive is to collect money (funny and sad piece by John Oliver on debt collectors).

A first party debt collector would have the reputation of its employer, the creditor, in mind. If you’re collecting in house, licenses shouldn’t apply to you but, again, some states have expanded their definition here (e.g., Massachusetts)

Credit Service Organization statutes:

Virtually all states have credit service organization statutes (“CSO Statutes”) that require registration for credit service organizations. These statutes generally define a credit service organization as a person who obtains or promises to obtain an extension of credit for another person.

Most CSO Statutes require that the person promising to obtain the extension of credit receive a fee or some sort of compensation directly from the person receiving the credit.

Money Transmission Licenses:

Finally, the mother of all licenses are MTLs.

Money Transmission is:

Transferring money

from

Person A to

Person B.

The typical money transmitter is Western Union (you are sending money to another person, Western Union is in the middle doing the transferring from A to B).

However, even then, it’s important to think about the movement of money in your organization in case you might be inadvertently a money transmitter.

And what’s the penalty of not obtaining an MTL if you are (even accidentally) a money transmitter?

Jail time! That’s right, it is one of the few licensing statutes with criminal penalties associated with it.

So, what’s the takeaway:

State licenses are fact specific but there are general takeaways:

(1) Do your homework before going to an expensive law firm. Talk to your lawyer friend, ask other founders, do internet research. Law firms are designed to give you the most conservative advice possible, and too many companies get stuck with following the 50 state survey.

Remember, licenses are expensive!

(2) When in doubt, see if there’s a way you can structure around getting a license.

Can you use more than one legal entity to separate some of the activities

Can you work with you bank partner to buy receivables only

Can you get a federally chartered bank to act as a trustee of your financial products

Can you use an FBO account to ensure you’re never taking custody of funds when they move from Point A to Point B

Here, a savvy fintech lawyer will, actually, help.

(3) If you must, see if you’re comfortable taking the risk of saying sorry later before asking for permission. This is ultimately your decision and, as with all legal decisions, a question of risk beyond the legal answer.

Exception, of course: If your business model requires you to be a money transmitter and you’ve decided that’s how it’s going to be, then please, please, please do get those Money Transmission Licenses!

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While we hope you found this post helpful, please note that the information in this post is not intended to be legal, financial, tax, or regulatory advice. Please consult your own advisor when considering your stock options…options.

Fintech Law and Compliance 101 is affiliated with https://www.itsaffinity.com/ a compliance learning management platform built specifically for banks, bank sponsors, and fintechs

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