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Regulation Is Strangling Fintech Startups: 4 Ways VCs Can Help Fintech startups need regulatory approvals from about 400 U.S. agencies, but a secret weapon can help them navigate this tough business environment.

By Tx Zhuo

entrepreneur daily

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Brexit wiped $3 trillion from global markets in the two days after the vote, but for British startups, the surprise referendum's economic rampage has just begun. While the total impact won't be visible until years after secession from the European Union, Brexit is sure to limit access to talent and markets for sapling startups.

A record 608,110 new U.K. businesses launched last year, which means hundreds of thousands more companies are searching for talent. But if Britain tightens immigration laws as Brexiters promised, the talent pool is going to get a lot shallower.

Startups also need access to customers in large, addressable markets, and Brexit will make it much tougher for British businesses to roll out Europewide product launches.

So, while U.S.-based businesses have faced relatively little fallout from the strife across the Pond, Brexit provides some instructive lessons. This country's 50 states offer a broad, diverse market, and that strong economy brings access to the global talent pool. But H1B immigration visa rules are tightening, and we've just elected a president who could stifle innovation even further.

Nowhere -- including either the United States or the U.K. -- are onerous government regulations strangling startup innovation more than in the fintech industry.

Fintech's regulatory burden

Both the U.S. technology and financial industries are heavily regulated, and the financial tech industry faces the worst of both worlds.

In this country, there are 400 agencies, subagencies and government departments from which most fintech startups must seek approval before they can begin operations. Research shows that 86 percent of financial CEOs worry about being too heavily regulated, and increased regulation has contributed heavily to the 1,971 community banks -- one in four -- that have failed since 2008.

Related: To Help Small Businesses, Cut Regulation

Dealing with those regulatory agencies costs the average fintech startup about $2 million in legal fees, and that doesn't include soft costs. Meeting regulatory muster requires fintech leaders to put essential business functions -- such as seeking funding, finding customers and building management teams -- on the back burner. Fintech startups must also meet certain capital requirements to become online banks.

So, while effective regulation is undoubtedly crucial to fintech innovation and secure markets, regulators are still unsure how to deal with challenges like cross-border transactional risk and cryptocurrencies. As a result, fintech startups are stuck with ever-changing regulations and market uncertainty, which discourage investment and innovative risk-taking.

The VC advantage

Venture capitalists, thankfully, are one tool startups can harness to navigate this tough business environment. Part of a VC's job involves understanding a startup's product-market fit. This means a VC has to spend time with end consumers to understand their needs, preferences and concerns, which puts VCs in a better position than regulators to protect the end consumer.

Related: How Innovation in The Fintech Space Can Solve Basic Necessities Of Our Life

Startups often see market challenges like regulations in the vacuum of their own businesses, while regulators are concerned about how regulations protect consumers. Both are understandable points of view, but both parties often miss how regulations hurt industrywide innovation.

That makes VCs the perfect middlemen (or women). They view regulations from a top-of-the-industry perspective, which helps them see why regulations are necessary for a secure market, but also how regulations can make success unattainable for fledgling startups.

VCs can cooperate with startups in four ways to fuel innovation in the face of regulations:

1. Identify open-source solutions

Open-source analytics platforms are low-cost or free, and excel as a data-sharing resource, making them increasingly popular among fintech startups. An open-source platform for financial regulation, such as an XML-based architecture to stream reporting data, could be instrumental in establishing new relationships between regulators and startups. VCs, which work with dozens of startups, know how advancing technologies can benefit budding fintech companies.

2. Design something consumers will fight for.

VCs can help develop a product or platform that gets consumers' attention, like Venmo, and customers will advocate on behalf of services they love. We've seen this with the ride-sharing and cannabis industries, which customers have repeatedly defended against regulatory clampdowns. When users want the product, they'll shape the narrative to ensure it remains available to them.

3. Be an industry advocate.

VCs can help mediate conversations between regulators and startups. Many of the best already have these relationships, like J.B. and Tony Pritzker of Pritzker Group Venture Capital, the siblings of U.S. Secretary of Commerce Penny Pritzker. These sorts of relationships can give fintech startups a voice when they work with regulators.

4. Prove value to regulators.

Uber was allowed to operate in California in the early days because it built a case based on actual data about the jobs it created and efficiencies it brought. VCs can help fintech startups follow Uber's lead in proving the consumer, environmental and societal values of their startups' offerings to regulators.

Related: How Open Source is Changing the Landscape for Entrepreneurs

Although it would be nice to do business in a looser regulatory environment, fintech startups don't have a choice in the matter. Instead, entrepreneurs must work within the realities of current regulations, but still recognize that VCs are the advocates and mentors who can help them do so.

Tx Zhuo

Managing partner at Karlin Ventures

 TX Zhuo is a managing partner of Karlin Ventures, an L.A.-based venture capital firm that focuses on early-stage enterprise software, e-commerce, and marketplaces. Follow the company on Twitter.

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