From a legal perspective, there’s a lot that goes into buying or making a significant investment in a fintech company. Beyond the purchase agreement, there’s governance, IP, employment, contract, compliance, privacy, tax, real estate and ESG issues. What’s the most important issue of the lot for a fintech target with state financial services licenses? Well, the Flash staff posits that it’s one of the least glitzy ones – the one that’s the long pole to closing and can cause delays: license change of control approvals by state regulators.
In this Flash we give a primer on change of controls and point up important things you should know about them.
Primer
The financial regulatory section of the due diligence request list for every fintech acquisition asks for:
1. A list of all state and federal licenses, registrations, qualifications, permissions, approvals, authorizations and exemptions held (collectively, “Licenses”), including the License type and number. A list of any application pending or planned.
Good diligence requests go on to ask for:
2. Any memorandums, charts, or other analyses completed analyzing the applicability of Licenses or work-arounds.
Fintechs involved in lending may have state lender, loan broker, or debt collector/collection agency licenses or registrations. Fintechs with payment solutions may have state money transmitter licenses or be federally registered with FinCEN as a money services business. It’s common for fintechs to have a 50-state chart analyzing whether or not these licenses apply to their business. There are arrangements fintechs may enter into that allow them to take a defensible position that licenses shouldn’t apply, including (in payments, for example) FBO account arrangements with banks. Fintechs often have the defensibility of a work-around memorialized in a memorandum. Fintechs that assert attorney work product privilege and don’t produce these materials in due diligence should accommodate with oral explanations of their positions via phone or videoconference.
And real good diligence requests for fintechs with licenses go further, calling for:
3. A chart by License describing the impact any new investor in, or new owner of, the Target may have on the License, including any change of control approval or notice filings that must be made, information that must be submitted regarding any new investor or owner, and filing and approval timing.
State licensing laws have change of control provisions that regulate licensee acquisitions. The provisions vary from state to state. States define “control” differently. In the acquisition context, “control” is often defined to include new individuals or entities that — directly or indirectly — own, control, or hold the power to vote a certain percentage of the voting securities or other interests of the licensee. The percentage trigger is usually 10%, but it can be as high as 25% in some states and is as low as 5% in at least one state. The securities in focus are usually voting securities, but can be any class of securities in some states. So, in most states, a transaction that would result in a new direct or indirect 10% owner is a change of control.
The big consequence of a change of control is that the licensing law may require the regulator to formally approve the change before the transaction may close. The policy behind this requirement is understandable: if a regulator has the authority to approve the initial license application and the applicant’s initial ownership, it should also have the authority to approve new owners down the line.
How states treat their consideration of change of controls is not uniform. Generally, states fall into one of five buckets:
- The transaction requires the regulator’s prior approval before closing.
- Advance notice must be provided without an approval requirement.
- Advance notice is required, and the regulator has the discretion to require its approval of the transaction before closing based on its review of the notice.
- Notice is required after the transaction closes.
- Post-transaction notice is required, and the regulator has the discretion to require after the fact approval based on its review of the notice.
States have different requirements for the types of information that must be submitted with an approval request or notice. Required information ranges from a full license application to updated NMLS forms to a description of the transaction, a new organizational chart, and a copy of the purchase agreement. If the new owner or investor with control is an individual, personal information — including financial information and fingerprints — must be submitted and a background investigation must be conducted. The same onerous information must be provided for new directors.
Below are some quick takes on important things to know about change of controls.
Quick Takes
Licenses Are Not Transferable. Licenses can’t be transferred. They can’t be acquired in an asset purchase. As a result, licensee acquisitions have to be structured as securities/interests deals.
The Licensee Makes the Filings, Not the New Owner. In virtually every state, the licensee submits the change of control approval request or notice, not the new owner. Naturally, the parties will work together on any filing because information about the new owner must be included in the submission. The purchase agreement should contain provisions on the filing process, including review and comment or approval rights for the new owner over submissions.
Timing. States also have different filing deadlines. Advance filings generally must be done 30 days in advance. For its mortgage banker license, New York requires 90 days’ prior notice. The timing of approvals is another matter. Assuming filings have no issues, many change of control approvals should come in within 30 to 60 days, but some could take much longer. Approval timing varies by license type, with mortgage lender licenses taking the longest. State licensing laws often prescribe a time period in which the regulator must approve or deny an approval request.
Sign and Delayed Closing. Because deals can’t close over change of control approvals pending with regulators, transactions involving targets with licenses in the prior approval bucket must be structured as a sign and delayed close with a closing condition on getting required regulator approvals in the purchase agreement.
Critical Mass Close? Time to close is always a concern — particularly so for a target with an eye on market conditions. The purchaser should be prepared for the target to try to negotiate some leeway in the regulator approval closing condition, such as, for example, the condition being satisfied when approvals from a high number of states representing a high percentage of revenue are received. The target’s position may have merit if approval of a license change of control from a low-volume state is significantly delayed. It’s possible to surrender a license before closing. State licensing laws, regulations, and regulator guidance cover license surrender, including timing, filings, and other surrender requirements.
Tracking. And the very best due diligence request lists ask the target to provide a chart, updated weekly, which includes important status information, such as filing dates, filing TBDs, summary of any contact with regulators, projected approval dates, approvals received, and any relevant commentary.
Anything Else? There is always something else, based on the particulars of the deal. For example, if the purchase is a distressed sale, careful consideration of the target’s compliance with licensing requirements should be undertaken. Licensing requirements include things like net worth, surety bond, and responsible person requirements. Naturally, distressed targets will have challenges meeting financial requirements and obligations, and retaining key employees. The timing of receiving change of control approvals from regulators is usually longer in a distressed sale.
Bottom Line. Stay ahead of change of controls, account for them in the deal documents, and keep on top of them through periodic updates from the target.
Goodwin’s Fintech Practice
Our Fintech team has a full-service practice, counseling clients on regulatory, transactional, and enforcement matters. A big part of the Fintech practice is supporting Goodwin’s deal teams in regulatory due diligence and drafting and negotiating Fintech regulatory-related provisions in deal documents.
