Building an MVP in the Highly-Regulated Finance Industry
Startups are often defined by their ability to move quickly, to pivot, to grow rapidly, to be iterative, and to launch an MVP as soon as they can. Fintech startups can be a different story. “In financial services,” says M1 Finance CEO and Founder Brian Barnes, “we need to accomplish all of those same things, but under the procedural security of stiff regulations. They’re in place to protect the consumer and are legally mandated, so of course we adhere strictly to these rules, but the landscape presents a particular kind of challenge different than what other startups face.”
Brian has been investing on his own since he was a pre-teen. After graduating from Stanford, he spent three years in the consulting and finance industry, and committed nights and weekends to educating himself on regulatory guidelines before founding M1 in 2015. He knew from the start that there’d be little room for error and held off on launching publicly until he had full confidence in the product. “Mistakes are pretty unacceptable in fintech,” he says. “We are legally obligated to do certain things, errors in moving around millions of dollars can be financially crippling, and people are emotional with their money. Establishing trust is hard and cannot be regained once lost.”
M1 is “a breakthrough, comprehensive solution built for the modern investor.” While traditional brokerages require many complex calculations and manual input of trades, with M1, a user can quickly set up his or her portfolio, then simply add or withdraw money; M1 manages the account for each user with intelligent and precise automation. Its service offers cost-effective investing tools that place the user in charge of his or her investment plan.
Brian and his team launched the company with the belief that customers are ill-served by their financial institutions and a system that ultimately protects incumbents, which are surrounded by the moats of tough regulations, massive reserves of money, and existing brand recognition. He feels this has led to a lack of innovation in the industry. “I’m excited that we can recreate the infrastructure of the giants and offer a better product at a better price, and that we can help people take control of their finances, their financial future, and their well being,” Brian says. The team talks often about their broader purpose as not just a finance app, but as a means to helping customers build financial security for themselves during a time when the wealth gap is increasing at a high rate. “The wealthy have access to making their money work harder for them,” says CMO Matt Witt, “we want to be able to provide people of all ages and income a way to make their money go to work for them, too.”
The Road to Launch
A year and a half before launching the product publicly, Brian began putting wheels in motion. “This was going to be a completely different beast than a typical startup,” he says. He spent two months studying for his Series 7, Series 63, and Series 24 tests, all while he started building the company. And he hired a General Counsel, Nick Dalmaso, early on to ensure regulatory compliance from the day one.
Nick and Brian led the small team on the path toward an MVP and to becoming a broker-dealer (a regulated entity that is allowed to buy and sell securities on behalf of clients). As a pending broker-dealer, M1 was required to employ two principals with five years of financial experience to be vetted and questioned by FINRA (the independent, not-for-profit organization authorized by Congress) over the course of 6 months. The vetting would explore M1’s capital, scope of business, familiarity with FINRA rules, and ability to protect investors. The time period would culminate in a final interview in order to officially grant the entity broker-dealer status.
After the status is granted, the entity enters a probationary period for one year, in which any publicly-disseminated information about their offerings has to be filed with FINRA ten business days in advance (where it’s reviewed heavily – the entity can’t, for instance make bombastic claims or use superlatives like “we’re the easiest,” or “we’re the best”). Every email communication has to be stored, archived, and accessible for five years (which M1 is required to burn and save on DVDs). Also within this probationary period comes a security audit, which requires confirmation of IP logging, two-factor authorization, strict password requirements, and an infrastructure setup between multiple redundancy zones. On an ongoing basis the company is required, among other items, to verify customer identities, and to perform credit bureau checks as a duty and obligation to prevent money laundering and money fraud.
All of this comes at a price that can be substantial for small companies. Once broker-deal status is granted, the company has to prove that it can sustain itself for one year with no revenue. Since this application process typically takes a year, this means a company needs two years of capital just to start. And the business model isn’t something that can be tested, Brian notes: “it’s not like Zuck creating a Facebook MVP and constantly iterating. We had to sit in the dark for a year before we could go to prospective users.” Legal oversight itself for a small team can cost upwards of $500,000 just to begin with, and the broker-dealer is required to hold a balance of $500,000 to prove financial strength. Other costs, like supplying stock information ($15,000/month) add up quickly.
Bottom line is that “you can’t innovate in this space without raising a lot of capital,” Brian says. “Creating a company like this is far more akin to the movie industry than a traditional tech startup: you have a script and a director, but you don’t have a finished product for a long time.”
During the regulatory approval process, the M1 team prepped to launch their MVP. Their system, which ultimately moves money in and out of many accounts, needed to be highly redundant, fail proof, low latency, and on the cutting edge of infrastructure. They knew they’d be able to create simulated environments to some extent, but also that there’d be no replacement for being in the real world. “It was practice vs. the game,” says Brian, who fears eroding the trust of the customer, or facing uncontrollable errors.
The company made its first trade in November 2015 by giving each employee a $1,000 “bonus” to use for making certain trades while they executed manual checks to make sure everything worked. In March 2016, it launched to employees to use with their own money, before opening it up to friends and family in June 2016. Throughout this time, adjustments were made, checks were executed, and the team ensured compliance with regulatory requirements while broker-dealer status was pending.
The MVP that most startups aim to launch — something that isn’t perfect and may break — looks a lot different than the MVP a fintech company launches. After close to a year of an incremental beta stage, M1 Finance launched to the public in September 2016. “We had a high bar to clear and needed to make sure we overdid testing to launch with total confidence,” Brian says. “Once you lose someone’s trust in this industry, they’re never coming back.”
With a respect for the regulatory safeguards in place, Brian and his team are quick to point out that financial regulation has been outpaced by technology. In fact, five of the six pieces of legislation in the SEC Securities and Exchanges law are 75+ years old, giving control to incumbents and ensuring that barriers to enter the market are unnecessarily high. When itching to move quickly in true startup form, you can “feel helpless” Brian says. “Even if you’re following all of the rules, you’re still at the mercy of the regulators.” Pushing innovation forward in a highly-regulated industry calls for more than just market forces, and will require a change in regulations to bring legislation up-to-speed with technological progress. Brian hopes that there will be enough of a ground swell with the public and businesses like his to change archaic laws, while still ensuring proper consumer protection.
On the flip side, Brian says, the benefit of these regulations is that they create discipline and force a startup to act more maturely from an early stage. “We have high conviction in our bets. To start the company, I had to project what two years out looked like. Most startups think in terms of weeks, so we’ve benefited by being forced into having a long-term vision.”
March 23, 2017