In Part I of the due diligence series, we discussed the technical considerations. In Part II, we shall address the legal aspect. Evaluating the legal implications of a project, compliance expenses, and limitations arising from the legal framework is essential in passing the due diligence process.
Does your company require licenses to operate, and which ones?
This question is especially crucial for highly regulated sectors, like fintech. Almost all financial services need some form of licensing, and some of them- like MiFID II in Europe- can take up to two years or more to obtain.
Besides, you may require separate licenses for each jurisdiction you intend to operate and offer services. Luckily, there are various arrangements between competent authorities, particularly between the EU member states, facilitating the easy transfer of licenses.
How do you plan to handle KYC/AML issues?
The financial service industry requires businesses to verify their customers and the source of their assets to prevent money-laundering activities. Nevertheless, making clients confirm their identity may not be a tremendous and engaging user experience, negatively affecting conversion rates. It would be best if you leveraged the proportionality principle- the higher the risk, the severer the measures.
Who holds the custody of the funds?
This question is common for businesses that permit users to deposit assets, such as a cryptocurrency exchange. Storing customer funds also needs licensing; hence, you can consider a partnership with a reputable license holder company.
Who is accountable for failures?
This happens to be one of the most ignored considerations. Even if you experience ultimate reputation damage, you can still protect your business from legal liability by creating parallel arrangements with service providers. For example, if you store customer data on third-party servers, they should be accountable for any data breach. However, you should be aware that such arrangements increase service costs.
Sometimes offering a service for which a liability may be taken is a primary role of a business. While it is impossible to avoid liability in some instances totally, it can be minimized. For example, if workers are liable, and not a company, or if limits are put in place on the magnitude of liability.
Founders of blockchain companies, especially decentralized projects, tend to say that they hold no liability since they do not control the network. However, regulators may have another view because the legislation is based on the principle of a responsible financial service provider, who is accountable to ensure that the system runs in the right way. Therefore, the company may become subject to claims in case of failures.
When taxes are poorly managed, they can significantly minimize business profits, especially in a hostile dual taxation regime between jurisdictions, the business operates in. Besides, taxation issues can make a business much less attractive as an investment opportunity. It would help if you took proper optimization to mitigate such problems.
What is the intellectual property of the company? Is it protected? Does the company violate any IP?
There are three primary points to note here:
First, a business may, at some point, become a target for patent trolls; hence, it should acquire patents and copyrights for all its pertinent assets.
Secondly, to build an MVP, a start-up may infringe upon someone’s IP. For instance, using protected images, design, UX, and others. It is less likely to be problematic in the early stages of the company. Still, the situation may worsen as the company grows bigger, mostly when the violated IP belongs to direct competitors.
Lastly, IP is an asset that increases valuation, which may be used for tax optimization.
In the recent past, GDPR has become an increasingly pressing issue. Basic privacy setup extends beyond cookies disclaimers and should entail proper handling of consumer data. Hijacking may lead to significant lawsuits, but adequate data management, like not sharing customer data with third parties, can prevent such issues.
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