Eight Things About Fintech-Bank Partnership Term Sheets

Sometimes overlooked as just a preliminary document that establishes economics, the term sheet can end up being more important than the ultimate definitive agreement. Beyond pricing, a thoughtfully marked term sheet can align the parties on other key business terms, stake out consensus on other material issues that are important to the parties, and even set up regulatory risk positions. And when a bank and fintech company work fast and well together on their term sheet, they begin to establish the rhythm and tone for the definitive agreement as well as the overall relationship and program. In this edition of Fintech Flash, we raise for consideration eight things about fintech-bank partnership term sheets that hopefully will be helpful in your preparation and review of them.

No Backsliding!

First and foremost: Although the term sheet says it’s nonbinding, for all intents and purposes, the parties stick closely to its terms if they go on to a definitive agreement. In negotiating a program agreement, it’s difficult to advance deviations from the term sheet and successfully parry a “we already agreed to this in the term sheet” comeback, particularly if the point was discussed at the term sheet stage. And if you try and deviate once, count on two backslides in return. These arrangements are largely built on trust, which begins even before a term sheet is provided. Backsliding doesn’t engender trust. Consequently, it makes sense for the fintech to spend good time on its review and mark of a bank’s program term sheet knowing it will carry over to the program agreement.

Moving Forward

The other seven things:

• Get a Couple. Fintechs should endeavor to get a few term sheets from different banks to compare. The best way to benchmark pricing is to place competing term sheets side by side.
• Pricing Likely Isn’t Best and Final. Fintech-bank partnership term sheets are chiefly vehicles to establish pricing and program revenue share. As outside counsel, we see many term sheets from start to finish and witness fintechs negotiate down pricing (e.g., lower basis points for loan volume tiers) and up their revenue share with varying degrees of success. Naturally, pricing and revenue share negotiation success is a function of a number of variables, including how much the bank wants the program, other banks competing, product type and pricing, track record of the fintech and its products and services, and projected volume. Pricing and revenue share should be negotiable.
• Be Specific on Fee and Cost Reimbursement and Think About Caps. On bank costs and expenses, the term sheet will often be served up flatly stating that the fintech “will cover the bank’s program costs and expenses, including outside counsel fees.” Of course, overhead expenses aren’t meant to be captured, but flat provisions can (at least technically) be read broadly to do so. Be specific on what reimbursable costs and expenses are contemplated. Annual dollar caps on certain costs and expenses, such as outside counsel fees, can be appropriate. Limiting reimbursement for outside counsel fees to set actions, such as negotiating and amending the program agreement, can also be appropriate.
• Consider Covering Key Business Terms Too. Term sheets are not just for pricing and revenue share but also for important business terms, such as:
  • Length of definitive agreement (initial and renewal terms)
  • Any program volume limits
  • Exclusivity
  • Right of first refusal (ROFR) or right of first offer (ROFO) on future additional bank products and services
  • Reserves
  • Loan/receivables retention and sales in lending programs
  
  A little elaboration on ROFRs vs ROFOs is in order. Many banks lead in their terms sheets with a ROFR on other bank products and services. Fintechs should consider countering with a ROFO for a couple of reasons. First, if a fintech has a term sheet for a new product or service with a different bank, that term sheet will almost certainly have a confidentiality or nondisclosure provision that prohibits the fintech from sharing proposed deal terms with third parties on a ROFR or any other basis. The fintech wouldn’t be able to share the terms of a term sheet that’s subject to confidentiality, so the ROFR doesn’t work. Second, fintechs shouldn’t have to give a ROFR to anyone on a new product or service without having due diligenced them on that product or service. There may be other banks better at the new product or service with better pricing. A bank’s policy behind a ROFR is simple: “We’ve put in the time, effort, expertise, and expense to help build the initial program, so we should reap the whole bank benefit for other programs too.” A ROFO, however, is a reasoned, down-the-middle approach. Unlike a ROFR, a fintech needs only to present the opportunity to work on a new product or service to the current bank first, and if the bank refuses or does not make an attractive offer, the fintech can move on to other banks. If a bank is a good partner on the initial program, it should have the inside track on the next program if it has the experience and makes a good offer on the second. Working with the same bank on a number of bank products and services makes for a better and more confident customer experience. Both parties have to “win” for a fintech-bank partnership to experience long-term success. A ROFO is a win for both: The bank gets a leg up out of the gate on the second product or service, and the fintech gets the benefit of the open market.

• Start Any Regulatory Positioning at the Top. If there’s any regulatory risk positioning for the program, memorialize it in the term sheet for pulling through to the program agreement. In lending programs where “true lender” could be an issue, point up the bank’s control over the program and cover any continuing economic interest the bank may have in the program loans. In FBO account arrangements, state that the FBO account will be in the bank’s legal name and EIN and clarify the parameters for the bank’s control over the account and its relationship with the customers. If the program will be structured in a way that does not implicate state licensing via activity restrictions or alignment (e.g., first-party servicing), not paying compensation for licensable activity, having licensed third parties perform the licensable activity, or other arrangements, weave these positions into the term sheet’s program description. It’s best to see eye to eye on regulatory positions at the start.
• Head Off Any Nonmarket Terms at the Pass. A few partner banks are reputed to have a couple of nonmarket provisions in their form program agreements — for example, indemnification provisions that require the fintech to indemnify the bank for all third-party claims that result from anything short of the bank’s gross negligence or willful misconduct. The effect of such a provision could, at least on paper, require the fintech to indemnify the bank for its losses even if the third-party claim resulted from the bank’s own negligence. Obviously, this doesn’t seem to be a fair allocation of risk and is therefore a minority position.
  
  Requiring the bank’s prior approval to market other nonprogram financial products and services to program customers sourced by the fintech is another example. Naturally, the fintech should be free to market other products and services that do not involve the program bank product or service without bank approval based on the separate customer relationship the fintech has with the customer.
  
  If the fintech or its counsel is aware of any nonmarket, material terms in the potential bank partner’s form program agreement, it may be prudent to negotiate them at the term sheet stage in an effort to bring them into market range.
• Address Anything Else That’s Important to You. If there’s anything else that’s very important to the fintech, consider covering it in the term sheet. For example, because these programs can become integral to customers’ day-to-day lives from a financial perspective, in the event of termination, cooperation in transitioning the program to a successor bank and continuing to honor existing accounts during the transition, particularly for open-end credit and deposit accounts, is critical for customers being able to pay for their necessities of life without interruption. Needless to say, continuing service in this way is very important to the business and reputation of the fintech. Term sheets usually are silent on program transition. Consider adding reference to transitioning where the length of the initial term and any renewal terms of the program agreement are covered in the term sheet. Another important consideration is customer data ownership or use. In today’s market, owning or being able to use customer data generated by the program has become pivotal to fintechs. Stating the position clearly in the term sheet leaves no doubt in the definitive agreement negotiation later. The term sheet stage can be used to smoke out any deal breakers.

What else? There’s much more, but this is a good start in broad strokes. There’s a lot of minutia to pay attention to in reviewing term sheets — such as, for example, when any monthly minimum fees should kick in and how any termination fee is calculated — that we leave to your close eye.

We should end by touching on the high-level, age-old question for term sheets: What’s the right level of detail? The term sheets that are most helpful in setting up a smooth deal are detailed enough to ensure alignment on the major economic, risk allocation, business, and operational issues at a medium level while leaving the finer details to the definitive agreement. In our experience, the form bank term sheets currently in the market are very good in this regard and can benefit from thoughtful proposed revisions by the fintech and collaborative discussions between the future partners.

Goodwin’s Fintech Team

Our Fintech team counsels banks, fintech companies, platforms, brands, investors, and other consumer and small business financial services providers on transactional, regulatory, and enforcement matters. A big part of our practice is drafting and negotiating bank program agreements. We are major proponents of program agreement arrangements and have seen the benefits these arrangements have brought to the market, including greater consumer access to financial products and services, lower costs, better customer service, and more customer rewards. Our team is led by partners Crystal Kaldjob, Kim Holzel, Alex Callen, Sammy Tang, and Mike Whalen and is highly ranked by Chambers and Legal 500.