A Primer on Fintech Term Sheets

A bowl of candy helped give Van Halen a reputation for rock-star excess. The band’s tour rider famously required M&M’s backstage, but with all the brown ones removed. Lead singer, David Lee Roth, later offered a more practical explanation: Van Halen traveled with an elaborate production that required venues to follow detailed technical specifications. If Roth spotted brown M&M’s, he took it as a warning that someone might have overlooked more consequential instructions, too. The candy, in his telling, was a reason to check the entire setup before the show went on. 

Community financial institutions (CFIs) negotiating fintech partnerships also need to look beyond the initial sell. Competitive pricing and promising technology matter, but so do the less glamorous provisions governing oversight, compliance, and what happens when something goes wrong. Addressing those priorities at the term-sheet stage can help establish a stronger foundation for the definitive agreement, before the partnership takes center stage.

Fintechs are often developing new products, services, and business opportunities that could become relevant to their CFI partners. When negotiating a term sheet, CFIs may want to consider whether a Right of First Refusal (ROFR) or Right of First Offer (ROFO) would help protect their interests in specified future opportunities.

A ROFR generally gives the CFI the right to match a qualifying offer from another party for specified future products, services, or business opportunities. This can help the CFI protect its interests as the fintech develops new offerings. A ROFO, on the other hand, gives the CFI the first opportunity to negotiate with the fintech before those opportunities are offered to other parties. If the two cannot reach an agreement, the fintech is generally free to pursue other partners, subject to the terms of the clause.

While a ROFR may provide the CFI with greater protection against losing an opportunity to a competitor, a ROFO can give the fintech more flexibility to pursue new business. Both provisions can influence a CFI's access to future offerings and the fintech's ability to expand its partnerships.

Understanding these differences can help CFIs negotiate terms that align with their long-term strategic interests.

CFIs may outsource activities, but they retain responsibility for compliance with applicable laws and regulations and for sound risk management. For example, when partnering with fintechs to provide services involving lending, payments, or deposits, CFIs must maintain appropriate oversight of those activities.

One important contractual protection is the right to audit and obtain information from fintech partners. CFIs must also retain responsibility for meeting applicable Bank Secrecy Act (BSA) and anti-money laundering (AML) requirements, even when certain functions are performed by third parties. In short, contractual provisions should support the institution's ability to fulfill its regulatory obligations.

Termination rights are another important consideration. If significant compliance or operational problems arise, or regulators require a partnership to be unwound, CFIs need the ability to terminate the arrangement under appropriate circumstances. These protections should be addressed during term-sheet negotiations and carried through to the definitive agreement, since term sheets are generally nonbinding, although certain provisions may be binding.

The following are items most commonly associated with a negotiable term sheet: pricing, revenue share, exclusivity, scope of work, and agreement length. A fintech will generally seek favorable commercial terms, while a CFI will be looking to secure the best arrangement while managing risk and maintaining strategic flexibility. These provisions can affect not only the economics of a partnership, but also a CFI's ability to introduce new services, change providers, or exit an arrangement.

In some cases, CFIs can find themselves at a disadvantage when dealing with an established fintech that has numerous deals under its belt. CFIs should be prepared to bring in outside experts, including consultants and legal counsel, to help evaluate contractual provisions and negotiate terms that support their institution's interests.

Federal risk guidance for third-party relationships, which was established in 2023, has undergone a revision that is currently a proposal awaiting final approval. An important consideration when negotiating terms is the general principle that risk oversight should be proportionate to the relationship’s complexity and overall risk. 

This principle can help CFIs determine the appropriate scope of contractual provisions, including audit rights, reporting requirements, ongoing monitoring, and termination protections. The goal is to establish expectations that reflect the risks of the partnership and the institution's ability to manage them.

Some fintechs are young companies with limited banking experience. A smaller CFI could get overwhelmed by the technology and terminology. Before agreeing to operational terms, the bank needs to make sure it has the personnel required to monitor and manage the new services and relationships. In short, a bank needs to make sure it has the bandwidth to properly oversee a proposed third-party partnership.

A strong fintech term sheet should do more than outline an attractive deal; It should establish a shared understanding of how the partnership will operate, who is accountable, and how problems will be addressed. Before agreeing to operational terms, CFIs should assess whether they have the personnel, expertise, and resources required to effectively monitor and manage the new services and relationships. Taking on more than an institution can reasonably oversee could introduce risks that outweigh the benefits of the partnership.