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Would-be payments disruptor Aaron Greenspan says a California money transmission law forced him to choose between killing his startup and going to prison. Other financial services startups may face similar choices.
August 6
As financial services startups debate whether it is better to ask regulators for permission or beg for their forgiveness after signing up customers, PayPal's history might offer some lessons.
Once a startup itself, PayPal, now a unit of eBay (EBAY), argued for years with officials over whether it was, or wasn't, an
In 2002, Louisiana regulators nearly banned PayPal from operating in the state, sending the company a warning that it might be operating there illegally.
"I think it's a great example," remembers Eric Jackson, who was PayPal's first marketing director and wrote about his experiences in a 2004 memoir,
The Louisiana Banking Department quickly reconsidered after meeting with PayPal's lawyers and other state officials. According to Jackson, it probably helped that hundreds of angry PayPal users phoned the state to complain.
"It has a funny ending, but it's not a funny story," says Jackson, who is now the CEO of CapLinked, an online platform for managing financings and M&A deals. "Because people were using PayPal to sell online and it was making life easier for consumers and [regulators'] first reaction was: 'We think you might be a bank, but we don't have any approval for you, so we're just going to ban you.' "
In its home state of California, PayPal is among those that have lobbied to amend a notoriously
"We perceive ourselves, in many ways, as having the same dog in the fight" as startups, says John Muller, PayPal's general counsel, who has been with the company since before the initial public offering. "We want to do new things, and even in some cases acquire new companies."
Part of the reason PayPal went public in 2002 was to satisfy capital requirements for state-licensed money transmitters, explains Muller.
In its infancy, PayPal structured the capital it received from investors as preferred rather than common stock. Even though the money was in the bank, it looked like debt on the books.
The IPO "caused the venture capital investment to convert to common stock," Muller says. "Just by the way the paper was shuffling, in a sense, all of a sudden we went from several million negative net worth to several million positive net worth, so we could easily meet the minimum capital requirements."
He's quick to say, however, that regulators are straightforward in their dealings with PayPal and well intentioned.
And he's less worried about state regulations than about the cost of federal requirements, "in particular having to create an anti-money-laundering program," Muller says. "For any international transactions or even domestic transactions not to totally downplay the states, the state process is burdensome, especially when you take into account 48 different states but to me what winds up being the biggest cost is the cost of federal requirements and anti-money-laundering programs in particular."
An average-size company can wind up spending at least several million dollars a year on anti-money-laundering compliance just monitoring and updating the program, Muller says, and PayPal's program costs the company far more.