Corporate & Securities Law

Why Finders Are Losers

By Ryan Roberts

Whenever a startup considers paying a “finder” for successful investor introductions, I have the same type of conversation with the founders that goes something like this:
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Startup: “Finder” knows a lot of investors and he’ll introduce us if we pay him [6]% of all capital raised through the introductions.

Me: Is “finder” a registered broker-dealer?

Startup: No.

Me: Well, it’s an issue because the finder offering to raise capital for your startup should likely be registered with FINRA (Financial Industry Regulatory Authority) and your state?s securities board. And the SEC is closing the window on these unregistered broker-dealers. Most importantly, using an unregistered broker-dealer can, at a minimum, jeopardize your startup’s private placement exemptions.

Startup: But how does everyone else do it?

Me: Just because they’re doing it doesn’t make it “legal.” Just because a law is not enforced does not mean the transaction is ok under the law. If I drive without my seatbelt but don’t get a ticket, does it mean it’s legal? The reality is, a tremendous amount of unregistered ?brokers? (as defined by the SEC) are out there raising capital for companies.

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Finders are one of the startup world’s dirty little secrets. And there’s a ton of these dirty little secrets trying to latch on to startups from coast to coast. If someone wants you to help your startup get seed capital only if they get a cut, you need to run far away.

You may think raising capital will take up an obscene amount of time at your startup (it does) and/or you don’t know any investors (you probably don’t), but your startup can not outsource or delegate this task. From my experience, these finders who want a cut rarely, if ever, deliver.

The finder may have a ‘rolodex’ of rich people but it’s usually chocked full of people who don’t typically invest in early-stage startups. Even if these finders deliver an investor, the investor isn’t hip to investing in startups and ends up asking for crazy investor-favorable terms that could will screw up a future financing.

Now the founders have either a really crappy financing deal (with a potentially blown private placement exemption) or have lost about 3-4 months not getting out there and networking with potential investors. You can develop your startup in a cave — but you’re going to have to leave it if you want to raise capital. No one can pitch your startup better than you.

And to any finders reading this, if your only contribution to the startup ecosystem is that you will introduce startups to investors, for compensation, then you aren’t contributing. Either genuinely help a startup, or don’t help at all.

Full post as published by The Startup Lawyer on October 28, 2010 (boomark / email).