Raising risk capital is always a challenge, and even more so in times (like now) and places (like the Upper Midwest) where risk capital is particularly scarce. It can be hard for an entrepreneur, confident as he is about his business opportunity despite several months of shooting blanks in the search for capital, to pass when a well-dressed, well-spoken and seemingly successful person shows up with an offer to help raise the capital for a seemingly modest fee. But while there are exceptions to every rule, the rule here, for serious entrepreneurs, is simple: walk, do not run, to the nearest exit.
What’s wrong with using a finder to raise money? Let’s make a quick list.
- Most finders, probably a pretty big majority, are at best operating in a legal grey area. Fair or not, what finders do (when they in fact do what they say they are going to do) is connect buyers and sellers of securities – which is to say what (SEC-licensed) “brokers” do. Alas, most finders are not licensed brokers.
- If point one seems like a problem for finders, and not the entrepreneurs they serve, well, not really. You see, deals put together by unlicensed “brokers”/finders are subject to after-the-fact review and rescission by the investors if the deal goes south. Ouch.
- Put points one and two together and, surprise, the vast majority of venture capital funds and many other sophisticated risk capital sources just won’t do deals arranged by finders. Look at just about any venture capital investment agreement and you will see a representation and warranty by the company that no finders have been engaged by the company.
- Finally, when you engage a finder – even when it is finally a good decision – you should recognize that you are signaling to a fairly significant part of the investment community, for example the venture capital community, that you are not very sophisticated about how their business works. More particularly, you are telling these investors that you either do not realize that most of the deals they do are referred to them by interested but uncompensated third parties (lawyers, accountants, other entrepreneurs, etc.) or do not have access to any of those conventional referral resources.
If despite the above notes of caution, you still think a finder is the route you should take for raising money, do so with your eyes open and (i) engage a finder who is properly licensed by the SEC as a broker; (ii) get at least a half dozen references from companies that have worked with the finder (including at least a couple where the finder failed to get the job done); (iii) don’t pay anything until the money is in the bank (if the finder wants to see some commitment, put some part of the proposed fee in escrow pending the closing of a deal); and (iv) make a list of potential investors you already have a contact with (or can easily get connected with) and have any capital that comes from investors on that list excluded from the finder’s fee calculation.
When it comes to finders…buyer beware.