When Raising Investment Capital, Can You Pay Someone
to Do it for You?
I was recently a speaker at a conference for
entrepreneurs. My topic was about the different ways to raise
investment capital. At the end of the program, a young
entrepreneur spoke with me about how he was raising capital to
produce a film.
A couple of weeks later, I received a
letter from an accounting firm who was soliciting investments
for the young filmmaker.
On its face, the letter
seemed like a excellent idea: the polished letterhead from the
accounting firm (and their endorsement) made the young
filmmaker seem more credible; this was a great reason for the
accounting firm to contact new people; and, if the filmmaker
raised the money he needed, the accounting firm would
surely have a great new client.
Problem is, both the
filmmaker and the accounting firm violated a number of state
and federal securities laws by mailing that
Let's face it, raising investment capital for a
business isn't easy-and most entrepreneurs would take all the
help they can get.
Entrepreneurs are a clever bunch of
people who are often required to make things happen with
limited resources. Problem is, many of the techniques that you
would rely on to fill a pipeline of prospective
clients often times violate state and federal
securities laws when used to find investors.
example, if you're selling shares in your company to raise
cash, it seems logical that you should get your company's
sales staff, or outsourced services, to help you out. Perhaps
you can even pay them a high commission on stock sales and
they'll be extra motivated.
After all, few things
motivate someone to sell like a big commission
Better yet, what about hiring one of these guys
who call themselves "consultants" or "finders" and claim to
help companies raise money? Just about anyone who's done some
networking in the venture capital seminar scene has likely run
across someone like this. They work on great terms: you don't
pay unless they raise cash. And even if the fee they charge
for their services may be high, who wouldn't give up a big
chunk of cash (or a kidney) for the ease of having someone
find investors for you?
On a fairly regular basis, my
entrepreneur and investor clients ask me if they can pay their
employees, or a finder-consultant a piece of the deal if they
help the company raise investment dollars.
every case, the answer is a definitive no. The payment of a
finder's fee or commission in connection with the sale of
securities to a person who is not a broker registered with
FINRA (formerly the NASD) is generally illegal.
Another common misconception among entrepreneurs is
that the payment of finder's fees falls within a "gray area"
of the law. This is just wrong. It's a myth that seems to be
perpetuated by entrepreneurs and finders who have engaged in
this activity and haven't been caught.
I can't tell you
how many times I have heard from clients "well, I know ABC
Company who paid a finder a commission and didn't have any
problems." My reply is always the same: "ever drive a car on
the West Side Highway at 75 miles per hour and get passed by
someone going faster than you and neither of you got a
ticket?" Just because you didn't get nabbed by New York's
Finest doesn't mean you weren't breaking the speed limit by a
fairly wide margin.
In my practice, I've represented
clients who have had problems with regulators by unknowingly
violating these rules. In nearly every case, the company went
out of business or sought protection from creditors under the
bankruptcy laws as a result of the mistake.
business of getting paid commissions for introducing investors
to companies is something that our government has taken a keen
interest in regulating.
If you are serious about
growing your business, you will need to become adept at
raising capital when your company requires it. Educating
yourself about what your employees and consultants can and
cannot do to help you raise capital is critical to your
Here are the basics about using
employees and finder-consultants to help you with your capital
What is a "finder?"
A finder is an individual, company or service
that receives compensation in connection with the solicitation
of potential investors. The most common examples of legal
finders are broker-dealers or investment bankers working for
What is a broker?
A "broker" is defined under the securities
laws as "any person engaged in the business of effecting
transactions in securities for the account of others." Helping
a company sell shares to raise capital, engaging in other
activities like participating in presentations and
negotiations, making recommendations to investors concerning
securities, receiving transaction-based compensation (i.e.
commissions or finder's fees), and continuing or regular
involvement in sales of securities are evidence of activities
rendering a person a broker.
If your employees or
finder-consultants perform these tasks, typically the person
is obligated to be registered as a broker with (and thus
regulated by) FINRA.
How can an employee help
a company raise capital lawfully?
certain conditions, a company can permit its employees to help
it raise investment capital without triggering the broker
registration requirements. For example, the SEC's Rules allow
an employee, officer or director of a company to participate
as a finder in a private offering provided that the employee:
**is not considered by the SEC to be a securities
industry "bad boy";
**does not get paid commissions in
connection with the offering;
**is not an associated
person of a broker or dealer at the time of his participation;
performs a job for the company other than in connection with
the company's offering (i.e., marketing or customer
**was not within the last year a
registered broker; and
**does not participate in the
company's securities offerings more than once every 12 months
(with certain restrictions).
Keep in mind, that each
state has its own set of regulations that may differ from
federal regulations. For example, in some states only officers
and directors of a company are permitted to engage in the sale
Does a finder-consultant always
have to be a registered as a broker with FINRA?
There are some circumstances where a
finder-consultant is not required to register as a broker.
However, if you're acting as a finder (or you're a company
hiring a finder), you must take extreme care to ensure that
the finder's activities are limited so that he or she is not
functioning as an unlicensed broker.
Finders can avoid
registering as a broker by limiting to:
introducing prospective investors to a company without
engaging in negotiations;
**not recommending the
company's securities to prospective investors;
basing their compensation on a flat fee that is not contingent
on the closing of a securities sale (for example, the finder
gets a fee of $50,000 for making the introduction to an
investor, regardless of whether the investor purchases shares
What kind of compensation cannot be
paid to finder-consultants?
compensation, or success-based compensation, like a finder's
fee or commission, is compensation that is contingent on the
transaction closing. Often the fee is a percentage of the
amount of securities sold. Unregistered persons are not
permitted to receive this type of fee from a company.
Permissible forms of compensation may include
professional fees based on hourly billing rates or fixed fees;
non-transaction based consulting fees; non-transaction based
due diligence fees; or expense reimbursements.
notice that common theme among permissible forms of
compensation is that the fee is paid regardless of whether
funds are raised. My experience is that most companies are
unwilling, or at least reluctant to pay a finder a fee for
services that may or may not turn into an investment.
Many companies have attempted to disguise a commission
as a permissible fee. For example, entrepreneurs often hire
"finders" as "consultants" and call the finder's fee a
"consulting fee." However, if the compensation the consultant
receives is ultimately tied to their activity of selling
shares in the company, and they would not have received the
fee absent the company raising capital, then the payment of
the fee to an unregistered person is not permissible.
Regulators will easily sniff out a thinly disguised
form of success-based compensation, and the fee will not be
What can happen if a
regulatory agency determines that a finder-consultant or
employee is acting as an unregistered broker?
If a regulatory agency, like the securities division
of a state or the SEC, determines that a finder-consultant or
employee has acted as an unregistered broker, the SEC or state
could impose fines on the finder, which may include disgorging
to the issuer commissions paid. Further, regulators could bar
the finder in some cases from ever registering as a broker in
with their agency in the future.
happen to a company if the SEC determines it unlawfully used
an unregistered finder?
If a regulator
determines that a company used an unregistered finder to
locate investors, they could force the company to offer
investors the right to rescind their purchase and obtain a
return of their entire investment. This may be a problem if
you've spent the investment money and there's nothing in the
company's coffers to purchase shares back from investors.
Also, under certain circumstances, the regulators
could impose fines on the company for participating in a
transaction that violated the securities laws or prohibit the
company from engaging in securities transactions in the
regulators' jurisdiction in the future.
irregularity in early financing activities can make subsequent
rounds of financing more difficult to complete. When disclosed
to subsequent investors, errors made in early-stage funding
efforts may cut the company off from funding options in the
What's Your Company Worth?
The art and science behind early-stage
about early-stage company valuation (originally
published last month in Entrepreneur.com)
was also picked up by:
For useful tips on valuation
and to receive a free copy of a 35 minute
interview with valuation expert Michael
Pellegrino, visit www.ValuationInfo.com.
Independent Contractor or
One of the most common mistakes
entrepreneurs make, particularly with respect to
start-ups, is the misclassification of an independent
contractor who is, in fact, an employee. Independent
contractors (also called 1099s for the tax form they
receive at the end of the year) are individuals who are
in business for themselves and hire out their labor to
Often, business owners prefer to
hire independent contractors rather than maintain
employees because of the contractor's unique advantages.
By hiring an independent contractor, the small business
owner does not have to pay the employer's portion of the
Social Security tax, unemployment taxes, workers'
compensation insurance premiums, or employee benefits -
thereby saving 30% or more in employee costs.
However, if you misclassify a
worker as an independent contractor, you could be held
responsible for uncollected income taxes, Social
Security taxes, unemployment taxes, and penalties for
not having adequate workers' compensation coverage. This
liability could, in certain cases, extend to you
personally despite having formed a corporate entity.
|ABOUT THE FIRM:|
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