Sometimes the only path to financing your startup is through the pitching and putting together a group of “angels” and other individual investors. That path takes time and can be frustrating; potential investors may hesitate to commit. The offer from a “finder” to introduce you to investors with cash sounds attractive. What is the downside of using a “finder”?
A “true” finder may be a good idea for you if he/she limits his/her role to making introductions, receives a flat or hourly consulting fee (not contingent on the success of the offering), and avoids any active role in negotiating and completing the investment. Finders acting in this very limited capacity are not considered broker-dealers. As a result, true finders are largely unregulated under the securities laws and need not be registered with the state or federal government as broker-dealers. This area is not clear, however, because there are not defined regulations and the rules have been developed in court cases and case-by-case “no-action” letters from the Securities and Exchange Commission. More active involvement by a finder, including payment through commission on the monies raised or through success-based/transaction-based compensation, are activities only permitted to registered broker-dealers.
A very real problem is that many finders do not limit themselves to mere introductions; added involvement may render the “finder” a “broker-dealer” under the securities laws, who must be registered under state and federal law. The risk for a company using an unregistered broker to assist with an offering includes a right of rescission in favor of the investors. A finder acting as an unregistered broker could be subject to severe SEC actions, and the investor-seeking company could void the finder’s agreement and require return of the finder’s compensation.
Even assuming the finder’s actions and compensation are legal the relationship might still be problematic for the company as the relationship has certain disclosure obligations which could conceivably prompt investigation by a regulatory body.
The bottom line is that using finders to raise capital is not the easy solution it appears to be and poses some legal risk. Check with your Ally Law member firm before you engage an intermediary to raise capital for your business to assure legal compliance, wherever your business may be. For more information about our services in this area, contact us at yourally@ally-law.com.
Click here for the complete article by Matthew W. Bower of Ally Law member Varnum LLP.
