Startup Fundraising And The Pitfalls Of Paying Finders Fees

All startups need money and many seek to raise money from outside investors. The trouble, though, especially for founders lacking extensive contacts in the angel/VC communities, is that it can be hard to find prospective investors.

Startup founders sometimes find a person who has the connections they lack and propose paying this person a “finders fee” to help the company find investors to invest.

Here’s the problem: most of the time these well-connected people are not registered “broker-dealers.” And state and federal securities laws proscribe companies from paying fees to people who are not registered broker-dealers in connection with securities transactions, like startup fundraising. These laws also prohibit those who are not registered as broker-dealers from a handful of other activities, like helping to structure investment deals, among other things.

While startups should exercise caution generally in this area, perhaps the most important thing to avoid is paying or agreeing to pay a non-registered person based on their success in finding investors. If they only get paid if an investor they find actually invests, you’re playing with fire.

A distinction is in order at this point. A startup could pay a well connected person to gain access to their list of contacts without exposing itself to regulatory risk, provided that the fees paid are not contingent on obtaining funding. For example, the startup could pay a fixed monthly consulting fee to this person that is earned and paid regardless of whether any of the person’s contacts decides to invest in the startup.

Even then, though, the startup and its well connected consultant should set strict boundaries on what the consultant can and can’t do. In short, the consultant should make a general introduction and then get out of the way. It will be tempting for the consultant to play a more active role, including setting up and participating in meetings about investment and generally trying to help shepherd the deal along, but this should be avoided. This is because these activities risk the consultant functioning as a “broker-dealer” which spells regulatory trouble if the consultant is not, in fact, a registered broker-dealer.

Before even considering agreeing to pay a fee to someone for help with soliciting investors—whether you call it a finders fee, consulting fee, or something else—your startup should consult a securities attorney. There’s plenty of risk here and often the things startups want these “finders” to do are precisely what should be avoided. Nevertheless, there can be ways to structure these arrangements to comply with securities regulations and also get the startup in front of more potential investors, so there’s no harm in exploring this option with the help of an attorney.