It is not uncommon for startup founders to be approached by people that claim they can raise money from investors on their behalf, for a fee. Particularly first time entrepreneurs can be persuaded that if they work with such person, they will have millions of dollars very quickly to start their business. Seed level investment is getting harder and harder to raise in 2015 with venture capital investment allocating only 3-4% of the money they have at their disposal to Seed Round (no more than $2M); even Google Ventures is pulling away from Seed Stage startups. Because of that, seed stage startups are most likely to be bootstrapped, and funded by handful of angel investors via equity crowdfunding platforms, not getting the funds the easy way with a broker.
How to approach people offering to make introductions to investors?
Unfortunately, it is very common for people to approach startup founders and offer to introduce them to investors in exchange for monetary compensation. Inexperienced entrepreneurs should be very careful with this arrangement, not only because of financial entanglements, but also legal implications.
- “Finder’s fee” — some people approach startups and ask for a finder’s fee if they make an introduction to an investor that actually writes a check to the startup. This set up can get you in legal trouble because only registered broker-dealer is authorized under SEC rules to charge a finder’s fee (typically 5% of total investment amount). Anyone who takes a cut from the investment and is not registered broker with FINRA is violating SEC rules so next round investors will most likely pass on the next round because of this violation.
- When someone approaches you, go to FINRA web site and see if they are registered broker: If you don’t see their name in the database, don’t do business with them. Be courteous, polite, keep the door open, but don’t get anything in writing and don’t make any financial deals.
- Brokers — officially registered brokers, investment advisers and firms that do have access to venture capitalists and strategic partners will be happy to work with you during fundraising. Typically, they will ask for a monthly retainer (in thousands of dollars per month, $10k/month is not uncommon), paid travel expenses and a finder fee (3-5%). They will ask for at least six months commitment from you and if you break the contract (yes, you can always do that without much fuss), but if you secure an investment in the immediate future from one of their introductions, they will still earn their finder’s fee. Brokers are expensive, so chose wisely. Take a look at their track record and make sure they understand your industry really well, particularly if you are looking for a strategic investment. They will also work with you to polish your business plan, teaser, pitch-deck, advise you on a business model. Brokers are the most useful for growth stage companies that are looking to raise Series C, D round of $20M or more. Such company is fairly established, has a CFO that can quickly provide all pro-forma statements, so broker can speed up the transaction.
- Advisor. If a person willing to make introductions on your behalf is genuinely interested in your success, I would suggest that you give some equity in return to let them know that you appreciate their time. As mentioned in the answer above, “time and resources are worth something”, or you can think of this arrangement as “there’s not such thing as free lunch”. I find TechCrunch article extremely useful benchmark on advisor composition: If this person is actively making introductions on your behalf, make them an advisor and give them equity appropriate to their contribution level (anywhere from 0.10% to 1.00%). Or you can compensate for their time with a monthly retainer. Either scenario is perfectly fine and you don’t have to worry about SEC violations if you were to give out a finder’s fee.
Entrepreneurs have to make thousands of decisions to take a company off the ground. Doing a due diligence on potential advisor, broker or an investor is just of of many decisions to make. Do your homework, and success will follow.
Dragana Mendel, a management consultant for startups, small and medium size businesses develops and executes growth strategies for her clients.