The Finders Paradox

First, what is a “finder”?  For purposes of this discussion, a finder (a.k.a. broker) is someone who offers to help an entrepreneur secure venture capital in exchange for compensation (cash and/or equity).  Most finders typically charge an upfront fee (to keep them fed and keep their lights on) and also charge a percentage of the amount of money they “help” the entrepreneur raise and/or equity in the company.  Pursuant to the Investment Advisers Act of 1940, finders/brokers must be registered with the Securities Exchange Commission (”SEC”) and licensed to transact in such matters.  Pretty straight-forward.  So what’s the paradox?  The paradox is the finders themselves and whether entrepreneurs should use them to secure venture capital financing.  Before reading further, you should know I’m prefacing my thoughts here with respect to the stage of the companies seeking financing and VCs and referring to early-stage only.  I’ll discuss later stage situations at the end as my sentiments differ there.

So, should you use a finder to obtain venture capital?  I won’t tell you definitively whether you should or shouldn’t, but I will share my personal thoughts on the matter here and summarize by stating that I wouldn’t use one (knowing what I know) for the following reasons, in no particular order:

1. Most finders I have encountered here locally are, unfortunately, not registered under the ‘40 Act and are therefore in violation of securities regulations (i.e. doing so illegally).  As always, consult with your attorney(s) about this matter for the explanation as to why and BE VERY CAUTIOUS if someone offers to make some intros and/or help you “find” venture capital money in exchange for money and/or equity.

2. Most VCs have a ton of deal flow from folks they know very well, respect, and trust.  Why would they entertain a start-up referred from a finder?  Most won’t.  In fact, most financing transactions require the CEO/Founder(s) to represent and warrant that there aren’t any brokers involved so as to avoid potential equity encumbrances.

3.  VCs invest in people so they will want to hear from you, not a finder.  They will also want to establish a rapport with you throughout the process (if they don’t already have one with you) as the financing results in a long-term partnership analogous to marriage.

4. VCs don’t want a portion of their investment going to pay some finder as it is an inefficient use of capital.  They want the money spent to build the business.  Similarly, VCs don’t want the equity of the underlying company encumbered (i.e., have a clean cap table when you approach them).

I realize this post may discourage you entrepreneurs out there — especially if you’ve already retained a finder (legal or otherwise) — but all is not lost.  The good news is that almost all VCs post their phone numbers and email addresses and have a number of ways to reach them to inquire as to their interest in investing in your company.  Personally, I answer my own phone and try to respond to emails as fast as possible with my inclination either way.  Given how many deals come our way on a daily basis, it may take awhile before we respond but most of us will get back to you.  Using a finder certainly won’t expedite any such response and, in most cases, can hinder your ability to raise early-stage venture capital.

So when, if ever, should entrepreneurs consider using finders?  The situations where I have seen finders work is in the very late stages of a company just prior to a liquidity event.  For example, I’ve seen a number of companies retain an investment banks and/or placement agents  to secure large amounts of working capital just prior to their initial public offering.

Until next time, happy venturing.